Part one of this essay began with hot money (global surplus cash) and how it's impacting our property market. We now want to turn to the banking sector and locate its place in the big picture of our housing crisis.
We all remember the story of mortgage lending from It’s a Wonderful Life, right? How Potter’s bank and The Bailey Brothers Building and Loan held everyone’s savings accounts and loaned out this same money to other folks in the community to buy homes? Loans at the time of the film were pretty hard to get—there were tight limits on what the banks could lend out, down payments were high (at least 30 percent of the property value), loan periods were short, interest on the loan was high (often 8 percent), and the hurdles to prove you could pay it off were tough. In this era, the banks operated outside the “real” economy, serving it by providing the loans that would be used productively in enterprises that would create wealth. (This illustration of money is now bullshit, but more on that later.)
During the post-war period, the federal government built the world’s biggest (white) middle class via a cohesive set of macroeconomic policies. Via progressive taxes, public investments in infrastructure and schools and R&D, trade policy aimed at job growth, the creation of new financial tools that made home ownership more attractive than renting, and close regulation of bank activities (a consequence of the crash the caused the Great Depression), our country built an intentional economy that generally worked in the interest of regular working families. The government guided banks to serve the real economy by managing the total volume of loaned money, balancing where banks allocated credit, and guaranteeing the bank’s loans. As a society, we believed the government should act on our behalf to shape and guide an economy that would keep money in healthy circulation and grow a middle class. And that is what they did.
During this time, an expanding housing market was part of overall economic growth. This is the story of how much of our housing in Seattle neighborhoods and inner ring suburbs were built. This process boosted job creation in construction trades, it offered housing security for millions of people, and it helped build private wealth.
In these decades, the '50s thru the '80s, demand for housing was only local. Wages and housing prices tracked together. Supply matched demand because demand was easy to predict, driven by simple factors like how many people were moving to the area and how much folks could afford to spend on housing. The public sector guided this process, working hand-in-hand with a closely regulated banking sector and home-builders in the private sector. Regular working people could afford to buy a decent house because the whole system existed to serve their needs. Housing values appreciated just slightly more than inflation; it was a pretty steady, boring equation.
And note that the government denied access to black and brown people to this whole home-ownership and asset-building process. This effective process could have included black Americans, and worked just the same. But federal and local Jim Crow policies like red-lining locked in a self-perpetuating racial wealth gap as those who could buy houses and land (mostly white) built up real estate assets, and those who couldn’t (mostly black) got left with what whites didn’t want—or got pushed into public housing, a project the government never much cared for and hardly supported after the Second World War.
In 2011, Demos compared household wealth, and found that typical black household has just 6% of the wealth of a typical white household. Latino households have only 7%. This disparity is largely due to the lasting impact of this exclusion, which means it is not accidental but reflect the racial history of our country. We still live with the lasting economic consequences of racialized wealth inequity.
During this post-war time, retirement savings worked pretty well, too. To young people this Golden Age of Capitalism can sound like a fairy tale, but in the old economy a person working a regular job could face retirement with confidence. Most people were paid enough wages or salary—and earned raises and promotions reliably enough—that they could afford to buy a house while also socking away some savings for retirement. Households didn’t have much debt, except for the mortgage. Everyone had Social Security and Medicare to count on in their old age. And if you also had a good pension from your job, you would do fine. (See the metrics here.)
This postwar growth period, with its policies that were beneficial—for the first time ever—to a very wide section of the population, lasted a few decades. This economic program worked until the cost of the war in Vietnam, growing competition from Japan and Germany, and an oil embargo instigated by a crisis in the Middle East caught economic leaders off-guard in the 1970s. Their lack of agility and lack of political skill to respond quickly with viable solutions presented an opportunity for economists who had been in the shadows for three decades, and they were ready.
The new guys ushered in a wholesale dismantling of the prevalent New Deal policies and institutions throughout the 80s and 90s, guiding Reagan and then Clinton to lead a political transition to our current economic system. They loosened oversight on how and where banks loaned money; they repealed controls put in place after the 1929 crash, like Glass-Steagall; they let banks merge and create the megabanks we have now; they allowed banks to invent new financial derivative “products”; they lowered taxes for the wealthy; they curtailed fiscal investment in favor of monetary policy; the sent jobs off-shore; they stopped managing how much banks could loan out, etc.
Their ideology, which came to be known as neoliberalism, changed the whole approach to managing the economy in the public interest by deciding NOT to manage it all. They convinced the western world we’d be better off if we let the free market manage itself, and get government out of the way. Neoliberalism has become so pervasive an ideology that today many people think they are discussing economics but instead are presenting only the neoliberal view. They can’t tell the difference between the economy as such and neoliberalism.
Most of us hold the naïve view of money learned from It’s a Wonderful Life—that banks must receive sufficient deposits before they can make a loan, that their role is to facilitate the transaction between buyer and seller, that there are strict limits on how much they can lend, that banks work OUTSIDE the real economy in service to it.
This picture of how money works is completely inaccurate. But it’s the picture we hold in our head. And this misconception is the main reason we seriously misunderstand how the housing market works now.
A more accurate picture is that private commercial banks create money out of thin air by creating a loan. Snap. It’s that simple. When they make a loan to you and you put it in your bank account, that is new money that did not exist before. They did not have to go get that $500,000 from somewhere before loaning it to you. They didn’t have to ask the federal government permission. With this ability, private banks basically control how much money is in the economy, and who gets access to capital and who does not.
Banks have a big incentive to keep loaning because the fees and interest payments on mortgage debt generate impressive profits. In the old days, federal policy limited their leverage and held banks accountable to not lend out too much in a hot market. Banks complied because they knew they would be left holding the bag when the bubble inevitably burst and housing prices plummeted. But not anymore! In 2008, after running up a huge housing bubble, the government let banks off the hook. Lesson learned by the banks: the government will bail out banks, no matter how irresponsible their debt overhang, instead of letting them fail. Economics writer Martin Wolf calls this practice “rational carelessness”—choosing to do what you know is irresponsible anyway because there are no consequences.
“When the private banking system is not managed, bankers can create more money than can usefully be employed. This can lead to too much credit or money chasing too few goods or services,” writes the UK-based economist Ann Pettifor in her short book Just Money.
Not really grasping the power banks wield to release money as loans, and their incentive to keep doing so, and how much this expanded credit has inflated asset prices, keeps us scratching our heads at the curious results of our current economy. We wonder why the already rich have access to SO much money to buy houses when the rest of us don’t. We wonder why banks keep giving out bigger and bigger loans to buy the same house that now costs 4 times as much as it did 20 years ago; aren’t they concerned this is likely a housing bubble? We wonder how this enormous flow of outside money is flooding Seattle to buy real estate, and where it came from.
Under the prevailing neoliberal economic policy, the accepted idea of how government best participates in the real economy is to allow banks the freedom to keep releasing new money into the economy by lending it out as new loans. The US government obsessively believes in supporting home ownership, and obsessively believes that more money loaned into the economy is good, so it is fueling this whole process.
If you want to give them the benefit of the doubt, you could say the Federal Reserve is hoping more private bank loans will increase overall circulation—more growing businesses, more good paying jobs, more money in workers’ pockets, more money spent buying things at the store, more money invested in R&D and innovation—around and around, making the economy vigorous and stable and diverse and inclusive. But in reality, most of the loaned money is going directly to purchase assets. Only 15% of all the credit banks extend now is being used to finance productive activities like business expansion and job growth; the rest goes toward purchasing assets. Like real estate.
As long as the Fed is pumping money into the banking sector, as long as the government isn’t requiring banks to invest that money in other more productive activities, and is not limiting how much banks can lend and where, as long as real estate is offering such high and effortless returns, and as long as there isn’t any real risk to banks...the result is nearly endless money chasing a limited supply of real estate, causing escalating house prices. See this excellent, succinct explanation of this process in the UK. And this research examining the larger economic effects of real estate lending booms and the ever-increasing size and leverage of the financial industry (PDF).
Because our wages have stayed flat, and costs for housing and college and medical care rise higher and higher, we’ve had to borrow a lot. The amount we Americans collectively now owe—in mortgages and student loans and car loans and medical debt—is, as everyone well knows, and has been told by Bernie Sanders again and again, higher than it has ever been.
Our government is using the mighty power of the Federal Reserve to inflate a private debt bubble, inflate the prices of assets like houses, and enrich the financial sector. We regular folks go deeper into debt trying to keep up, and housing prices escalate out of reach, while the financial sector gets fattened from interest and fees from the nothing money and hot money circulating within the finance industry.
This situation, maddening as it is, was created intentionally. Wall Street has a lot of power over economic policy, holding key authority in the in the Federal Reserve and spending an estimated $1.5 million PER DAY lobbying Congress. There is a virtual revolving door between Wall Street and the administration. Even if you’ve never spoken the word macroeconomics in your life, you can see something is wrong with this picture. And we can no longer afford to think that our housing market is somehow outside of this macro-economic picture. It is in it; it is heated by it.
Tomorrow see part 3: Seattle is desperately bailing against a rising tide.