The Big Short: is the next financial crisis on its way?

Patrick Collinson in The Guardian

In the Oscar-winning The Big Short, Steve Carell plays the angry Wall Street outsider who predicts (and hugely profits from) the great financial crash of 2007-08. He sees sub-prime mortgages rated triple-A but which, in reality, are junk – and bets billions against the banks holding them. In real life he is Steve Eisman, he is still on Wall Street, and he is still shorting stocks he thinks are going to plummet. And while he’s tight-lipped about which ones (unless you have $1m to spare for him to manage) it is evident he has one major target in mind: continental Europe’s banks – and Italy’s are probably the worst.

Why Italy? Because, he says, the banks there are stuffed with “non-performing loans” (NPLs). That’s jargon for loans handed out to companies and households where the borrower has fallen behind with repayments, or is barely paying at all. But the Italian banks have not written off these loans as duds, he says. Instead, billions upon billions are still on the books, written down as worth about 45% to 50% of their original value.

The big problem, says Eisman, is that they are not worth anywhere near that much. In The Big Short, Eisman’s staff head to Florida to speak to the owners of newly built homes bundled up in “mortgage-backed securities” rated as AAA by the investment banks. What they find are strippers with loans against multiple homes but almost no income, the mortgages arranged by sharp-suited brokers who know they won’t be repaid, and don’t care. Visiting the housing estates that these triple-A mortgages are secured against, they find foreclosures and dereliction.


What is very negative is that in every country in Europe, the largest owner of sovereign bonds are that country’s banks


In a mix of moral outrage at the banks – and investing acumen – Eisman and his colleagues bought as many “swaps” as possible to profit from the inevitable collapse of the mortgage-backed securities, making a $1bn profit along the way.

This time around, Eisman is not padding around the plains of Lombardy because he says the evidence is in plain sight. When financiers look to buy the NPLs off the Italian banks, they value the loans at what they are really worth – in other words, how many of the holders are really able to repay, and how much money will be recovered. What they find is that the NPLs should be valued at just 20% of their original price. Trouble is, if the Italian banks recognise their loans at their true value, it wipes out their capital, and they go bust overnight.

“Europe is screwed. You guys are still screwed,” says Eisman. “In the Italian system, the banks say they are worth 45-50 cents in the dollar. But the bid price is 20 cents. If they were to mark them down, they would be insolvent.”

Eisman is careful not to name any specific Italian bank. But fears about the solvency of the system – weighed down by an estimated €360bn in bad debts – are not new. In official “stress tests” of 51 major European banks in July by the European Banking Authority, Italy’s third largest bank, Banca Monte dei Paschi di Siena, emerged as the weakest. It triggered a rescue package – and soothing words from Italy’s finance minister, who said there was no generalised crisis in the banking system. But MPPS’s share price remains at just 25 cents, down more than 90% from two years ago.

How worried should British bank account (and shareholders) be? “I’m not really worried about England’s banks,” says Eisman. “They are in better shape than most in Europe.” When it comes to the US, Eisman’s outrage, so central to the plot of The Big Short, has melted away (just don’t start him on Household Finance Corporation, the HSBC-owned lender at the heart of sub-prime crisis). “I think the regulators did a horrendous, just horrendous job pre-crisis. But under the Fed, the banks have been enormously deleveraged and de-risked. There are no sub-prime mortgages any more... the European regulators have been much more lenient than the US regulators.”

Eisman was of the view that US banks were rather boring as an investment – although Donald Trump’s victory has changed that. “I have a feeling there could be a softening in the Department of Labor rules (an Obama-led crackdown on how banks sell financial products) and the regulatory environment has now changed in favour of the banks.”

 Steve Eisman: ‘I’m not really worried about England’s banks. They are in better shape than most in Europe.’ Photograph: Bloomberg via Getty Images

Trump’s victory has sent the bond markets into disarray, with the yield on government bonds rising steeply. While this sounds good for savers – interest rates could rise – it is bad news for the holders of government bonds, which fall in value when the yield rises. Eisman sees that as another woe for Europe’s banks, who hold vast amounts of “sovereign bonds”.

“What is very negative is that in every country in Europe, the largest owner of that country’s sovereign bonds are that country’s banks,” he says. As the bonds decline in value, then the capital base of the banks deteriorates.

He doesn’t share the optimism around Deutsche Bank since Trump’s victory. The troubled German bank, facing a $14bn fine in the US for mortgage bond mis-selling, was for a long time one of the biggest lenders to the Trump business empire. In the three days after Trump’s victory, shares in Deutsche Bank, regarded as Europe’s most systemically important bank, jumped by a fifth from €12.90 to €15.30 as traders bet on Trump-inspired leniency over the fine.

But Eisman doesn’t buy it. By his reckoning, Deutsche Bank was less fundamentally profitable than its rivals, and relied more on leverage to boost earnings. His analysis suggests it will struggle to return to its former profitability.

Critics will point out that shorting the likes of Banca Monte dei Paschi di Siena or Deutsche Bank sounds fine – except that the share price of both have already fallen so dramatically the bad news is already in the price. But we don’t know for sure if they are Eisman’s precise targets – because he’s not willing to say unless you give him at least $1m to manage in one of his “personal accounts”.

Eisman now effectively runs his own “boutique” operation within a bigger Wall Street firm, Neuberger Berman. His “Eisman Long/Short SMA” account has opened to wealthy investors, and in January he will be in London drumming up interest among investors.

But not everything Eisman touches turns to gold. He declines to say how much he made during the financial crash, when he was manager of funds at FrontPoint Financial Services, though it was reportedly as much as $1bn. But in 2010 FrontPoint ran into trouble after one of its manager pleaded guilty to insider trading and was given a five-year prison sentence.

Eisman later set up a hedge fund, Emrys Partners, gathering nearly $200m from investors, but its returns were relatively humdrum compared to the drama of the great crash, making 3.6% in 2012 and 10.8% in 2013, according to the Wall Street Journal.

Did he think the film accurately portrayed what went on? He visited the set, and gave Carell and the other actors (Brad Pitt and Christian Bale also starred) advice and notes.

“When I saw the film, I thought it was great and that Steve Carell was wonderful. But I thought, hey, I wasn’t that angry. After the crash I was interviewed by the Federal Crisis Inquiry Commission, and I saw a transcription later on. After reading it, I realised that ‘yes’, I really was that angry... but the Fed has done a very good job since.”

Susan Smith complains after judges ordered her four-year-old to stop wearing girls’ clothes

Ashifa Kassam in The Guardian

A Canadian mother has called for lawyers and judges to receive better training on gender identity after two judges in the province of Alberta ordered her four-year-old child to stop wearing girls’ clothing in public.

The order was first issued last year by a family court judge in Medicine Hat, a small city of 63,000. Some three months later, the clothing restriction was upheld by a second judge.

Susan Smith said her child was born male but began identifying as a girl soon after turning two years old. “First I thought it was really cute. It was like ‘oh no no honey, you’re a boy,” said Smith, whose name has been changed in order to protect the child.

But her child only became increasingly insistent. Smith, who is separated from the child’s father but shares custody, struggled with how to respond. “I was kind of questioning, is my kid doing this for attention? What is going on?”

Then one evening, after her child surprised her by asking when their penis would fall off, Smith sat the child down. “I told them sweetheart, you were born with a penis, so you’re a boy. You will always have your penis, therefore you’ll always be a boy.”

A few nights later her child woke her up, visibly upset. “It was along the lines of mom, I don’t want to be a boy,” said Smith. “And then it went to almost shouting. I’m going to cut my penis off, I want my penis off.”

Trans children allowed to express identity 'have good mental health'


Concerned for the safety of the child, she sought professional help and began researching gender dysphoria, a condition that causes a person to experience extreme distress because of a disconnect between their birth sex and gender identity.

Soon after, Smith decided she would acknowledge the child’s choice of gender identity. “I was going to do whatever I could to validate and support them and to be that one person they could go to,” Smith said.

After conferring with the staff and children at her child’s preschool and daycare, she began offering her child the option of wearing either male, female or gender neutral clothing. Her child consistently chose stereotypically female clothing and opted to go by a female name, she said.

According to Smith, her child’s confidence bloomed, while the yelling, screaming and unhappiness disappeared. “Everything was perfect,” she said.

Throughout the process, Smith had kept the father informed. But about one month after she began allowing her child to choose their clothing, Smith was served court documents. The father – who Smith said blamed her for the child’s anxiety and confusion around gender – was seeking full custody of the child.

The first interim order, issued in December 2015, said Smith could continue as the primary caregiver. But the judge said the child would not be permitted to wear clearly female clothing in public. The child could choose to do so in private, the order said.

The ruling came as a shock to Smith. “I’m the person that knows this kid more than anybody in this world,” she said. “It’s like telling your kid who has a huge thing for being Spiderman – and that was allowed to have a Spiderman backpack, a Spiderman shirt, a Spiderman pencil and a Spiderman cup – and all of a sudden you come along and you take all of that away. And you give them a Batman cup.”

In February, a second judge upheld the ruling, and also granted the father primary custody of the child, with Smith allowed limited access.

In September, a third provincial judge overturned the clothing restriction after consulting with a parenting expert. The child, said the judge, must now be provided with male and female clothing options and then can choose from these options.

Smith said the consecutive orders – all issued within a nine-month span – have taken a toll on the child, who is now five. “When my child was removed and placed with Dad, they internalised it and took it like they did something wrong. They were being bad because the judge doesn’t like them to be a girl.”

She plans to file a judicial complaint with the province, demanding that all legal representatives in Alberta – from judges to lawyers – be better trained on gender identity. “If they were properly educated and aware of the severe consequences and the turmoil this has had on my child, they could not ethically say it’s in the best interests of the child.”

Ron Hewitt, the executive director of Alberta’s provincial court system, said judges study and refer to a number of sources of information to keep current on the law and other matters that apply to their role as judges. “Our court carries on extensive professional development for the judges of the court in all areas as appropriate,” he said.

Transgender children: the parents and doctors on the frontline

While Alberta’s justice minister, Kathleen Ganley, could not comment on the specifics of the case, she pointed to an amendment made last autumn to the province’s Human Rights Act, which saw gender identity and gender expression added as prohibited grounds of discrimination. “This is now law, and we expect all Albertans to follow the law,” she said in a statement.

Smith said her complaint – and the remedy she’s demanding – will do little to help her in her ongoing court battle to regain custody of her child. But she hopes it will prevent other families from experiencing what she and her child have been through in the past year. “This has been so hard on my kid,” she said, her voice shaking as she fought back tears.

“My kid then started talking about dying. At four, they didn’t feel that the world wanted them to be a girl. That they were no good,” she said. “My kid was asking me, mom, does it hurt to die, how can I die, where would I go when I die? Mom now that you know, when I die, grow me in your belly but grow me as a girl, not with a penis. Because now you know.”

Empowerment - How Trump and Modi get their support

Irfan Husain in The Dawn

SO here we are again, scratching our heads over how everybody got the US elections so wrong, and pondering a future with a narcissistic joker like Donald Trump as the commander-in-chief of the most powerful military on the globe. My early reaction was: stop the world, I want to get off!

But on reflection, we’ve been here before. This is not the first time a rabble-rousing populist has clawed his way to the top. Remember Hitler? He, too, was elected because his message of anti-Semitism and nationalism resonated with Germans who were being squeezed by sanctions imposed by the victorious Allies after the First World War.

Closer to home, we have seen the rise of Altaf Hussain to utter dominion over a liberal, cosmopolitan city like Karachi. He may now be in decline, but for nearly three decades, he wielded more power than most politicians in Pakistan have. He could shut down the city with a word, and allegedly have opponents liquidated with a mere nod.

Many of us in Karachi wondered at this hold he had over his followers. Thousands sat on roads in the blazing sun while he regaled them with bizarre, scarcely comprehensible rants from London while clearly under the influence. For rational, sensible Pakistanis, the whole MQM phenomenon passed all understanding.

The wave of support for Imran Khan is another example of apparently irrational group-think. Why should thousands of educated people camp out in Islamabad for months over allegations of rigging that have been dismissed by the election commission as well as the courts? Why this blind faith in Imran Khan?

Why this blind faith in demagogues?

The reason for failing to comprehend this seemingly illogical behaviour is, I suspect, rooted in our inability to grasp that motives other than logic often drive people. In Trump’s case, he appealed to people not because they necessarily believe that he will bring jobs back, or rid America of Muslims and Mexicans. What resonates is the feeling of empowerment ordinary Americans think they have gained by kicking the liberal elites out of power.

Supercilious and superior, educated, well-heeled types made little attempt to tap into the rage and the angst felt by millions of insecure Americans who felt threatened in a number of ways: unemployment, a demographic shift that will soon reduce white Americans to a minority, and the increasing economic and political power of women. So while there might be nothing rational about a desire to take America back to the 1950s when wages rose and whites were unchallenged, many Trump supporters equated his campaign with a rosy, almost utopian vision of their country.

Similar sentiments were on display during the Brexit campaign in the UK. The Leave supporters insisted they wanted to ‘get control’ of their country. Whatever the economic arguments made by both sides, the driving force behind Brexit had little to do with the promise of prosperity, and more to do with returning the country to an era that had few foreigners.

The MQM phenomenon was about Mohajir identity and empowerment. While the prospect of government jobs was a powerful incentive, the movement was basically driven by a search for pride and dignity. We missed this because we were part of an entitled elite living in our own cocoon.

In our rationality and our complacency, we misread how important they really are to people who have little sense of self-worth. So when a demagogue comes around and channels these elements into a powerful movement that challenges the status quo, we are totally blindsided.

One thing these random examples have in common is that they are all part of a post-truth politics where a demagogue can tell any number of lies without being penalised by voters. The American media, including fact-checking websites, listed the semi-truths and outright lies Trump frequently deployed in his speeches and debates. But for true believers, they were irrelevant to the overall message of redemption and hope.

When truth loses relevance in political debate, it is next to impossible for rational liberals to win. If your opponent can make up whatever he likes to prove his point, either you descend to his level of dishonesty and lose credibility with your constituency, or stick to the truth and lose the argument.

This narrative composed of rumours and fabricated figures rules supreme on 24/7 TV chat shows and the internet. Panellists and bloggers can peddle the most outlandish conspiracy theories and accusations without being questioned. False stories can be planted with ease and go viral. Ill-informed and gullible voters are easily swayed by spin doctors.

So what does this mean for the future of democracy? Clearly, populism and demagoguery are on the march, and liberalism is in retreat. The politics of identity is in conflict with tolerance and inclusiveness. The important thing is to shed our sense of superiority, emerge from our bubbles, and try and understand what people like Trump and Imran Khan represent.

Taslima Nasrin at India Ideas Conclave 2016

It’s only wrong when YOU do it! The psychology of hypocrisy

Dean Burnett in The Guardian


In these times of political turmoil, aggressive online discourse, “post-truth”society and lord knows what else, one thing is hard to deny: there’s a lot of hypocrisy flying around. People regularly and angrily lambast others for doing something, while doing pretty much the exact same thing themselves.

Pundits condemning young people for being “special snowflakes” for wanting to be sheltered from controversial views in “safe spaces”, then having an apparent meltdown whenever they see anything even vaguely inconsistent with their opinions. Angry online types who condemn the BBC for “bias” while enthusiastically linking to sites that make no effort at all at neutrality. People who preach tolerance and respect but get outraged whenever anyone disputes their methods. The list goes on.

You’d think that the highest level of politics wouldn’t allow such behaviour, but no, seems more common than ever there. Wherever you find it, it’s often infuriating. Where do people get off dictating how others should behave, putting restrictions on what they can say and do that they don’t adhere to themselves? It’s wrong and immoral, and shows that they can’t be trusted.

Or does it? In the scientific sense, hypocrisy is somewhat more complicated. It can manifest in several ways, and for several reasons, and often times the people guilty of it aren’t doing it purely to be self-serving.

Sometimes timing is the difference between being called a hypocrite or a saint. Photograph: Linda Nylind for the Guardian

The nature and timing of hypocrisy

A lot of things that are labelled hypocrisy may not actually be hypocritical, and a lot of the time, things that are hypocritical are given a pass because they are consistent with the observer’s worldview.

For example, someone who urges people to give money to charity but is then found out to give nothing themselves, they’d be considered a hypocrite. But if someone is known to be something of a skinflint then starts urging people to give to charity, they may still be considered a hypocrite, but it’s also possible they’ve just had a change of heart. Changing your mind or working for redemption are regularly considered good things. Bob Cratchit didn’t stop to accuse Scrooge of being a hypocrite.

Also, people tend to react more strongly to hypocrisy when it includes criticism or negative judgement. Someone boasts about being a live music supporter but is found to never go to gigs? Hypocritical, annoying, but not really worth getting angry about. But, a right-wing politician condemns homosexuality and attacks gay rights, but is then found to be engaging in homosexual activity themselves?Appalling. People react strongly to perceived injustice, so hypocrisy like this will get them very angry and demanding retribution.

Similarly, people are far quicker to notice and call out hypocrisy when it goes against their own beliefs. A politician you oppose promotes family values but is caught having an affair? Hypocrite! Drum them out of office! But if it’s a politician you support? Gutter journalism! So he’s not perfect, give him another chance! There are more important issues to worry about etc.

Basically, people aren’t 100% rational or consistent. Value judgements are typically subjective rather than objective, so the extent and seriousness of the hypocrisy is often in the eye of the beholder. This feeds into hypocrisy in other ways too.

  We have a much higher opinion of ourselves than is usually warranted. Hopefully, other people will be willing to point this out. Photograph: PeopleImages.com/Getty Images
You think you’re better than others

Humans aren’t cold logical robots, and we typically have a higher opinion of ourselves than is warranted. Most humans have a self-serving bias, where we evaluate our own abilities and performance far more highly than is actually the case. People who achieve a certain level of intellectual achievement in certain contexts can reverse this, but we mostly think overly-well of ourselves.

It’s no surprise; the brain is riddled with cognitive and memory biases that are geared towards making us feel like we’re good and decent and capable, no matter what the reality. The problem is that our judgements of other people are far more “realistic”.

In some cases, this can lead to hypocrisy. A pilot would be well within her rights to stop an untrained person from assuming control of a plane, even though she does that all the time. This isn’t hypocrisy, this is simple acknowledgement of ability. Likewise, some people may tell others to do something and not do it themselves because they genuinely think they don’t need to do it, but the other inferior people need to be told. Not very nice, granted. May even not be a conscious decision. But it’s also not deliberate hypocrisy, if you look at it that way. Not that this makes any difference to the outcome, as far as most are concerned.

 Thinking one thing and doing another can cause a lot of internal distress, and you just want it to go away. Photograph: Alamy Stock Photo

Dissonance is disturbing

Those of you who are familiar with cognitive dissonance, the process whereby a mismatch between behaviour and attitudes/beliefs causes discomfort in the brain, may wonder why this doesn’t undermine hypocritical behaviour. Surely it would prevent people from doing things they openly condemn?

Again, it depends on the situation. Often, the “I’m better than other people so it’s OK” conclusion would be enough to reconcile it. But other times, it gets more serious. Take the earlier examples of anti-gay politicians found to be engaging in homosexual acts. This comes across as immensely hypocritical so they should be experiencing serious dissonance. But it could be argued that their actions are an attempt to resolve the dissonance. You’re raised in an environment that believes homosexuality is a sin, and you end up believing this completely. Why wouldn’t you? Then you hit adolescence and it turns out you are homosexual (it’s not a choice, after all). Now you’ve got serious dissonance; beliefs that insist homosexuality is wrong combined with physical attraction to the same sex.

One way to resolve this is to double down on the anti-gay behaviour. “I can’t be gay, look how much I hate them and work against them!” Now your beliefs and behaviour are more consistent, a sort of “fake it ‘til you make it” approach. But it’s difficult to maintain, as sex is a very powerful motivator, and people often aren’t strong enough to fight it. So you end up with strident anti-gay campaigners submitting to their desires. It’s not intentional hypocrisy in a sense, and it would be easy to only pity them for their struggles if they didn’t harm anyone else.

But they do. So it isn’t.

  “I could work hard to be a good person, but... why bother?” Photograph: Blend Images/REX/Shutterstock

Hypocrisy is just easier

The problem with practising what you preach, or maintaining a high moral standard, is it’s work. You tell people to give money to charity or abstain from certain indulgences, this means you have to do these things too. But what if you just said you do these things, but didn’t? You get all the benefits of people thinking you’re a good and capable person, but you don’t have to practice any restraint. It’s win-win.

Humans are prone to the principal of least effort, often known as the “path of least resistance”, which means they’ll go for whatever option requires the least work. Hypocrisy allows you to appear principled without having to be so, which is much easier than adhering to strict principles. Modern politicians seem to have grasped this fact, making big speeches about all the great things they’ll do and then never doing any of them. Given how they seldom seem to suffer any consequences for their hypocrisy being revealed (i.e. any political event of 2016), why would they stop?

There are some positives though. Some studies show that, when called out on hypocrisy, people can end up more dedicated to the beliefs and practices they only claimed to adhere to previously. So don’t be afraid to point out hypocrisy when you see it, you might be doing some good overall.

And that includes hypocrisy about things you agree with, otherwise you’ll be… well, there’s a word for that.

He’s right, the economy is sick – and businesses like Trump’s are part of the disease

Mariana Mazzucato in The Guardian

Trump won because he unashamedly stood as the champion of the dispossessed. More than the 16 Republican rivals he left in his wake, and more than the Democratic party standard-bearer he defeated, he led the cry of those who felt they had been left behind by globalisation. He channelled and inflamed inchoate anger, inflamed racial divisions and exploited a sense of burning injustice at a system “rigged” against the little guy. He was the self-styled winner who knew how to play the system, the strong man who alone could fix it.






To Trump, as to the Brexiteers, the enemy was the outsider: the Mexicans, the Chinese (the biggest “theft” in human history), Muslims, even Nato allies. His economic and security messages melded together: it was time to circle the wagons, to put America and Americans first. Trump won because he offered what seemed to the ears of many a plausible narrative about the failures of US economic policy that left so many behind– failures stretching back three decades before the collapse of the economy in 2008.

But while he was forceful about the consequences of a sick economy, his diagnosis could not be more wrong. He won by blaming external forces, trade and immigration. The truth lies much closer to home. It is the actions of US businesses, like his own, that lie behind the failure of the economy to deliver rising living standards for ordinary Americans. They have made money by extracting value, not creating it. And the problem has only become worse since the 2008 crisis.

The shareholder value revolution of the 80s created a corporate governance model that rewards quarterly returns over investments in the productive capacity of companies. Companies increasingly spend their profits, now at record levels, on buying back shares in order to boost stock prices, stock options and executive pay. This has led to a financialised economy, which many of Trump’s policies – including a lowering of corporate income tax – will only worsen.

Until the 80s, wages kept up with productivity, but since then they haven’t, and unions have weakened. As wages failed to keep pace with living costs, personal debt increased to cover the gap.

This rise in personal indebtedness has given life to new types of financial instruments that suck blood out of the system, leading to an increasingly financialised economy. The growth in size of financial intermediation as a percentage of GDP has outpaced growth in the rest of the economy.

The globalisation of capital (in contrast to labour) has meant that when growth falters capital can go elsewhere. Indeed, Trump’s behaviour – setting up businesses, letting them fail, avoiding paying suppliers, using bankruptcy laws to avoid taxes for decades, then setting up another business somewhere else – is the perfect symbol of this asset-stripping form of capitalism.

It is this breaking of the unwritten contract between capital and labour – that is, the sense of shared purpose and shared reward between the American worker and his or her employer and an associated failure to support American workers as they adapt to structural and technological changes - that lies at the heart of the problem. It is not the robots that are the enemy.

The reckoning that should have happened in 2008 never came. Not enough has been done to reform the model of capitalism which is itself responsible for Trump’s rise. We can only hope that his election will finally open the eyes of his opponents as to why new ideas are needed.

For this is not the only way. Trump sees the role of the state as limited to protectionism and funding basics like infrastructure, but what is needed is a much more active state, able to address societal problems through investments in innovation, in order to stimulate private investment and give direction to growth.

We need a decisive shift towards investment-driven growth, replacing the current consumer-driven, credit-fuelled model which adds to the stress of the most vulnerable. Tackling inequality should be a central objective of economic policy, for economic reasons every bit as much as social reasons. We must reconnect the company with society, and instil a sense of broader obligation, rewarding value creation over value extraction. In other countries such as Germany and Scandinavia a more participatory form of stakeholder capitalism gives workers a role on company boards.

Trumpism might be a uniquely American political expression, but the dysfunctions in American capitalism that have given rise to it are not. Though the specifics of the solutions may differ, European models of capitalism have many of the same fissures. Now, more than ever, Europe must find its own distinct language and policies if we are to solve the political, social and economic crisis on this side of the Atlantic .

Why you’re wrong to think that your house will finance your retirement

Treating houses as a financial instrument leads to an undiversified investment portfolio, with a large proportion of wealth concentrated in a single asset

Satyajit Das in The Independent


According to English writer Virginia Woolf, a woman in Victorian England needed money and a room of her own in order to write. In the modern world, housing itself has become a work of fiction.
A house provides shelter and a dwelling place. But increasingly this simple consumption good has been converted into a financial asset or investment as well as instrument of policy.

Governments subsidise home ownership in different ways. They may provide tax benefits such as tax deductions for mortgage-interest payments or lower taxes on capital gains from the sale of a residence. Common concessions include lower property taxes or stamp duty of property transfers as well as direct assistance for the purchase of homes. It also includes housing finance on preferential terms.

The subsidies mean that where they can, people buy multiple homes. The affluent own holiday homes which stay empty for much of the year, while less well-off are made to make do with sub-standard accommodation or, in the case of the poor, no homes at all.

Houses become larger. Virginia Woolf would have recognised these MacMansions: “Those comfortably padded lunatic asylums which are known, euphemistically, as the stately homes of England.”
Over-investment in housing is economically inefficient. Unlike businesses, houses once constructed generate limited income, profits, employment or investment.

Excessive housing investment also creates an inflexible labour force, reducing the mobility of workers. The ability to follow employment opportunities is restricted by fluctuations in house prices, the lack of liquidity of the housing market and high transaction costs (buying and selling can cost 5-10 per cent of the value of the house). It also limits wage flexibility, as workers are constrained by their mortgage commitments.

The replacement of company or government-funded retirement with self-funded arrangements means that houses have become a means for wealth creation. As homeowners pay off their mortgages, their home becomes a major financial asset. But residential property produces no income even where they increase in value. Maintenance costs, utility bills and property taxes mean that houses require rather than provide cash.

Homeowners must generate income by borrowing against their home to finance consumption and eventually finance retirement. The strategy requires realising the home equity (the difference between the value of the house and the mortgage debt outstanding) by either borrowing or selling the property, moving into a smaller house or a rental.

Treating houses as a financial instrument leads to an undiversified investment portfolio, with a large proportion of wealth concentrated in a single asset – the home, which does not produce income.

Investors also buy houses and apartments with borrowed money to rent out. The income from property is rarely higher than that on other income-producing investments. Where borrowed money is used, the rent may not fully cover interest and other outgoings. There is speculative reliance on ever-increasing property prices to boost returns or repay the debt used to finance the property leaving a profit for the buyer.

Reliance on houses creates exposure to volatile house prices. As the global financial crisis illustrated, prices can be affected by a confluence of adverse events – economic cycles, the availability of credit and demographics where large cohorts may retire at the same time. Price fluctuations are exacerbated by the illiquidity of the asset.

Many economies now rely excessively on the housing market. Housing investment sustains economic growth. Unlike many industries, it is largely domestic, driving employment, income and economic activity. In The Age of Turbulence, Alan Greenspan approvingly quotes economics columnist Robert Samuelson’s assessment of his policies in the early 2000s: “The housing boom saved the economy… Americans went on a real estate orgy. [Americans] traded up, tore down and added on.”

Governments continue to promote housing and home ownership using rising wealth from home ownership to mask lack of growth or declines in real income levels and uncertain employment for the population. But the policy is paradoxical.

Current policy, lower interest rates and increased availability of housing finance, boosts the price of existing housing stock rather than increasing housing construction. If it succeeds, then higher house prices ironically make housing unaffordable for large portions of the population.

Where the policy fails, an unwinding housing bubble is difficult to manage, as evidenced by events in the US, Ireland and Spain.

Economic activity slows as individuals and investors suffer large falls in wealth. Governments suffer revenue losses from lower property taxes. At the same time, government expenditures may rise as savers are forced to turn to available social services due to falling income and wealth.

Banks can find their solvency affected quickly by a fall in houses prices because of their high exposure to mortgage loans or property as security, requiring government support.

A considered debate about housing is needed to improve the structure of economies. It may also have an unexpected collateral benefit, improving TV entertainment beyond shows about the property or housing ladders and lift the standard of dinner table conversation above the level of: “Do you know how much they got for the house down the street?”