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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.