Tag Archives: real estate

Nationalization: Cutting Losses and Creating Solutions

A debate rages on different plains about rescue of the banking industry and real estate market.  That is a clean way of putting it.  Not the debate–the debate is pretty clean.  But the notion that it is just the banks and homeowners who are at risk is pretty sanitary. 

Without banks there is no substantial financing of business activity.  We could reinvent financing, especially since the Internet was not around when the current banking system was begun, but it would take years to reach anything like national capacity.  In the meantime, now, falling business activity continues a downward spiral of unemployment, business failures, investment losses, and postponed planning and recovery.

With no finance and no confidence, there can be no real estate market.  There is only deterioration in values and losses in investment.  Forward business activity and healthy market forces require confidence in the future. 

Hence, the nationalization debate.

If the government takes over weak segments of the banking system, it can, at a cost, make them stable institutions of the recovery economy.  They can loan money without fear of failing for lack of sufficient loan reserves.  Similarly, the government could buy up and hold real property at discounted prices throughout the United States.  This would eliminate the concern that numerous properties sit in default with no payments made on the mortgages and with no interested buyers.  The government is used to owning land in America–it owns much of what is not developed or used.  Add to that a fraction of the housing stock, to be resold later, and you have a more stable marketplace for the remaining property.  (You would have to create a formula such as automatic purchase of all homes in foreclosure at a set percentage discount for a six month period).

Why not nationalize one or both fractions of the marketplace?  Certainly this is not an efficient method of setting prices and running financial and real estate markets.  It would be a really bad idea if you had a functioning marketplace because like the communist economies, it would lead to poor allocation of resources, lack of private incentive and declining productivity.  But, should we be holding out for efficiency, when the very functioning of the system is so broken down?

It must be particularly hard for the Obama administration to look towards nationalization as an option.  The first African American president is hardly a financial liberal or political radical.  He taught at the University of Chicago, a free-market powerhouse.  He was not, so far as I know, part of the “Chicago School” of conservative economics, but neither was he ever noted as a liberal economic standout.  His centrist, free market, choices for Treasury department and economic advisors confirm this.  

What’s the solution?  How about giving a group of responsible Republicans the challenge of crafting and selling the temporary-nationalization plan?  Cherry-pick them in advance so they are willing, at least, to do what is needed.  Despite all our anti-politician rhetoric, there are many among them who are in an of themselves, profiles in courage. 

Rather than indulging in battle over whose party it is, and what it stands for, why not take on the problems of the day and solve some?  

We are clearly at a point of great uncertainty.  The recovery may come as the bottom of the market is reached according to market forces or it may not.  The stimulus spending and tax cuts may aid the recovery or they may not.  But the hole in the plan needs to be repaired, one way or another.

There is a significant, whether that’s one percent or more, risk of more devastation to business activity and investment value.  At some point, rather than aiming for a refined solution, you need to aim to protect yourself from the risk of catastrophe.  Protection from disaster is different than planning for optimal results.  We should, at least someone should, be advancing ideas on that level.

When the countries of the former Soviet Union endured its collapse and economic crisis in the 1990s, industrial production, standards of living, and life expectancy declined deeply.  Painful as it was, within a few years, conditions improved.  We might learn from these experiences as well as from other nations that have had to nationalize collapsing industries, and our own savings and loan crisis in the 1980s.  In each of these cases privatization was eventually successful, so we should not worry about a slippery slope towards socialism or the communist domino effect.  The real risk in those directions comes only if the United States is unable to pull itself up by its bootstraps and demonstrate a viable system.

Ponzi Scheme or Free Market?

Originally published on March 3, 2009, at politicsunlocked.com

A pyramid scheme or “Ponzi scheme” (named after legendary swindler Charles Ponzi) is the name given to a bit of financial trickery in which early investors are rewarded with big returns from money put in by later investors. The promise of big returns lures more and more people to keep adding to the pot, until the public is spooked, the market for funds tapped, or the game shut down by authorities. At that point, the later contributors, who greatly outnumber the early participants thanks to publicity and word of mouth (hence “pyramid”), are left empty-handed, as the funds have already been paid out to the first investors who generated buzz and paid off the scheme’s instigators.

Stock market

Compare this with the stock market, where investors bid against other investors for shares in companies. The more people are willing to pay for shares of a company, the higher the price, according to supply and demand. The company uses the investment funds as capital to finance their operations, and successful businesses reward stockholders with dividends, higher share prices, or simply confidence that the business will grow and the stock will increase in value. In a successful business, even if shareholders abandon the stock, one could retain shares — albeit with little value — until a later time where the stock might again come into favor.

Real estate

Real estate is similar in that people purchase land at a price based on supply and demand. The price goes up if many people want to buy and are willing to pay more in order to have what’s being sold. Price goes down when there is less demand, but if you own the land, you really own it and it has some value as a home or as land to be developed.

Added leverage

Unfortunately, it’s not that simple. In recent years, stock prices have gone up so fast, and real estate values have increased so much, that many people wanted to invest even after they had no more money to invest. But interest rates were lower than the profit they believed they could make, so they borrowed money and invested it in stock and real estate. This is called leveraging, and it’s perfectly legal: borrow money, buy stock or real estate, sell stock or real estate, pay back interest, keep the profit.

An individual who had ten thousand dollars to invest might borrow another ten or twenty or hundred thousand and invest the total. If they doubled their money in a year, they would have sixty thousand dollars, minus the thousand they had to pay in interest to borrow the funds for one year. Institutions did this with millions of dollars; one million to invest might be added to ten million or thirty million borrowed.

Then something happened. Was it the price of oil sucking the profits out of companies large and small? Was the limit of leverage as everyone willing to borrow heavily to invest had already done so and there were no more people lining up to play the game? Was it fear of the growing deficit (2006), the flailing war effort in Iraq (2007), or the pending presidential election exacerbating tension and uncertainty (2008)? Risks went up and the expectation of reward fell. The real estate market slowed; the stock market topped.

People began to sell, to take their profits.

Prices started to fall, and economic clouds darkened. People who borrowed money to invest were still paying interest. They had to make the calculation. Was the fast run-up in prices going to continue? Would a gradual gain in prices outpace the cost of the funds that they borrowed? Was it worth the risk? The answer was likely “no.”


As prices fell, the stock and real estate prices fell below the purchase price for many investors. Now they were taking a loss on their borrowed funds. Paying back the bank became more difficult. Banks started to find that the risk of default was going up.

Ponzi scheme or free market? The bank’s fault or the investors? Where is all this going?

These days, financial experts are looking for the bottom. At what point is the speculation gone, the deleveraging complete, and the more authentic supply and demand for productive use of land and capital remaining?