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I get to see many economic charts, but they very rarely manage to illuminate a current situation as this one does.  In a morass of often conflicting economic data, graphs can lead to confusion rather than clarity and insight but this chart, which has taken a huge amount of research to produce, is a very welcome exception.  Charts covering a really long time span are seldom available, and one like this that extends for 140 years is rare indeed.  The data used for the graph has taken the combined resources and time of a team of international economists and academics who have cooperated to pull it all together from disparate sources in 17 developed countries. The chart clearly shows that since the 1980s banks should no longer be called banks because banking is no longer their primary function.  More accurately these organisations should be known as: “mortgage lenders” or “property investors” or “real estate finance” companies.  For several decades now banking’s main interest has been in lending money to individuals to buy property, as opposed to investing in companies which will grow and create employment.  After the collapse of Lehman Brothers and the following economic disasters, our governments in the U.S., U.K. and Europe didn’t bail out the banks, using trillions of debt, to prevent industry grinding to halt.  No, we actually bailed out the avaricious property investors who were responsible for pumping up the housing bubble in the first place and who would have been bankrupt without our help.   So how did this nonsensical situation come about?  More importantly, why didn’t our governments understand what was really happening?  And why are we still being sold on the idea that investment in industry is banking’s primary role, when it patently isn’t?  Banking insiders tell us that modern banking is a highly complex, highly-pressured business when the truth is that they take deposits from retail customers (borrowing short) to lend to people in the form of mortgages to buy primarily domestic houses (lending long).  This is a very simple business with very little risk as the mortgage loans are secured against a tangible asset (the property).  But, as long as the banks continue this activity, property prices will continue to rise and the bubble will continue to grow.   Eventually it will burst as it must when, like any Ponzi scheme reliant on new entrants, our young people are so burdened with debt they cannot afford to buy property, however much they would like to.  I suggest we may be close to that point now.  Those of you who read this article I wrote in May this year will know that so called “quantitative easing” is a mechanism that uses newly created public money for debt relief for banks, or perhaps I should refer to them more precisely as real estate finance companies.  Funny, but It doesn’t sound such a desirable and wholesome process when you swap the banking word for real estate or property finance does it?  Governments are devaluing our currencies at a touch of a keyboard to protect greedy property speculators, and not to help our industries, increase employment prospects or to protect the weak and the poor. The data used to produce this chart compares bank mortgage and non-mortgage lending and their relationship to Gross Domestic Product (GDP).  GDP is a very crude measure of the total of goods a country produces defined in, as close as it gets, a world currency - the imperial U.S. dollar.  As Philipp Lepenies points out, GDP measurement has many weaknesses, and economist Simon Kuznets argued against making GDP the main economic measurement because it is focussed on production rather than the more human- centred measurement of National Income.  Kuznets originally devised the National Income measurement for President Roosevelt in 1931 and it was used up until the Second World War, when GDP came into favour as all the politicians were concerned about was measuring their own country’s total production.  Post war, politicians continued to find GDP an easier measurement to use because it was fairly basic and took no account of income distribution.  This failure to measure income and its distribution has played a significant factor in creating the very unequal society of the 1% versus the 99% that Thomas Piketty writes about in his book: Capital in the Twenty-First Century.  As the management axiom says: you cannot control what you do not measure, even if you wanted to.  Any discussion about the fairness of the differences in income quickly becomes a polarised political debate.  Thus it was far easier to simply measure a country’s productive capacity in dollar terms, so consequently GDP became the universal standard of economic measurement.  But GDP is actually a relatively poor measure:  For example it doesn’t include any form of unpaid work such as child care, or caring for an elderly relative.  Nor does it consider any form of voluntary work like staffing the millions of charity shops that litter our high streets, particularly here in the U.K.  But, notwithstanding its many limitations, GDP still remains a useful measure because, since the 1940s, we have a reasonably consistent dataset for comparison between countries.  This chart therefore compares bank non-mortgage lending and bank mortgage lending against an approximate measure (GDP) of the production capacity of 17 economies.   Following the two graph lines from 1870 we can see that bank non-mortgage lending was always in excess of bank mortgage lending up until around 1995.  So banks behaved like banks, essentially fulfilling their traditional role of supporting business and industrial development.  This was very much the case during and after the First World War.  But observe that during the Second World War, when obviously there was substantially less bank lending as populations fought each other, non-mortgage bank lending and bank mortgage lending converged.  Following the war both types of bank lending grew, with non-mortgage lending resuming its traditional role right up to the mid- 1990s.  But from that point on it’s clear that bank mortgage lending accelerated and then became the primary activity, significantly outstripping non-mortgage lending.  From 1995 banks no longer behaved as they had for the previous 125 years.  Their primary business became real estate or property financing.  Naturally, all the new property-loan money created by them has fuelled an explosion in property prices.  The net result of this is that people, especially younger people, are becoming poorer as they have to pay an ever larger proportion of their disposable income to have somewhere to live. Meanwhile, in the U.S. within people’s living memory the limit on the amount that banks would extend against a property was 25% of a family’s income.  But the U.S. Government’s latest housing loan guarantee has just raised that ratio to 43% of a family’s income.  If you add a student’s educational loan repayments, car loan costs for commuting to work, plus credit card debt, most people are left with barely 20% of their income available for purchasing goods or services.  So it’s hardly surprising we have ended up with a stagnant economy caused by what economists define as debt deflation.  So much of most people’s income goes on paying a mortgage and other debts that there is little left for any discretionary spending, and this is resulting in a shrinking economy. Against so much evidence to the contrary, many economists, still hidebound by their early education, stubbornly continue to believe that property prices are “relatively inelastic”.  They’re convinced that property prices only have a narrow band of price movement in relation to income.  Yet for decades there’s been no growth in wages in real terms for most workers in the U.S., and the incomes of the bottom 90% of the population have stagnated for a third of a century. If you find this hard to believe, the realistic economist, Joseph Steiglitz, says that median incomes for full-time male workers are actually lower in real (inflation-adjusted) terms than they were 42 years ago.   And, at the bottom end, real wages are comparable to their level 60 years ago.  Yet look at the chart: the data shows that however much lower incomes are, property prices continue to rise fuelled by bank lending.  So the assumption by economists that house prices are “relatively inelastic” is patently false.  Forget economic theory, the reality is that a house is worth what a bank will lend you to buy it.  I realised this 40 years ago when I visited Frankfurt, Germany.  At that time most of the population lived in flats with strict rent controls, and to own freehold property could take a family two or three generations to complete the purchase.  In other words property prices are very elastic in that they can easily exceed one, two or more lifetimes.  In fact there appears to be no upper limit.  This is a situation which many people are now beginning to face, where prices are so high they may not be able to complete the necessary mortgage before they die. Common sense demands that we must return to the traditional model of banking.  If we continue on the present course, where banks are primarily about property finance, then we all become impoverished - except for the bankers.  We will end up as debt-slaves to them as they compound the interest we pay on the ever increasing amounts we owe.  What is just as bad is that this transformation from the role of banking into property finance starves businesses of investment and growth.  Nowadays a bank will always prefer the security of a tangible asset like a house over any other type of loan.  But prior to 1995 banks understood that their raison d’etre was primarily to help business, not to finance property.  So what changed?  I would argue that 1995 was when the property bubble, doomed to eventually burst in 2008, really developed.  One might think, hope, that banks would have learnt to minimise their exposure to property after such a lesson.  But no.  The free money they are being fed by “quantitative easing” is mostly being used to finance property.  Some people, like Adair Turner, feel that in rich, developed societies it is perfectly natural that property prices will continue to rise as more people want to live in better neighbourhoods and chase after nicer houses of which there is a limited supply.  Whilst this may be an underlying trend there is no doubt, as the chart above shows, that the new and apparently boundless increase in bank lending for property purchase is the driving force that’s creating another property bubble.  And every Central Bank seems intent on blowing the new property bubble ever bigger as it provides free money in the form of quantitative easing for banks. In the 17 countries used in the dataset above, more than two thirds of the loans extended by banks are for property loans.  In a country like the U.K. the figure is even higher at 79% (2012 data) as I noted in May this year.  Yet, at the beginning of the 20th century, property lending was less than a third of all the loans extended by banks which meant nearly two thirds of bank loans went to help grow businesses.  But we now live in The Great Recession (or, as I called it in an article in early 2014, The Great Long Depression), so banks consider any loan other than a property loan as risky.  Part of this situation was created by the bankers themselves in 1988 when in the Basel Accord  (Basel 1) they decided that loans secured by mortgages on residential properties should carry only half the risk weighting of loans to business.  Changes to Banking Regulation also allowed banks to extend two loans for property to every one loan for business, at the same risk level.  As they could make more and safer profits from property loans this naturally led to banks preferring these to any other sort of loan.  In the chart above, the data reveals this trend starting to show up around 1995 and then rising inexorably until 2010 when the chart ends.  But the property loans haven’t, nor are they likely to.  We desperately need new banking regulation to revise that flawed Basel 1 agreement and to double the risk weighting on property loans, thereby reducing the incentive for banks to finance property.  But as politicians seem to be in thrall to the powerful banking lobby, don’t expect this dangerous property bubble to be controlled by government intervention any time soon. September 2016
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Blowing bubbles…

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Blowing bubbles…

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I get to see many economic charts, but they very rarely manage to illuminate a current situation as this one does.  In a morass of often conflicting economic data, graphs can lead to confusion rather than clarity and insight but this chart, which has taken a huge amount of research to produce, is a very welcome exception.  Charts covering a really long time span are seldom available, and one like this that extends for 140 years is rare indeed.  The data used for the graph has taken the combined resources and time of a team of international economists and academics who have cooperated to pull it all together from disparate sources in 17 developed countries. The chart clearly shows that since the 1980s banks should no longer be called banks because banking is no longer their primary function.  More accurately these organisations should be known as: “mortgage lenders” or “property investors” or “real estate finance” companies.  For several decades now banking’s main interest has been in lending money to individuals to buy property, as opposed to investing in companies which will grow and create employment.  After the collapse of Lehman Brothers and the following economic disasters, our governments in the U.S., U.K. and Europe didn’t bail out the banks, using trillions of debt, to prevent industry grinding to halt.  No, we actually bailed out the avaricious property investors who were responsible for pumping up the housing bubble in the first place and who would have been bankrupt without our help.   So how did this nonsensical situation come about?  More importantly, why didn’t our governments understand what was really happening?  And why are we still being sold on the idea that investment in industry is banking’s primary role, when it patently isn’t?  Banking insiders tell us that modern banking is a highly complex, highly-pressured business when the truth is that they take deposits from retail customers (borrowing short) to lend to people in the form of mortgages to buy primarily domestic houses (lending long).  This is a very simple business with very little risk as the mortgage loans are secured against a tangible asset (the property).  But, as long as the banks continue this activity, property prices will continue to rise and the bubble will continue to grow.   Eventually it will burst as it must when, like any Ponzi scheme reliant on new entrants, our young people are so burdened with debt they cannot afford to buy property, however much they would like to.  I suggest we may be close to that point now.  Those of you who read this article I wrote in May this year will know that so called “quantitative easing” is a mechanism that uses newly created public money for debt relief for banks, or perhaps I should refer to them more precisely as real estate finance companies.  Funny, but It doesn’t sound such a desirable and wholesome process when you swap the banking word for real estate or property finance does it?  Governments are devaluing our currencies at a touch of a keyboard to protect greedy property speculators, and not to help our industries, increase employment prospects or to protect the weak and the poor. The data used to produce this chart compares bank mortgage and non-mortgage lending and their relationship to Gross Domestic Product (GDP).  GDP is a very crude measure of the total of goods a country produces defined in, as close as it gets, a world currency - the imperial U.S. dollar.  As Philipp Lepenies points out, GDP measurement has many weaknesses, and economist Simon Kuznets  argued against making GDP the main economic measurement because it is focussed on production rather than the more human- centred measurement of National Income.  Kuznets originally devised the National Income measurement for President Roosevelt in 1931 and it was used up until the Second World War, when GDP came into favour as all the politicians were concerned about was measuring their own country’s total production.  Post war, politicians continued to find GDP an easier measurement to use because it was fairly basic and took no account of income distribution.  This failure to measure income and its distribution has played a significant factor in creating the very unequal society of the 1% versus the 99% that Thomas Piketty writes about in his book: Capital in the Twenty-First Century As the management axiom says: you cannot control what you do not measure, even if you wanted to.  Any discussion about the fairness of the differences in income quickly becomes a polarised political debate.  Thus it was far easier to simply measure a country’s productive capacity in dollar terms, so consequently GDP became the universal standard of economic measurement.  But GDP is actually a relatively poor measure:  For example it doesn’t include any form of unpaid work such as child care, or caring for an elderly relative.  Nor does it consider any form of voluntary work like staffing the millions of charity shops that litter our high streets, particularly here in the U.K.  But, notwithstanding its many limitations, GDP still remains a useful measure because, since the 1940s, we have a reasonably consistent dataset for comparison between countries.  This chart therefore compares bank non-mortgage lending and bank mortgage lending against an approximate measure (GDP) of the production capacity of 17 economies.   Following the two graph lines from 1870 we can see that bank non- mortgage lending was always in excess of bank mortgage lending up until around 1995.  So banks behaved like banks, essentially fulfilling their traditional role of supporting business and industrial development.  This was very much the case during and after the First World War.  But observe that during the Second World War, when obviously there was substantially less bank lending as populations fought each other, non-mortgage bank lending and bank mortgage lending converged.  Following the war both types of bank lending grew, with non-mortgage lending resuming its traditional role right up to the mid-1990s.  But from that point on it’s clear that bank mortgage lending accelerated and then became the primary activity, significantly outstripping non-mortgage lending.  From 1995 banks no longer behaved as they had for the previous 125 years.  Their primary business became real estate or property financing.  Naturally, all the new property-loan money created by them has fuelled an explosion in property prices.  The net result of this is that people, especially younger people, are becoming poorer as they have to pay an ever larger proportion of their disposable income to have somewhere to live. Meanwhile, in the U.S. within people’s living memory the limit on the amount that banks would extend against a property was 25% of a family’s income.  But the U.S. Government’s latest housing loan guarantee has just raised that ratio to 43% of a family’s income.  If you add a student’s educational loan repayments, car loan costs for commuting to work, plus credit card debt, most people are left with barely 20% of their income available for purchasing goods or services.  So it’s hardly surprising we have ended up with a stagnant economy caused by what economists define as debt deflation.  So much of most people’s income goes on paying a mortgage and other debts that there is little left for any discretionary spending, and this is resulting in a shrinking economy. Against so much evidence to the contrary, many economists, still hidebound by their early education, stubbornly continue to believe that property prices are “relatively inelastic”.  They’re convinced that property prices only have a narrow band of price movement in relation to income.  Yet for decades there’s been no growth in wages in real terms for most workers in the U.S., and the incomes of the bottom 90% of the population have stagnated for a third of a century. If you find this hard to believe, the realistic economist, Joseph Steiglitz, says that median incomes for full-time male workers are actually lower in real (inflation-adjusted) terms than they were 42 years ago.   And, at the bottom end, real wages are comparable to their level 60 years ago.  Yet look at the chart: the data shows that however much lower incomes are, property prices continue to rise fuelled by bank lending.  So the assumption by economists that house prices are “relatively inelastic” is patently false.  Forget economic theory, the reality is that a house is worth what a bank will lend you to buy it.  I realised this 40 years ago when I visited Frankfurt, Germany.  At that time most of the population lived in flats with strict rent controls, and to own freehold property could take a family two or three generations to complete the purchase.  In other words property prices are very elastic in that they can easily exceed one, two or more lifetimes.  In fact there appears to be no upper limit.  This is a situation which many people are now beginning to face, where prices are so high they may not be able to complete the necessary mortgage before they die. Common sense demands that we must return to the traditional model of banking.  If we continue on the present course, where banks are primarily about property finance, then we all become impoverished - except for the bankers.  We will end up as debt-slaves to them as they compound the interest we pay on the ever increasing amounts we owe.  What is just as bad is that this transformation from the role of banking into property finance starves businesses of investment and growth.  Nowadays a bank will always prefer the security of a tangible asset like a house over any other type of loan.  But prior to 1995 banks understood that their raison d’etre was primarily to help business, not to finance property.  So what changed?  I would argue that 1995 was when the property bubble, doomed to eventually burst in 2008, really developed.  One might think, hope, that banks would have learnt to minimise their exposure to property after such a lesson.  But no.  The free money they are being fed by “quantitative easing” is mostly being used to finance property.  Some people, like Adair Turner, feel that in rich, developed societies it is perfectly natural that property prices will continue to rise as more people want to live in better neighbourhoods and chase after nicer houses of which there is a limited supply.  Whilst this may be an underlying trend there is no doubt, as the chart above shows, that the new and apparently boundless increase in bank lending for property purchase is the driving force that’s creating another property bubble.  And every Central Bank seems intent on blowing the new property bubble ever bigger as it provides free money in the form of quantitative easing for banks. In the 17 countries used in the dataset above, more than two thirds of the loans extended by banks are for property loans.  In a country like the U.K. the figure is even higher at 79% (2012 data) as I noted in May this year.  Yet, at the beginning of the 20th century, property lending was less than a third of all the loans extended by banks which meant nearly two thirds of bank loans went to help grow businesses.  But we now live in The Great Recession (or, as I called it in an article in early 2014, The Great Long Depression), so banks consider any loan other than a property loan as risky.  Part of this situation was created by the bankers themselves in 1988 when in the Basel Accord  (Basel 1) they decided that loans secured by mortgages on residential properties should carry only half the risk weighting of loans to business.  Changes to Banking Regulation also allowed banks to extend two loans for property to every one loan for business, at the same risk level.  As they could make more and safer profits from property loans this naturally led to banks preferring these to any other sort of loan.  In the chart above, the data reveals this trend starting to show up around 1995 and then rising inexorably until 2010 when the chart ends.  But the property loans haven’t, nor are they likely to.  We desperately need new banking regulation to revise that flawed Basel 1 agreement and to double the risk weighting on property loans, thereby reducing the incentive for banks to finance property.  But as politicians seem to be in thrall to the powerful banking lobby, don’t expect this dangerous property bubble to be controlled by government intervention any time soon. September 2016