photo credit: derekkeats

Mark Braund

Guardian UK

The South African government’s recent decision to abandon its Expropriation Bill, aimed at addressing the painfully slow pace of land reform, prompts the question: how can the country move towards a more equitable distribution of land and natural resources 14 years after the end of apartheid? Given the catastrophe in Zimbabwe following Mugabe’s land seizure policy, South Africa needs to get it right.

Land reform has always been high on the ANC’s agenda. In negotiations over the 1996 constitution it secured the inclusion of provisions to enable it to force through the land reforms necessary to give the black majority a real stake in the country’s economy. The constitution includes both a commitment to “the right to land ownership” and an acknowledgment that under exceptional circumstances that right could be suspended to promote land reform. Until recently, however, the government opted not to exercise its constitutional right to expropriate land.

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photo credit: laurenatclemson

Michael Hudson

July 14, 2008

I am writing this article about Fannie Mae and Freddie Mac while sitting in the Queens Botanical Garden. This was not my plan today. The central air conditioning in my apartment broke down six weeks ago, and still has not been fixed. (It’s a nice condominium building, but accidents happen.) It is over 90 degrees outside, and nearly 100 as a result of the greenhouse effect in my apartment. Yesterday I took refuge in the Forest Hills Public Library, but it is closed on Sunday. One of the few libraries near public transport that normally is open on Sunday is in Flushing. So I went there to write the final draft describing the past week’s financial turmoil.

Unfortunately, when I got to the Flushing Public Library, a lady explained that because of the city’s budget cuts, the library no longer would be open on Sundays. Already before noon, when it was supposed to open, a large number of Chinese were waiting to get in, expecting to use the books and computer terminals. There was no sign explaining the situation in Chinese, and they continued to wait as I went down Main Street to the Botanical Garden.

At first glance this might not seem to have much to do with the turmoil of the last few days over the fate of Fannie Mae and Freddie Mac or the real estate markets they have helped inflate over the past decade. But actually, my experience today has everything to do with this topic. These two semi-public mortgage-packaging companies dominate the nation’s mortgage market and have supported real estate prices by steering over $5 trillion to enable homebuyers to bid higher and higher prices for homes, earning billions of dollars of bonuses, profits and interest for the bankers, mortgage brokers and Wall Street debt packagers who are the financial beneficiaries of the real estate bubble.

And that is what really is at stake. If cities such as New York did not cut back public services, they would have to do what they and nearly all American cities and municipalities traditionally have done: finance most of their public budgets by taxing property. But to do that in today’s market would leave homeowners – and commercial building owners as well – with less revenue to pay their mortgages. Already this year over a million debtors have defaulted on their home mortgages, and enough have now fallen behind to suggest that Treasury Secretary Paulson’s warning that two million mortgage defaults for 2008 may be a million too low.

So that is the tradeoff: If cities are to maintain their customary level of public services, they will have to tax property at the traditional rate. But this would mean that housing prices would be less. The revenue paid in taxes would not be available to pay bankers to capitalize into interest payments on higher mortgage loans to buy homes at higher and higher prices. given a choice between more affordable housing and better public service on the one hand, or “wealth creation” in the form of higher-priced housing (along with its higher carrying charges), Americans have voted overwhelmingly for the latter – that is, for debt peonage rather than economic choice of what to do with their earnings except pay their bankers.

To me, this seems crazy, but then I’m an economist and we’re notoriously unable to explain why people vote against what seems to be their self-interest. In any case, this seeming craziness is what the plunging prices for stock in Fannie Mae and Freddie Mac last week was all about. One politician after another was televised pontificating about the need to keep real estate at unaffordably high prices rather than falling back to more affordable levels. Nobody mentioned the option of cities and states avoiding public service cuts by taxing the real estate – mainly the land’s site value – that has soared since 2000. Nobody discussed how an economy would look with lower housing prices and less mortgage debt. All they could say was the need to preserve the value of bonds and packaged bank mortgages held by financial institutions, that is, ultimately, by the economy’s wealthiest layer of the population, the 10 percent that are responsible for the net saving – saving that takes the form mainly of loans to indebt the bottom 90 percent.

Debt write-downs and lower property prices would be good for most of the economy, but are anathema to Wall Street. Bear Stearns already has gone under as a result of its business model based on packaging junk mortgages, and last week it looked like Lehman Bros. was going down the same road. It amazes me that the election is not being fought over this economic issue, but I guess that’s why I’m sill in Dennis Kucinich’s camp rather than elsewhere.

The policy question

For millions of homeowners watching the price of their homes fall below the mortgages they owe, the question is whether to pay or default. Many have no choice. They have Adjustable Rate Mortgages (ARMs) that are resetting at sharply higher interest rates and require amortization payments far beyond what the debtor is able to pay.

The looming defaults threaten financial institutions holding mortgages on such properties, moving up the economic pyramid to reach investors and creditors at the top. Somebody must take a loss. But who? Big fish or little fish?

For lawmakers there are two possible policy responses. The first and seemingly most logical response would be to re-set bad debts at levels that can be paid. This write-down would be in keeping with the direction of legislation since the 13th century to favor debtors more than creditors. It would restore balance between what people earn and what they can afford to pay for housing and other debts.

This is not the path that Congress is taking. Instead of bringing debts within the ability to pay, its banking and real estate committees are trying to find a way to re-inflate housing prices. The hope is to enable existing mortgage debtors who have defaulted, or are on the brink of doing so, to get into a position to sell out or to borrow the money due on even easier terms from the Federal Housing Administration (FHA). This would leave government agencies rather than Wall Street holding junk mortgages. It would give security not to home owners and mortgage debtors but to the lenders and speculators holding the $5 trillion in mortgages guaranteed by the Federal National Mortgage Association (FNMA, “Fannie Mae”) and the Federal Home Loan Mortgage Corp. (“Freddie Mac”), as well as the default-insurance companies on the hook and whose IOUs have now sunk to junk status themselves.

What is the point of buying insurance against mortgage defaults, after all, if the insurance reserves are miniscule in comparison to the likely default volume? The monoline insurance companies (firms whose only business is to write default insurance) have made their money writing policies, not paying out. Their executives have already taken the money and run. Yet it is for their wealthy financial clients that Congressional hearts are bleeding, not for the victims of subprime mortgage fraud and the associated Wall Street fraud in packaging junk mortgages and selling them to institutional investors at home and abroad.

The question is, how can an economy survive with millions of homeowners defaulting and wealth ownership polarizing between creditors and debtors. This is what plunged the world into depression in the 1930s, and long before that, reduced the Roman Empire to debt bondage and serfdom.

Is it all happening again today? Or can things simply return to normal with today’s debts be paid off by borrowing yet more money and running yet further into debt, in what is known as the “magic of compound interest”?

The Democratic congress pushes for American families to pay higher home prices

Congressional banking committee heads are simply behaving as politicians traditionally do by giving priority to their major campaign contributors in the financial and real estate sectors. Led by Democratic senators Charles Schumer from Wall Street and Christopher Dodd from Connecticut’s insurance industry, and supported by Congressman Barney Frank from the real estate sector, Congress is seeking to bail out the bubble’s sponsors, not its victims. The plan is to re-inflate the housing bubble at least long enough for the largest banks and other financial speculators to dump their riskiest holdings. Book values on these mortgages – and the real estate that backs them – are purely fictitious, despite the AAA whitewash from bond-rating agencies which themselves are now under investigation for the fatal Arthur Anderson-style conflict of interest between their research and sales arms.

Dealing as they do with real estate, and hence with local urban politics where most of the property values and maneuvering occur, Fannie Mae and Freddie Mac are largely Democratic creations. James A. Johnson ran Fannie for most of the 1990s and was its main lobbyist. Until June he headed Barack Obama’s vice-presidential search team, but resigned when it was revealed that he got mortgages on unrealistically favorable terms from Angelo Mozilo’s notorious Countrywide Financial. FNMA’s former head, Franklin D. Raines, was President Clinton’s budget chief. He was forced to step down when serious accounting problems were discovered. Other Fannie apparatchicks include Jamie Gorelick, former Clinton deputy attorney general, and Thomas E. Donilon, Clinton chief of staff to the secretary of state.

To be sure, political opportunism leads Fannie and Freddie to cover all the bases, becoming known for hiring relatives of powerful politicians wherever they may be in a position to help. But at least this time the problem is not George Bush’s fault. The Wall Street Journal seems closer to reason than the Democratic Congress. Over the weekend its editorial clarified what socialists since Marx have been saying: “What taxpayers need to understand is that Fannie and Freddie already practice socialism, albeit of the dishonest kind. Their profit is privatized but their risk is socialized.” Calling FNMA and Freddie “high-risk monsters,” the newspaper noted that “Wall Street and the homebuilders also cashed in on the subsidized business, and also paid back Congress in cash and carry.” It concluded by questioning whether these government-sponsored enterprises (GSEs) were justified at all. “Apart from outright failure, the worst scenario would be a capital injection that left the companies free to commit the same mayhem all over again two or 10 years from now.”

In a separate article the Journal noted that, “On a fair-value basis, the company [Freddie Mac] had negative net worth of nearly $17 billion.” The problem is that there is no “market” – that is, no supply of equally gullible buyers – to take on these bad loans, except at distress prices. Through short-term greed and incompetence, the home-debt industry has pawned off highly debt-leveraged mortgage loans drawn up from fraudsters. I cannot actually call them crooks because instead of being indicted, they have been rewarded with tens of millions of dollars in bonuses for making so much money as debt innovators for the finance, insurance and real estate sectors.

Their place is to be taken by the government as bad-debt buyer of last resort. I suppose this might be called Finance Socialism – the stage at which it becomes necessary to rescue Finance Capitalism, at least its largest institutions (“too large to fail”) at the top of the economic pyramid. I suppose it might be called “real estate finance capitalism.” But in Washington-talk it is euphemized in the Democratic Party’s usual populist garb as “democratizing property” and “increasing homeownership,” by which is meant indebting a rising share of the population to the point where carrying their mortgage absorbs most of their disposable personal income.

Can a new real estate bubble be inflated?

The fact remains that like every financial bubble in history starting with England’s South Sea Bubble and France’s Mississippi Bubble in the 1710s nearly three centuries ago, today’s bubble has been sponsored by the government. Forget the “madness of crowds” free-market propaganda. Insiders and enabling politicians always try to blame the victim. The reality is that Fannie, Freddie and the FHA gave a patina of confidence to irresponsible lending and outright fraud. This confidence game led them to guarantee some $5.3 trillion of mortgages, and to keep $1.6 trillion more on their own books to back the bonds they issued to institutional investors. Their strategy has been to issue bonds paying fairly low interest rates, and use the proceeds to buy mortgages yielding somewhat higher rates. This kind of interest-rate arbitrage is what the S&Ls did in the 1980s – a relevant parallel, as I will discuss below.

The myth is that Fannie’s and Freddie’s role is simply to spread homeownership by making it affordable for more of the population. Fannie Mae was established in the Depression, in 1938 as part of Roosevelt’s New Deal, and privatized in 1968. Freddie Mac was established two years later, in 1970, to buy up S&L mortgages and give “liquidity” to their mortgages, by developing markets outside of the banks and S&Ls that originated these loans. But this turned out to be the “original sin,” so to speak. Outside investors were obliged to place their trust in the mortgage originators – banks, S&Ls and mortgage brokers, whose ranks are filled with fraudsters and crooks.

Whatever we may call it, their dream is to bring back the seeming golden age sponsored by Alan Greenspan at the Federal Reserve. It was a decade of quick mortgage billionaires writing fictitiously high mortgages and selling them off to pension funds and to German and English bankers eager to seek a few extra fractions of a percentage point in current income so as to justify a big bonus by claiming to outperform more reality-based money managers.

All this is as American as apple pie. Altruistic political talk aside, the reason why the finance, insurance and real estate (FIRE) sectors have lobbied so hard for Fannie and Freddie is that their financial function has been to make housing increasingly unaffordable. They have inflated asset prices with credit that has indebted homeowners to a degree unprecedented in history. This is why the real estate bubble has burst, after all. Yet Congress now acts as if the only way to resolve the debt problem is to create yet more debt, to inflate real estate prices all the more by arranging yet more credit to bid up the prices that homebuyers must pay. The plan is thus to pretend that the Bubble Economy’s financial unreality may be made real by Finance Socialism.

Can the plan work? The reason why Fannie and Freddie have been able to borrow at lower rates than their rivals is because their public sponsorship led investors to believe that there was an implicit public guarantee not to let them fail. And in view of the fact that these two agencies account for some $5 trillion in mortgages – nearly half the nearly $12 trillion U.S. home mortgage market – they do indeed seem to be “too big to fail.” The face value of mortgages they have guaranteed is nearly as large as the entire U.S. federal debt held by the public. This means that the nominal federal debt would double if they went under. But at least the government can always print money, while the real estate backing the mortgages guaranteed by Fannie and Freddie (or held in their own accounts) is plunging in price into the dreaded Negative Equity territory.

But on their shoulders ride the hope of re-inflating housing prices to bail out the financial managers who sought to make money by debt creation rather than tangible capital formation. So the question is whether housing prices can be raised to a level that oblige families to run into even more debt than they now are carrying – with even lower down payments, subsidized at public expense.

In this case the subsidy would not really be for homeowners at all, but for the financial system’s mortgage holders. The aim would not be to make housing more affordable, but less so, because the debts would be larger!

Most investors view the situation as being more political than strictly economic. One hears again and again these days about the “implicit” government guarantee to make good on the bonds Fannie and Fred issued to fund these junk mortgages. Its constant repetition reflects the anxiety that bondholders feel about how sound their bond holdings really are. (The stocks of Fannie and Freddie have now plunged to less than 10 percent of their former highs. Investors obviously expect their equity to be wiped out, a la Bear Stearns.)

The word “implicit” means “not explicit.” There is a tantalizing hint of what might be, but does not yet exist in a legal sense. Financial free lunchers on Real Estate Finance Capitalism claim to be innocent victims of an “unexpected” bad turn in the market. (Bad news always is “unexpected” as far as financial spokesmen and media reporters are concerned, just as Claude Rains was “shocked, shocked” to find that there was gambling going on at Rick’s Café.)

The distinction between implicit and explicit may be too philosophical for most money managers who work in the financial institutions that have bought Fannie Mae and Freddie Mac bonds and packages of junk mortgages. Most of these apparatchiks don’t need much of an education. All they need is greed, and that can’t be taught. It is a mentality – and on Wall Street it lives in the short run, from one annual bonus to the next.

Wall Street bonuses are based on how well one “performs” relative to the norm – a Treasury bond’s rate of return, or the average mutual fund or money market fund. Anyone can out-perform these averages simply by buying the most risky and hence highest-yielding bonds around.

Predator vs. victim – who will Congress support?

On the subway to my hoped-for cool spot in Queens, I opened today’s Sunday New York Times to find an article by the always informative Gretchen Morgenson about a Countrywide Financial customer saddled with an adjustable-rate mortgage re-setting at a rate beyond his means to pay. The mortgagee got so frustrated with non-responses to his earlier attempts at communication that he sent an e-mail message to a block of Countrywide addresses asking to renegotiate his mortgage on more affordable terms so as to avoid default. This is what Henry Paulson has been urging “responsible” lenders to do – and Countrywide is responsible for some $1.5 trillion in mortgage loans, most of them subprime.

The e-mail actually got to Countrywide co-founder and CEO Angelo Mozilo, cited above for having given GNMA head and erstwhile Obama advisor a mortgage on remarkably affordable terms. Mr. Mozilo is the Darth Vader of the global mortgage market, and the person probably more responsible than any other for wrecking more lives financially than any other man on the planet, including Ken Lay and Michael Milken. Until the movie biography arrives, we will have to do with Ms. Morgenson’s article.* (*“The Silence of the Lenders,” The New York Times, July 13, 2008.)

Mr. Mozilo actually responded. He found the request to lower his company’s mortgage demands “Disgusting.” The very thought of debtors not living up to written contracts they had signed – contracts which turned out to be bait-and-switch deals signed under duress – seemed to threaten the institution of private property itself. After all, had not the mortgage agreed to “adjust” his teaser interest rate upward to a more real-world rate of extracting his income?

A Countrywide “workout advisor” on the company’s “home retention team” tried to be more helpful. She suggested that “Maybe you can eat less,” when the mortgagee told her that all he could afford was $10 a day after paying his mortgage.

Perhaps my mind was wandering too far, but I was reminded of Sumerian and Babylonian language for creditors. Contracts said that they would get to “eat” the interest on debts owed by cultivators and debtors. Bronze Age contracts from Hammurapi’s time (c. 1750 BC) typically called for rural debtors to pay their debts in grain (which exchanged on a par with silver, one liter of grain per shekel of silver), weighed out at harvest time on the threshing floor. Post-classical economic theory is based on the principle of diminishing marginal utility. According to this theory, the pleasure of consuming more of any given commodity diminishes with each additional unit that is consumed. This seemed to suggest that as people got wealthier, they would become less greedy, leaving the path open for the poorest consumers to “catch up.” It was a happy picture of economies leading naturally and almost automatically to a more equal distribution of wealth.

Of course, it was utter fiction. But it was a “successful error” that won for the marginal utility school such enormous financial subsidies for economics departments teaching this distraction that it drove classical economics off the board with its discussion of unearned increments, free lunches and the polarization of wealth by rentiers (a word that today is almost as anachronistic as “usurer”).

Obviously, these marginal utility theorists never heard of the wealth addiction that Aristotle and other ancient observers described. How much can a creditor “eat” in practice? The answer is, “everything”! That is what wealth addiction is all about.

It is implicit in the mathematics of the “magic of compound interest.” This is the magic that has causing the real estate crisis plunging Fannie Mae, Freddie Mac and Lehman Bros. to the brink of insolvency.

A replay of the federal S&L insurance crisis: Bailing out the risk-takers, not their victims

Junk bonds issued by corporate raiders were the highest-yielding bonds in the 1980s – before they brought down the S&Ls. Since the Federal Reserve flooded the economy with credit after the dot.com bubble burst in 2000, junk mortgages have been the highest-yielding securities. Meanwhile at the Federal Reserve, Chairman Alan Greenspan deregulated the banking system to let the usual array of financial crooks express the “animal spirits” that he believed were the driving force in his Ayn Rand fantasy world.

The result is a replay of the S&L collapse two decades ago – a financial “golden oldie,” so to speak. The S&L bailout is relevant today because proposals to bail out FNMA and Freddie Mac bondholders are distressingly like the bailout of S&L depositors in crooked S&Ls back in the 1980s. Only a handful of S&Ls went under – and they were the notorious risk-takers. Their depositors were not neighborhood moms and pops. They were large institutional savers, who didn’t care about risk or crooked behavior, because there was a government guarantee by FSLIC: the Federal Savings and Loan Insurance Corporation. And that bailed out the large depositors.

Fast forward to today. FNMA was shown many months ago to have been cooking the books. But large speculators didn’t care. Although there was no official government guarantee, there was an “implicit” protection for risk-takers. Financial insurance firms sharply raised the protection for these two government-sponsored mortgage agencies. But investors still were able to make a few basis points more than normal by buying their bonds.

Should they be bailed out? And if the government does not do so, would this mean that FNMA goes under and the US mortgage market plunges?

Do we really want a new bubble? Or re-industrialization?

Let’s take a step back and look at the function that Fannie and Freddie have played in today’s Bubble Economy.

Who would one expect the Fed as “board of directors” for the commercial banking system, the Federal Housing Agency (FHA), FNMA and Freddie Mac as creatures of the real estate sector, to support? Ostensibly created to serve “the people,” 90 percent of whom are debtors, these institutions actually back the 10 percent of the population who are creditors.

This year already has seen a million foreclosures and the junk mortgage collapse is worsening. Home prices are plunging as interest rates on the euphemistically named adjustable rate mortgages (ARMs) “adjust” in the only direction they ever were intended: jumping up from teaser rates to distress levels. It is more difficult to borrow in today’s market. The economy has reached its debt limit and is entering its insolvency phase.

We are not in a cycle but the end of an era. The old world of debt pyramiding to a fraudulent degree cannot be restored, even if the Glass-Steagall Act is not restored to stop the conflict of interest that it unleashed when the Clinton Administration backed Treasury Secretary Robert Rubin and financial lobbyist Greenspan in repealing it. The real estate bubble was made possible by the unique degree to which America’s population emerged from World War II relatively debt free. Each recovery has taken off from a higher debt level. This something like trying to drive a car with the brakes pressed tighter and tighter to the floor each time there is a stoplight (recession). We have now reached the debt limit, and the economy is stuck. The class war is back in business, with a vengeance. Instead of it being the familiar old class war between industrial employers and their work force, this one reverts to the old pre-industrial class war of creditors versus debtors. Its guiding principle is “Big Fish Eat Little Fish,” mainly by the debt dynamic that crowds out the promised economy of free choice.

This is being portrayed as a post-industrial economy, but it is a much older story. No economy in history ever has been able to pay off its debts. That is the essence of the “magic of compound interest.” Debts grow inexorably, making creditors rich but impoverishing the economy in the process, thereby destroying its ability to pay. Recognizing this financial dynamic most societies have chosen the logical response. From Sumer in the third millennium BC and Babylonia the second millennium through Greece and Rome in the first millennium BC, and then from feudal Europe to the Inter-Ally war debts and reparations tangle that wrecked international finance after World War I, the response has been to bring debts back within the ability to pay.

This can be done only by wiping out debts that cannot be paid. The alternative is debt peonage. Throughout most of history, countries have found again and again that bankruptcy – wiping out the debts – is the way to free economies. The idea is to free them from a situation where the economic surplus is diverted away from new tangible investment to pay bankers for the monopoly they alone have been given to create bank-credit and charge interest on it. That is the classical idea of free markets.

Current proposals would replace bad debts that are not publicly insured (except by an “implicit” guarantee that relevant legislators have been bought into) with new debts, and new suckers are to be left holding the bag. Bahrainis and Saudis in particular are being courted.

But most of all, there is a public campaign being waged by the FIRE sector (Finance, Insurance and Real Estate) to convince the American public that, in the infamous words of Margaret Thatcher, TINA, “there is no alternative.” (See for instance the Wall Street Journal’s excellent coverage of the FNMA/mortgage crisis on July 11, 2002, p. A12.) When one hears this, it means that political censorship is being mobilized to flood the popular media with the intellectual equivalent of sterile fruit flies being released to stop the spread of a threat. All one hears is a barrage of claims that the government must preserve the financial fictions of FNMA and Freddie Mac in order to “save the market.”

But what is “the market” that is to be “saved”? To Wall Street and its Congressional advocates, it is the mass of bad debts growing at compound “magic” rates of interest, beyond the ability of debtors to pay. If the debtors cannot pay, then the Government – “taxpayers” are to pick up the check to Wall Street. Meanwhile, more tax breaks are to be given to leave the finance, insurance and real estate sectors with enough money to “earn back” their losses, by extracting yet more rent and interest from the industrial economy’s consumers and wage-earners.

The usual hypocrisy is being brought to bear claiming that all this is necessary to “save the middle class,” even as what is being saved are its debts, not its assets. Something must give – and the upper 10 percent of the population wants to make sure that it is not its own economic position, but that of the bottom 90 percent. The “way of life” that is being saved is not that of home ownership, but debt peonage to support the concentration of wealth at the top of the economic pyramid.

My modest proposal

Shareholders of FNMA and Freddie Mac probably will be wiped out, as were S&L shareholders in the bailout of S&L depositors in the 1980s. There’s a simple way to save FNMA’s and Freddie’s public functions, if they indeed are deemed necessary to keep supporting the debt market. This can be done without bailing out the speculators who bought the mortgages it packaged.

First of all, not all the mortgages that these two agencies have bought or guaranteed are junk. Most are genuine and are being paid. The poor are honest, after all, and think that they should pay as a matter of honor even if it is not in their economic interest to do so when their homes fall into negative equity. Let these mortgages continue to back the existing FNMA and Freddie Mac bonds to the degree that they actually receive mortgage debt service. If there is a shortfall, let bondholders take the usual haircut that is supposed to go hand in hand with risk. That is why these mortgages had such high rates of interest, after all. The loss would be proportional to the financial and real estate fraud they have enabled. This is the law for all other bondholders when their investments go south. Why make an exception for participants in the real estate bubble?

The rule caveat emptor should apply to bankers and investors here. They have bought a product – a flow of income that they either believed or pretended could be paid. Any student taught the mathematics of compound interest knows that in the end no economy’s debts can be paid. So this should be a special financial caveat.

To keep their activities current, let Fannie and Freddie issue a new series of bonds – the “we won’t fake it anymore” series. They would be based on a new honesty based on more realistic appraisals of the affordability of housing, which they were supposed to be promoting all along. These steps would not cause a collapse.

But before stepping up to save FNMA and Freddie Mac, we might ask whether it would be a tragedy for their debt guarantees to cease. Wall Street has given politicians a cover story that to support FNMA and Freddie on the pretense that its packaging and reselling mortgages in big “tranches” provides liquidity. Its defenders claimed to be “modernizing” the real estate mortgage market by creating uniform standards and homogeneous packages. But these packages were increasingly tainted with junk, putting floor sweepings of ARMs with no-down-payment and NINJA (no income, no job) loans into financial sausages.

What Fannie and Freddie did was to provide a vast new source of demand for mortgages. Their role has been to extend the market for mortgage debt, creating opportunities to make money financially in an environment of asset-price inflation – the Bubble Economy. The effect was to push up housing prices. This has been the great American game for a century. And it has turned increasingly to outside investors (including gullible German banks which were the first to go bust by trusting the U.S. junk mortgage market), swelling the supply of loanable funds that bid up property prices.

Prior to FNMA and Freddie Mac, banks that issued mortgages held onto them, because there were no outside blind buyers. This was the pre-fraud era. It is now looking like a Golden Age. Housing prices were lower, and buyers did not have to go so deeply into debt to purchase homes. But the Senate and Congress – at least the Democrats – are urging the FHA and other government agencies to prop up the mortgage market by issuing zero-down-payment loans and other subsidies. The immediate aim is not to help homeowners – who indeed will have to pay more if the housing market re-inflates. Each new economic crisis adds a few new words to the English language. This time we get “reflate.” Others include NYU Prof. Roubini’s “stagdeflation” for a combination of debt deflation of incomes and price inflation for commodities as the dollar sinks in response to the balance-of-payments deficit resulting largely from the war in Iraq. But that is another story. Today’s story is about how Congress is aiming to bail out the banks that have bought or packaged these junk mortgages, about how needless this bailout is, and about how much simpler and more fair to just write off the bad debts.

Conclusion

America’s $13 trillion in domestic real estate debt is no more payable than is the government’s $3.5 billion dollar debt to foreign central banks, or the public debt itself for that matter. Adam Smith remarked over two centuries ago that no government ever had repaid its debts. At that time the aristocracy – the heirs of the Viking warlords who conquered Britain and other European countries and turned their common lands into private property – held most of the land free and clear. Today, real estate has been “democratized,” but this has been done on credit. Mortgages are the major debts of most American families. In this role, real estate debt has become the basis for the commercial banking system, and hence the basis for the wealthiest 10 percent of the population who hold the bottom 90 percent in debt. That is what Fannie Mae, Freddie Mac and “the market” are all about.

Neither party in Congress supports a new bankruptcy bill. The lobbying money simply isn’t there. So the preferred alternative seems to be a new real estate bubble, which means more debt peonage for new homebuyers rather than housing prices falling back to more affordable proportions.

Of course, there is another alternative (TIAA). It is to change the tax system so as to collect rent as the basis for taxation, not for an expansion of debt to the banks. Real estate could free labor and industry from having to pay taxes. Instead, un-taxing property has forced labor to bear the tax burden, and to pay an equivalent sum in interest to the banks as well.

But that is a topic for a future article.

Michael Hudson is Chief Economic Advisor to Dennis Kucinich and the Kucinich-for-Congress campaign. A former Wall Street financial analyst, he is Distinguished Research Professor of Economics at UMKC, and author of Super Imperialism: The Economic Strategy of American Empire (new ed. Pluto 2002), and Debt and Economic Renewal in the Ancient Near East (CDL Press, 2002). He has more insightful analysis at his website.

Frank toured Australia this time last year for the True Cost Economics Forum. He wrote this piece in lieu of exciting developments in Canada.

For the first time to my knowledge, Toronto will be collecting economic rent to pay for infrastructure — in this case to redevelop a section of a busy shopping street. (The wealth that accrues to locations is known as economic rent).

It was reported in the Globe and Mail as follows: “The city will borrow the money up front, to be paid off gradually by the businesses along the ritzy strip.”

Significantly, although the city has refused to pay for the street redevelopment out of property taxes, the adjacent businesses know the benefits to them will outweigh the costs, and are therefore willing to pay for it themselves. These Toronto businesses know that if infrastructure is warranted and beneficial it will raise the value of their land by more than the cost of that infrastructure. When redevelopment makes locations more desirable, more economic rent is attracted, over time, than the cost of the initial redevelopment.

This example is not at all unique; the economic theory is universal. The implication is that any infrastructure that increases land values should not be funded out of government tax revenue, but instead be paid for through the collection of the increased economic rent generated by the infrastructure, whether it is a hospital, school, sewer upgrade, park or transit system.

Normally the increased economic rent goes (untaxed) to the person or company that owns affected land, even though governments pay for the improvements out of the tax base. Taxpayers everywhere are unjustly expected to pay for improvements that only benefit the local land-owning minority.

The law of economic rent offers a model of how to finance more efficient transportation systems, reconstruct public infrastructure and green public buildings without bankrupting governments or raising taxes. Like this Toronto street redevelopment, all towns, cities, provincial and federal governments should collect the economic rent that migrates to land (and other finite assets like oil, aggregates, pollution) and use it to finance the greening of the country.

Scottish government: Developing a Methodology to Capture Land Value Uplift Around Transport Facilities

Wheels of Fortune: Self-Funding Infrastructure and the Free Market Case for a Land Tax: Fred Harrison

Kill the Tax Scams and Create Jobs

IT’ S ENOUGH to make Marx turn in his grave! His arch champion, the Soviet Union, capitulated to the capitalists in 1991 just as the market economies crashed into their most severe crisis since the 1930s.

Government ministers from the seven richest nations on earth burdened with 24m jobless people, double the number since the spirit of Thatcher/Reagan was unleashed in 1979 - met in Lille on April 2 to agonise about what to do. Global unemployment is running at 700m people, according to the International Labour Organisation, but governments are bereft of ideas about what to do to liberate the labour market.

Governments face a double whammy a shrinking tax base and an increasing pool of aging people who need welfare support.

There is no mystery about the problem: the structure of taxation means that employers not only have to carry the cost of employing workers, they also have to carry the cost of public services. Non-wage labour costs represent an enormous proportion of total labour costs. This means that many people who would otherwise be able to provide goods or services to customers with a competitive profit to employers are excluded from the workforce because Wages+Taxes > Revenue, given the resistance to price rises.

There is no mystery about the solution: President Clinton’s chief economic adviser, Prof. Joseph Stiglitz, knows that the optimal fiscal policy - the one that does not distort the economy- is one in which the rent of land and natural resources is treated as the fiscal base. This policy, far from destroying jobs, would positively create them. It’s the market approach to full employment: a partnership between the private and public sectors which reduces prices to their costs of production and therefore expands the demand for workers.

So why are governments not transforming their fiscal philosophy? In his INSITE essay (see page 2) Wall Street analyst Dr. Michael Hudson explains that the financial institutions, operating in a tradition that accords primacy to the interests of the real estate sector, will not allow governments to think about such a reform. Russia is currently suffering the brunt of the threats. The IMF has just advanced a $9bn loan to Boris Yeltsin on the condition that their idea of what constitutes “the market” is adopted. This has forced the Russian president to sign an illegal decree which privatises the rent of land. That rental income, when tied into loans linked to land as collateral, will flow out of Russia and thereby tilt the tax system further against the workers.

RUSSIA is learning that global markets emancipate the corporate giants from the clutches of the tax authorities. Britain, for example, is chasing £100bn in unpaid taxes, penalties and interest - and is adapting anti-money laundering laws to try and snare the funds that ought to be flowing into the public coffers. A conference on money laundering in Lisbon this month will be reminded that multinationals use creative accounting techniques - such as reporting profits in low-tax territories to side-step their fiscal obligations.

Because the multi-nationals dodge their tax liabilities, the fiscal burden falls mainly on employees. And governments suffer because they have to plug the deficits (the 15 European Union countries have a total budget deficit of 296bn pounds) by borrowing. That borrowing then disrupts the economy by forcing entrepreneurs (who need to borrow to start new businesses) to pay higher rates of interest than would otherwise be necessary.

Russia, like other nations that do not regulate the flow of capital, has to learn that there is one way only to snare the full taxable surplus of the wealth creators without disrupting the economy: drawing its public revenue from the publicly-created rent of land. That policy would also stop the drain of public revenue into private pockets: you cannot conceal prime commercial sites near the Kremlin in a bank in Switzerland!

Rent-privatisation will ruin the chance to create a fair and efficient economy in Russia, says Michael Hudson. The West should learn the balance-of-payments lessons behind the hijacking of land and resource rents.

[DR Michael Hudson is a Wall Street analyst and a leading balance-of-payments theorist. His Super Imperialism: The Economic Strategy of American Empire, was published by Holt Rinehart & Winston, New York, 1972. 1t revealed how the US uses the World Bank and IMF against European and Third World countries.]

Banking on Rent

MOST debt in the modem economy is mortgage debt. This is because the land, natural resources and other real estate is by far the largest asset. In the US, for example, land accounts for about 40% of assets, homes and office buildings for another 20%. Creditors are eager to lend money against such collateral, because it is the most valuable asset.

The principle of mortgage lending is simple: A banker can lend money up to the point where interest and amortization absorb the entire net rental income (or its equivalent value to owner-occupants). This transformation of rent into interest has occurred in every major industrial economy, from America to Japan.

As the land becomes mortgaged, bankers convert the rental revenue generated by farms and forests, mines and oil wells, office buildings and residential housing into interest and amortization payments. As the home market for such credit is exhausted, lenders remit their earnings abroad to continue the process wherever incomes or asset values remain unpledged to creditors.

The transfer of earnings abroad will gain momentum as foreign banks and financial institutions establish subsidiaries. In a country like Russia the “foreigner” is simply a Russian operating out of his offshore bank account. Inasmuch as financial capital knows no country, it tends to flow to wherever in the world interest rates are highest and free income remains unpledged for debt - today into Russia tomorrow out of it.

THE remission of interest and amortization on loans puts downward balance-of-payments pressure on the rouble. And as its international value falls, the main victim will be Russian workers. This is because prices for most economic inputs - fuels and other raw materials, paper and wood, capital goods and interest rates - are uniform internationally, and are set in US dollars. The most important domestic variable to be devalued is the price of labour. Regardless of what labor unions may win, wage gains and public income supports are offset by the currency’s decline. This explains why IMF “austerity plans” involve devaluation as a basic anti-labour strategy.

As the rouble falls. domestic output is siphoned away from the home market as the export market (priced in foreign currency) becomes more profitable. Consumers must pay more for imports, as well as for domestic goods whose prices are raised to the higher levels of imported goods.

As land becomes a commercial asset and an object of financial speculation, the tendency is for it to pass into the hands of absentee buyers and creditors, especially for the most valuable sites. As economic conditions deteriorate, distress sales and emergency borrowings increase. Many Russians living on low wages will be tempted to use their land as collateral for loans to balance their income and expenditure.

This has never been a stable situation for any economy. Adding interest charges to a family’s already tight living expenses makes it even harder for them to survive. Inevitably, much of the land sold to absentee owners. The moral is that privatizing the land gives its present occupants the freedom to lose their tenure righs. If they seem to gain in the short run, it is ultimately to benefit the absentee owner or creditor. And because Russia’s savings has been all but wiped out, today’s major source of credit and purchasing power is abroad.

THE indebting and forfeiture of land has been occurring for four thousand years. What is new in Russia today is the foreign-exchange effect. As land is loaded down with debt, its revenue is remitted abroad. (The IMF bans capital controls.) This capital outflow by Russian banks and lenders represents the hidden depth charge in Russia’s privatization plan. It is the major Western objective in Russia. It is this objective that shapes IMF and World Bank advice to Mr Yeltsin. Privatization thus does not mean ultimate Russian ownership and enjoyment of the revenue produced by its land and raw materials. It means turning over this revenue to repay debts to foreign creditors.

The mature industrial nations have a problem. They have an expanding mountain of savings which keeps growing. Much of this saving ought to be plowed into investment that produces more goods and services, creates jobs and improves the quality of life. Instead, the banking and financial system rolls over each year’s interest income and amortization (and capital gains) into more new lending. This expands the economy’s burden of debt-claims at compound interest rates.

Industrial profits likewise are diverted into the bond and stock markets as it becomes more profitable to extract interest than to invest directly to make the economy grow. In colloquial American terms, Wall Street “downsizes” Main Street: workers are sacked, capital equipment is not upgraded, and the public infrastructure is left to decay: roads and bridges, air and rail transport, the education and health systems. And the worse matters get, the less incentive there is to make new direct investment. The stock market may rise, and bond prices also as interest rates fall. But this is simply because savings are not going into building or modernizing new factories or undertaking more research and development. More savings are plowed into lending at interest, even as the economy’s ability to pay this interest is being hollowed out by its deflationary debt burden.

The essence of double entry book-keeping is that one person’s saving is another’s debt. Financial claims on wealth tend to grow more rapidly than the means of production, or the incomes of labour or industrial capital. “Paper wealth” thus overtakes “real” wealth.

Marx called this phenomenon the “self-expanding power of capital”. He made fun of this term, for obviously debt (finance capital) cannot continue indefinitely to grow more rapidly than the ability to pay interest. Marx therefore considered the financial system to be composed increasingly of “fictitious capital”, that is, of debt-claims in excess of the economy’s abillty to pay the stipulated interest.

Marx was an optimist in believing that finance capital would become subordinated to industrial capital. He thought that creditors would use their interest to finance the industrial system’s productive powers. But this is not what occurred. Emperors of finance conquered captains of industry. The process culminated in the 1980s, when financial raiders took over industrial companies using high-interest “junk bonds” as their weapon in corporate takeovers.

Like taxes, interest charges become elements of intemational pricing. They are not returns to the factors of production, they add to the economy’s overall cost structure. This is what worried American trade strategists in the closing days of World War II, when they decided to exclude Russia from the World Bank and the stillborn International Trade Organization. (See Ch. of Super Imperialism: The Economic Strategy of the American Empire). The fear was that socialist economies were free of a major cost that burdened the finance-capitalist economies. Capital invested in socialist enterprises did not have to pay interest. Nor did it have to bear the cost of market real estate rental. In the West, interest costs are factored into the cost of capital used up in producing output (including exports). Tax charges likewise must be defrayed out of sales proceeds. This increases the cost of exports for highly indebted economies, as compared to economies with lower interest rates and taxes (such as Hong Kong). American officials actually worried that Russia might have an economic advantage in this kind of market competition between socialist and capitalist countries.

Of course, the Soviet economy had a cost burden of its own: bureaucratic inefficiency. The question was, which kind of overhead would prove to be more costly in the end: finance-capitalism, or bureaucratic collectivism?

Russia’s economy can now obtain the best of both worlds: avoiding statist inefficiencies by using market reference-points. while minimizing, the debt and rental burden by promoting user-occupancy of the land rather than absentee ownership. Will Russia follow Hong Kong’s example by financing its public spending out of the rental income of land rather than labour and industrial capital? These are the issues which will determine the outcome of competition between Russia and the mature industrial nations.

The central issue is the kind of banking system Russia will have. Will it follow the German long-term investment-banking model? Or, will Russia retrogress and adopt the much less successful Anglo-American merchant-banking model which focuses mainly on real estate, lending money against whatever collateral is easiest to foreclose on? A passive banker lends on real estate and bills due for output already sold. An active banking system lends to create the productive assets that generate the interest to repay the loan.

Collateral-based banking ends up lending money mainly against the land and natural resources. (About 70 percent of U.S. bank lending takes the form of real-estate mortgage lending.) This does not bring new productive assets into being; it merely loads down the wealth creators with more debt, diverting more of a shrinking income stream into interest and amortization payments.

This means that land rent is collected by the banking system rather than by society. It is more efficient to create a banking system that finances new direct investment, instead of merely foreclosing on existing property, financing absentee ownership and speculation, and creating the kind of fiscal crisis that is now plaguing the Western economies which are being de-industrialized.

The industrial economies are in a debt crisis, above all a real-estate crisis since their financial bubbles broke in 1989. In modernizing Russia’s economy, I hope that they aim at getting the best of both worlds. But I fear that the Yeltsin/World Bank plan will burden Russia with the worst of both worlds: bureaucratic corruption stemming from the privatization of land and mineral assets, and a banking system that burdens the Russian economy with a growing debt rather than financing its industrial and agricultural modernization.

THE MIDDLE CLASS

With the rise of the Industrial Civilization in the world about two hundred years ago, there also arose a social body which we know as the middle class. Before that, most of the world suffered under a feudal system in which the people were truly slaves of their governments in all things. There was no strong buffer between them and their despotic rulers, no assurance of freedom to pursue commerce and to live decently, to keep the fruits of their labor and hold the paying of tribute at a minimum. The middle class made the dream of liberty a possibility, set limits on the government, fought for its constitutions, removed much of governmental privilege and tyranny, demanded that rulers obey the just laws as closely as the people, and enforced a general civic morality.

Sound leaders looked to the experience of Rome, the first to encourage a middle class, noting that Rome had been a strong and prosperous Republic, with much public virtue, a large degree of freedom for every citizen, and a constitution (the Twelve Tables of Law) on which our own is based. After the fall of Rome, governments had everywhere destroyed the middle class, returned to despotism, and entered the Dark Ages. It had been centuries since a rising middle class, looking to the experience of Rome, resolved to keep government at a minimum and to force respect for the people and eschew tribute except for such absolute necessities as armed forces, street protection, and the guarantee of the authority of contracts in commerce.

OUR RULERS

Those who for centuries had ruled their nations, from father to son, in total despotism, realized that they were threatened. Were they not by birth and money entitled to rule a nation of docile slaves? Did the people not understand that they were truly inferior dogs who needed a strong hand to rule them, and should they not be meek before their government? Were not the people too stupid to understand that the elite needed to extort tribute for their own use?

Little wonder that the elite hated the middle class which challenged them in the name of God-given liberty, and little wonder that this hatred grew deeper as the middle class became stronger and imposed restrictions through which all the people including the most humble had the right to rule their own lives and keep the greater part of what they earned for themselves.

Clearly, if the elite were to rule again, the middle class had to be destroyed. It had to be destroyed so despotism and the system of tribute could be returned, and the grandeur and honor and immense riches for the elite …. assuring their monopoly rule of all the world. For you see the elite of all nations, then as now, were not divided. They were one international class, and worked together and protected each other. But the middle class laughed and said “we will bind you with the chains of our Constitution, which you must obey also, lest we depose you, for we are now powerful and we are human beings and we wish to be free from your old despotism.”

The elite did not give up. While it profited from the Industrial Revolution which under liberty of enterprise freed the people from the feudal and despotic systems, and which gave new birth to the middle class, it also hated the threat to its own authority. It did not wish to destroy the Industrial Revolution; it wished to use it for its exclusive purposes. In the early Nineteenth Century, this elite looked for a way. once and for all, to regain its power and extort tribute from the people and to destroy the burgeoning middle class which stood in its way and to subdue the populaces again to their proper role as slaves of government by the elite.

ENTER MARX

Through the “League of Just Men,” elitist conspirators sought a fanatic to cloak the point of their purpose in slogans and cant. The man they hired was Karl Marx. Certainly Marx was no worker; he had never soiled his hands with labor. He hated the middle class, which he contemptuously called the bourgeoise, for he considered himself superior in mentality and breeding to what he called “the gross merchants of commerce and exploitation.” He did not attack the waiting despots; no indeed. They were of one mind with him. Rather he proposed in his books and pamphlets the return to government of the total power to exact tribute from the people in order that the government might better direct every phase of the people’s lives, as he asserted, “for their own welfare.” “The elite in turn, would control the governments.

Marx began to accuse the middle class of heinous crimes and aroused the workers against their benefactors. He labored to create envy and malice among the workers - all aimed at the entrepreneurial middle class which had raised them from serfdom, restored their human dignity, and given them liberty for the first time in nearly two thousand years.

Karl Marx was made to order by the self-styled elite. They financed the propagation of his sedition all over Europe and in America. They bled France and Germany with it. They financed sedition in Russia. And the plan began to succeed. By 1910 the Scandinavian countries had already fallen to the Socialism of Karl Marx. Only three nations stood between the elite and their ambitions, the British Empire, Czarist Russia and the United States of America. To a lesser extent, Germany also stood in their way, though Bismarck had greatly succeeded in introducing Socialism there, too. The saving hope was that Germany had a great middle class which the Kaiser honored and supported.

Much is now made of supposed Czarist tyranny. But the fact is that the Czar of Russia had already granted his people a greater measure of freedom. A Constitution had been established and a Parliamentary system. Russia, too, was well on her way to nourishing and encouraging a middle class.

The elitists were anxious to promote the Marxist notion of demanding tribute from the people, for only through forced tribute could freedom be destroyed and the people reduced again to forced labor for the benefit of the elite. Only this could the middle class be eliminated. So, we have Karl Marx’s infamous notion: “To each according to his needs, from each according to his ability.” That is the foundation for slavery and tribute. Marx and the elite had a juicy bait for the workers, who were deluded to envy and hate the middle class which had freed them. If the riches were taken away from the middle class, then the workers would become equals. He called this redistribution of wealth. Not wealth from the elite, with their vast fortunes in every country of the world-inherited fortunes which would not be taxed as income - but wealth from the strong middle class, which would be robbed in the name of the people. Only earned income would be vulnerable to seizure.

INCOME TAX - DIVIDE AND RULE

But in the way of all this happiness for the conspiring international elite and the slavery of the people, stood the United States, the British Empire, and Czarist Russia. They would have to be destroyed. Britain had only a small income tax, used for the armed forces, for roads, for the maintenance of law and order, and for the payment of a tiny body of bureaucrats who did the paperwork. The nonsense of Karl Marx had made little popular headway in Britain in Russia or in America. The United States, for instance had no income tax at all.

Over and over in America, the elite tried to establish their federal income tax, but they did not succeed. The people were too vigilant, too jealous of their freedom, too proud, too respectful of themselves. They embraced the ancient proverb, “To work is to pray,” and they guarded the fruits of their labors. No, America had no graduated income tax to drain the capital of the hard-working middle class, and so she became strong and rich and powerful, the envy of nations which exacted tribute and forced labor from their people. Attempts were made to exact such tribute from Americans during the Civil War and the war with Spain, but each time the Supreme Court declared that our Constitution prohibited it. As late as 1902 the graduated income tax was again declared unconstitutional, and the Chief Justice observed: “It is a method to enslave our people, and deprive them of their liberty and right to the fruit of their labors.”

WAR?

The conspiratorial elite fumed. How best, now, to institute their system of tribute and slavery? The solution was war. During wartime governments were better able to tax the people, harnessing their patriotism to maintain enlarged armed services.

And so the elite began to prepare America for war, and conspirators of the French and German and Russian and English elite worked with them - for the destruction of their own nationals, and the elimination, once and for all of the defiant middle class. Again the American elite, under the advice of their brother conspirators in. other nations, proposed an Amendment to the American Consitution, the Sixteenth Amendment - a graduated income tax, just as Karl Marx had proposed. To support this the elite were very busy, through their henchmen, the Socialists and the Populists, and through their secret Communists, in arousing the envy of the workers against the middle class. They told the workers that they would never be taxed, “only the rich” and even then the highest rate would be only two or three percent. And the taxes would go to “our exploited workers” through all sorts of governmental benefits. The unthinking, the envious and the stupid and the malicious, thought this was wonderful. They supported the Sixteenth Amendment, the federal income tax, and it was passed into law in 1913.

Now the stage was set for war, the attack on the British empire, Czarist Russia and the German empire. The major thrust of the effort to destroy freedom of the whole world, and reduce it to total control by the elite, had begun.

ECONOMIC SLAVERY

The rest is sad contemporary history. Few in America heeded what Thomas Jefferson had said long ago, that when we are taxed on our earned incomes, in our food and our drink, in our coming and going in our property, we would face the return of slavery and the reestablishment an all-powerful and despotic elite. So it is that we of the middle class are being destroyed in an ever-increasing power and despotism of a central government controlled by a conspiratorial elite, and everlasting wars to subdue us and drive us to our knees.

Do not believe for an instant that the world’s conspiring elite in every nation have so much as a serious quarrel among them. They have just one object: control through tribute. Your slavery through tribute, and mine. And they use wars for their purposes just as they use the inequities, harassments, bullying, capriciousness and extortion of their graduated income tax. The system of taxation with which they have yoked us is really forced tribute from the hardworking and especially from the middle class who are slowly being eliminated. The conspirators know that the spiralling payment of tribute will lead to our serfdom and the black night of slavery.

Behind this attack are the self-styled elite, secure in their own power and riches. Most of them have huge fortunes which are tax-exempt. But every man and woman of us - we of the middle class - are taxed in our food and drink, in our property, in our incomes, in our comings and goings. The harder we work the more tribute we have to pay, for the elite are determined that never again will the middle class challenge them and never again will we be able to save money and so rise to power, and never again will we protest the slavery they have planned for us.

But many of us still dare to protest and will continue to do so while God gives us breath. To be effective we know we must direct our attacks on the real criminals, the wealthy and powerful and secret elite of all the world - the conspirators laboring night and day to enslave us. Even our own government is now their victim. For it is the conspiratorial elite who choose our rulers, nominate them and remove them by assassination or smear. I have fought these enemies of liberty in every book I have written. But too few have listened to me, as too few have listened to others who have warned of these conspirators. The hour is late. Americans must soon listen and act …. or endure the black night of slavery that is worse than death.

Nicolaus Tideman

There is a bumper sticker that says, “If you want peace, then work for justice.” At a superficial level, this simple slogan contains an important half-truth. At a deeper level, it contains a more profound half-truth. To understand these half-truths and why they are only half true, we need to know what peace is, what justice is, and we need to understand the relationship between the two. So in this talk I want to explore the meanings of peace and justice, their relationship, and the role of economic reform in attaining both.

“If you want peace, then work for justice.” The more obvious and superficial meaning of this slogan is that people who are treated unjustly will prevent the attainment of peace until the wrongs to which they are subject are righted. Demonstrators shout: “No justice. No peace.” The apparent meaning of peace in this case is tranquility, the absence of strife. And if this meaning of peace is accepted, the slogan is true. You cannot expect to end strife as long as people have unresolved grievances. But the reason that this is only half true is that this meaning is only a shadow of what peace really is.

Peace is more than armistice, more than the cessation of violence. Peace is unity and harmony. In a peaceful world people are all pleased to cooperate with one another. When we have attained true peace, there will be no person who has any purpose that any other person seeks to thwart. In a peaceful world, everyone will feel the truth of John Donne’s meditation,

No man is an Island entire of itself; every man is a piece of the Continent; a part of the main; if a clod be washed away by the sea, Europe is the less, and well as if a promontory were, as well as if a manor of thy friends or of thine own were; any man’s death diminishes me because I am involved in Mankind; therefore never send to know for whom the bell tolls; it tolls for thee.[1]

Is it imaginable that we might ever attain a world where everyone felt so? And if we do so, what will be the role of justice in that world? What is justice?

There are so many conflicting, strident claims for different conceptions of justice that a person might reasonably despair of ever finding a meaning of justice that people would agree upon. Any conception of justice may seem to be no more than one person’s opinion. And yet there are things that we all know about justice. If I tell you that I stand before you as justice, you know that across my face you will find–a blindfold. In my left hand I hold aloft–a pair of scales. You know that in my right hand I have–a sword that I will use if necessary. And my gender is female.

The blindfold, the scales, the sword, and the feminine gender. These features of the traditional symbol tell us much about justice. The blindfold might seem out of place, since it prevents justice from either seeing what the scales say or wielding the sword effectively. But we know that the blindfold has a distinct and essential meaning. The blindfold ensures that justice will not be swayed by any visible characteristics of those who plead before her. Justice is not concerned with whether you are black or white, short or tall, beautiful or ugly. Every person receives the same treatment from justice.

The scales have at least two possible interpretations. The first interpretation is that the disputants at the bar of justice each place their arguments in one of the pans of the scales, and justice determines who has the weightier arguments. Our language supports this interpretation with references to the scales of justice tipping in one direction or another. But there is different use of the scales that is particularly relevant to questions of social justice, as opposed to personal disputes. The scales can be used to achieve an equal division. Justice is done when the contents of one pan of the scales are exactly balanced by the contents of the other. This is the meaning of the scales that I shall apply.

And then the sword. The sword represents the fact that justice is prepared to use the threat of force, and force itself, to see that her decrees are carried out. In a world where men have so often used weapons to achieve selfish dominance, the feminine gender helps make credible the claim that the sword is used only to achieve justice, and not to advance the selfish interests of the person who wields it.

Thus if we know that justice is the blindfolded woman with the scales and the sword, then we know that justice is the principles of equality and evenhandedness that command and prohibit the use of force in resolving conflicts.

Consider what this tells us. It tells us first that if we wish to claim that justice authorizes the force we wish to use, or that justice forbids the force that others wish to use against us, then we must be able to show that our claim is consistent with equality and evenhandedness.

The slogan “might makes right” is an oxymoron, a misuse of language. An autocrat like Genghis Khan who imposes his will on others, without any reference to principles, does not operate in the realm of justice.

Second, the blindfold tells us that we are not in the realm of justice if the principles we offer to explain why our use of force is justified are of the form, “Because I am better than you,” or Hitler’s, “Because Aryans are better than Jews.” Justice compels us to acknowledge the equality of all persons. Claims of individual or group supremacy cannot be accepted by justice.

Third, not only are all persons equal in the blindfolded eyes of justice, but their different goals in life all deserve equal respect. Lenin’s claim that all power should be in the hands of the Central Committee of the Communist Party, because the Party was the unique source of true understanding of the historical dialectic, cannot be accepted by justice. Even if the Party is the unique source of true historical understanding, that is not a sufficient reason to give all power to the party. Justice provides equal treatment for those who wish to pursue lives that are inconsistent with the advance of the historical dialectic. And any other elitist claim that some particular goal provides the basis for favored treatment must similarly be rejected by justice.

Even the utilitarian proposal that conflicting claims should be settled in the way that yields the greatest possible utility must be rejected as an elitist imposition of a particular goal on people who may have other plans. If I choose to pursue a life that can be guaranteed to lead to depression and despair, I have as much claim to the protection of justice in that pursuit as if I choose the path that leads to bliss. Justice must be neutral in its evaluation of people and their goals. As Bruce Ackerman has said in defining neutrality,

No reason [justifying the exercise of power] is a good reason if it requires the power holder to assert: (a) that his conception of the good is better than that asserted by any of his fellow citizens, or (b) that, regardless of his conception of the good, he is intrinsically superior to one or more of his fellow citizens.[2]

If we commit ourselves to neutrality, does that provide a unique definition of justice? No, it doesn’t. There are a number of definitions of justice that might claim to satisfy neutrality, although the claims of some definitions are dubious, and other definitions can be rejected on other grounds.

Consider first the conservative claim that justice is defined by traditional rules. The conservative says, “I don’t say that I’m better than anyone else, nor do I say that my conception of the good is better than anyone else’s. I may not even like what tradition demands. But if you want to be just, you will follow the rules that have traditionally been followed.” I have seen one drawing of justice that reflects this conservative view by portraying justice as a seated woman, with a book in her lap. The book is clearly the received law, the source that justice cites as the foundation of her decrees. But this is not the standard image of justice.

There is an important virtue of conservatism. This is that it eliminates the waste of resources in fighting over who has what rights, the waste from what economists call rent-seeking. Furthermore, there will be some situations where there is no time to secure agreement on anything other than the status quo. Thus there is reason to have at least some element of conservatism in the procedures by which disputes are resolved. But conservatism cannot be the ultimate rule of a just society. It would perpetuate slavery, the selling of daughters as brides, racial and sexual inequalities in civil rights, and every other historical injustice that, through our moral evolution, we have overcome. The neutrality of Conservatism is superficial. Conservatism cannot claim to offer either the evenhandedness that the blindfold promises or the equality that scales require.

Next, consider the claim that justice is defined by what the majority wants. The majoritarian says, “If you want to know who should prevail in a conflict, take a vote.” As appealing as majoritarianism may be on the surface, it cannot provide a coherent theory of justice.

If one wishes to make sense of majoritarianism, one must first specify the perspective from which voters are expected to vote. Are voters to vote as proponents of their selfish personal interests, or are they to vote as disinterested judges of what is best?

Suppose first that voters vote on the basis of their selfish personal interests. Then voting is incoherent as a basis for justice. If voters always vote selfishly, then at any time when you might think that the voting was over, there will always be some measure that can be proposed that will benefit a majority at the expense of a minority, which could therefore be adopted by selfish voting. The process of deciding by voting will never end if any proposal can be advanced at any time and people always vote selfishly. Selfish voting can be used to decide between any two proposals. And it can be used in more general settings if there is some more or less arbitrary stopping rule to keep the process from going on indefinitely. But selfish voting as a general mechanism for determining what is just is incoherent.

Now suppose that voters behave as unselfish, disinterested judges of what is best. In this case, voting as a mechanism for determining what is just is incomplete, because it leaves unanswered the question of what is meant by “best.” Does “best” mean “creates the greatest total utility” or “comes closest to preserving the expectations of the status quo” or “maximizes the rate of growth of the population” or something else? How would you know what best means? If the Supreme Court knows that what is best is what comes closest to preserving the expectations that have developed from our Constitution and traditions, then the justices can employ voting to decide cases and establish new precedents. But to say that what is just is what is voted to be best by unselfish, disinterested judges without specifying what best means is to decline to answer the question of what justice is. Thus neither selfish voting nor unselfish voting serves to define justice, although there can be an element of voting in our efforts to resolve disagreements about what an agreed definition of justice requires in particular circumstances.

If voting cannot be used to define justice, one might entertain the possibility of using a contractarian formulation: What is just is the rules to which people would have agreed if they did not know their personal circumstances. In his 1958 paper, “Justice as Fairness,” John Rawls said,

[Suppose that a group lets] each person propose the principles upon which he wishes his complaints to be tried with the understanding that, if acknowledged, the complaints of others will be similarly tried, and that no complaints will be heard at all until everyone is roughly of one mind as to how the complaints are to be judged. . . . each person will propose principles of a general kind which will, to a large degree, gain their sense from the various applications to be made of them, the particular circumstances of which being as yet unknown.[3]

This is a reasonable recipe for implementing the Golden Rule and a fine idea for seeking agreement about the principles by which complaints shall be judged. If people were to follow this suggestion and achieve the agreement that is described, they would achieve fairness.

However, this does not make Rawls’s suggestion a good way to identify justice. The critical difficulty with his suggestion is that those who mete out justice cannot afford the luxury of securing complete agreement on principles. They must bring their judgement to bear on those who have not agreed on principles. In this context, the closest that a person can come to Rawls’ suggestion is to ask himself, “Are the principles that I propose to apply ones that I would agree to if I did not know how I would personally be affected by them?”

In later writings, Rawls claims that in the original position, people would choose the rules that maximized the well-being of the representative member of the least advantaged class.[4] John Harsanyi, on the other hand, has said that in the original position people would choose the rules that maximized average utility.[5] Someone else might say that in the original position people would choose the rules that provided the greatest stability. How can we know what people would choose?

No matter how a contractarian answers this question, there will be the difficulty raised by Ackerman, in Social Justice in the Liberal State. Describing the attempt to apply the Rawlsian criterion, Ackerman says:

Despite my best efforts, I shall be defenseless . . . the moment I try to make it clear to another person why it is right that I, rather than he, should establish a claim over a disputed thing: I: When I look into myself, I am sure that I would have insisted upon this right as a condition for entering society with you. YOU: You haven’t the slightest idea what you would have insisted on in a presocial state. You’re simply using the idea of a potential entrant as a screen upon which to project the deepest desires of your socialized self. But I too have desires; why should mine be sacrificed to yours? And if you insist, it is possible that I too may delve deep into my psyche and find a transcendent grounding for my desires.[6]

The sword of justice is too momentous to be constrained by only the requirement that those who judge be able to convince themselves that their judgements satisfy principles to which they would have agreed, if they had not known how they would be affected by those principles. The contractarian approach may be a good way to seek consensus. It may be a good guideline for those who are called upon by disputants to arbitrate between them. But it is not a good way to define justice.

Next, consider egalitarianism. The egalitarian says that justice is equality. There is a conceptual difficulty in specifying how beings as different from each other as humans are could ever be equal, unless we create a society where all humans are female clones of one another. (This should be technologically feasible within a few decades, if it is not already.) But I do not think that egalitarians want a society of clones.

Ackerman has offered a suggestion for determining whether any persons among a genetically diverse group are genetically disadvantaged. His suggestion is that, to be genetically undominated, a person must possess a set of abilities that permit him to pursue some life purpose that some persons have, with as much facility as any other person is able to pursue that life purpose. And Ackerman asserts that every person has a right to be genetically undominated.[7]

I doubt that we have the technological capability yet to ensure that every child who is born will be genetically undominated, and until we have that capability and decide to use it, any egalitarian will need to deal with the question of how genetic inequalities are to be rectified.

John Rawls has proposed that the talents that individuals possess be regarded as a common pool, so that anyone who has more than his share has an obligation to compensate those who have less then their shares.[8] Ronald Dworkin has made the contractarian suggestion that people can justly be required to pay an income tax that represents the insurance against being untalented that they would have desired to purchase before they knew what talents they would have.[9]

Dworkin’s acknowledges that his suggestion would not produce equality. If we believe Harsanyi’s claim that people who did not know their personal circumstances would want to maximize their expected utility, then, even in the absence of adjustments for incentive effects, Dworkin’s suggestion leads not to equal utilities, but rather to equal marginal utilities of money, which generally implies unequal utilities when people have different capacities to get utility from money.

Ackerman suggests that each person who is genetically dominated is owed compensation by those who dominate him.[10]

All of these suggestions should be rejected. Talents are not a common pool from which some persons have taken more then their shares. If we are all fishing in the same pond, the quantity of fish that you take will diminish the quantity that is available to me. But the quantity of talent that you have in no way diminishes the quantity that is available to me. Your talent is not acquired at my expense.

From the perspective of peace, no man is an island; each of us is a part of mankind. And any of us who has been graced with an extra measure of talent should recognize that, often, the best use of our talent is to provide for others. Nevertheless, from the perspective of justice, each of us must be allowed to act like an island if he wishes.

Suppose that a bone-marrow transplant from me would save your life–or at least prolong it. And suppose that there is no other person whose tissue type matches yours. Would you assert that you have a right to receive such a transplant whether or not I want to give it? Would you suggest that the sword of justice should be used to force me to give it? An egalitarian ought to be prepared to require me to provide the transplant, for if I refuse I am denying the possibility of continued life to another person, when I have continued life for myself, and the cost to me would be relatively modest.

If you do not mind requiring a bone-marrow transplant of me, then what about a kidney? Suppose that, through no fault of your own, both of your kidneys have failed, and I am the only person who has a kidney that is compatible with your tissue. Would you force me to donate a kidney? And if you call yourself an egalitarian and you would not, then why not? After all, I have two working kidneys and you have none. What could be more equal than requiring us to divide the available working kidneys equally?

If you do not mind requiring me to donate a kidney, then what about my heart? Suppose that I have lived for 50 years and you have lived for only 25. Your heart has been damaged by an illness, through no fault of your own. I have the only heart that matches your tissue, and it would be good for another 25 years. One of us will have to die. Why shouldn’t we put the one available heart in your chest, so that we might divide the available years of life equally between us? A good egalitarian should require me to part with the one available heart after I have had my share of years.

But I don’t think you would. I don’t think anyone would. We are not egalitarians. We recognize the sanctity of the boundaries of the human body. In a peaceful world I will gladly give a spare kidney to anyone who needs it. But in a just world, no one will forcefully extract a kidney from me, even to save someone else’s life. Justice is not egalitarianism.

Just as I own my kidneys, so do I own my talents. In a peaceful world I will use them for the benefit of all mankind. But the sword of justice should not be used to force me to compensate those with less talent. Nor should it be used to force me to abide by the insurance contract that you believe I would have signed, if I had had the chance, before I knew what talents I would have. Nor, in Ackerman’s framework, should I be held responsible for the fact that someone else decided to have a child that turned out to be genetically dominated by me. If anyone is held responsible for the fact that a genetically dominated child is brought into the world, it should be the child’s parents. And if the parents are irresponsible, then the parents’ parents, or the parents’ teachers, should be held responsible.

If would-be parents are too poor to provide for the children that they ought to be able to have, then we should ask whether their parents provided inadequately for them, or whether they were unjustly deprived of resources that ought to have been theirs. But it is not a reason to levy assessments on those who have talent. An egalitarian redistribution to compensate for differences in talent is as unjust as an egalitarian redistribution of kidneys. Egalitarianism is not justice.

A proper definition of justice begins with the principles of classical liberalism. In a just world each person is permitted to determine the purposes to which his or her body is put–the hands and the brain no less than the kidneys. We each have rights of self-determination. This includes the right of ownership of what we produce, at least, as John Locke said, when we leave as much in natural opportunities for others as we appropriate for our own productive activities.[11]

We have the right to co-operate with whom we choose for whatever mutually agreed purposes we choose. Thus we have the right to trade with others, without any artificial hindrances, and we have the right to keep any wages or interest that we receive from such trading.

These components of the classical liberal conception of justice are held by two groups that hold conflicting views on a companion issue of great importance: how are claims of exclusive access to natural opportunities to be established?

John Locke qualified his statement that we own what we produce with his famous “proviso” that there be “as much and as good left in common for others.” A few pages later, writing in the last decade of the seventeenth century, he said that private appropriations of land are actually not restricted, because anyone who is dissatisfied with the land available to him in Europe can always go to America, where there is plenty of unclaimed land.[12] Locke does not address the issue of rights to land when land is scarce.

One tradition in classical liberalism concerning claims to land is that of the “homesteading libertarians,” as exemplified by Murray Rothbard, who say that there is really no need to be concerned with Locke’s proviso. Natural opportunities belong to whoever first appropriates them, regardless of whether opportunities of equal value are available to others.[13]

The other tradition is that of the “geoists,” as inspired if not exemplified by Henry George, who say that, whenever natural opportunities are scarce, each person has an obligation to ensure that the per capita value of the natural opportunities that he leaves for others is as great as the value of the natural opportunities that he claims for himself.[14] Any excess in one’s claim generates an obligation to compensate those who thereby have less. George actually proposed the nearly equivalent idea, that all or nearly all of the rental value of land should be collected in taxes, and all other taxes should be abolished. The geoist position as I have expressed it emphasizes the idea that, at least when value generated by public services is not an issue, rights to land are fundamentally rights of individuals, not rights of governments.

There are two fundamental problems with the position of homesteading libertarians on claims to land. The first problem is the incongruity with historical reality. Humans have emerged from an environment of violence. Those who now have titles to land can trace those titles back only so far, before they come to events where fiat backed by violence determined title. And the persons who were displaced at that time themselves had titles that originated in violence. If there ever were humans who acquired the use of land without forcibly displacing other humans, we have no way of knowing who they were or who their current descendants might be. There is, in practice, no way of assigning land to the legitimate successors of the persons who first claimed land. And to assign titles based on any fraction of history is to reward the last land seizures that are not rectified.

The second fundamental problem with the position of the homesteading libertarians is that, even if there were previously unsettled land to be allocated, say a new continent emerging from the ocean, first grabbing would make no sense as a criterion for allocating land.

It would be inefficient, for one thing, as people stampeded to do whatever was necessary to establish their claims. But that is not decisive because, if we are concerned with justice, it might be necessary for us to tolerate inefficiency. But the homesteading libertarian view makes no sense in terms of justice. “I get it all because I got here first,” isn’t justice.

Justice–the balancing of the scales–is the geoist position, “I get exclusive access to this natural opportunity because I have left natural opportunities of equal value for you.” (How one compares, in practice, the value of different natural opportunities is a bit complex. If you really want to know, you can invite me back for another lecture.)

Justice is thus a regime in which persons have the greatest possible individual liberty, and all acknowledge an obligation to share equally the value of natural opportunities. Justice is economic reform–the abolition of all taxes on labor and capital, the acceptance of individual responsibility, the creation of institutions that will provide equal sharing the value of natural opportunities.

Getting back to where we started, is it true that, “If you want peace– real peace–you should work for justice?” and if so why? Well, it’s half true. To see why, consider what peace is, and how one might create it.

Peace is unity and harmony. Peace is people recognizing that we are all parts of one another, that it is always for ourselves that the bell tolls.

What keeps us from attaining peace? One of the greatest hindrances to the attainment of peace–real peace–is that resistance that so many of us feel to tolerating oppression and injustice. When we know that we, or others we care for, have been treated unjustly, it is ever so difficult to attain a state of unity and harmony with others. The leap to peace is so much easier from a position of justice. So, even though peace and justice are very disparate things, and peace is much the more attractive one, still it make sense, if you want to help people reach peace, to work for justice.

But the reason that this is only half true is that, in fact, justice is not actually necessary to your attainment of peace. If you want peace for yourself, you can have it, at any time, in any circumstances in which you find yourself. Whether you are treated justly or not, you are a part of the being that is all humanity. Each person’s joy is your joy. Each person’s grief is your grief. You don’t have to wait until you are treated justly to see this.

So if you want a peace for others, then work for justice. Work for freedom. Work for the elimination of all taxes on the productive things that people do. Work for equality in the right to benefit from natural opportunities. All these things will make it easier for people to make the leap to peace.

But if you want peace for yourself, simply have it.
Endnotes

1. John Donne, Meditation XVII.

2. Bruce Ackerman, Social Justice in the Liberal State, New Haven: Yale University Press, 1980, p.11.

3. John Rawls, “Justice as Fairness,” Philosophical Review, 57 (1958), pp. 171-72.

4. John Rawls, A Theory of Justice, Cambridge: Harvard University Press, 1971, pp. 75-83.

5. John Harsanyi, “Can the Maximin Principle Serve as a Basis for Morality? A Critique of John Rawls’s Theory,” American Political Science Review 69 (1975), p. 594.

6. Bruce Ackerman, Social Justice in the Liberal State, New Haven: Yale University Press, 1980.

7. Ibid., pp. 113-120.

8. John Rawls, “Distributive Justice,” in E.S. Phelps (ed.), Economic Justice, Harmondsworth, Middlesex, England: Penguin, 1973, p. 338.

9. Ronald Dworkin, “What is Equality? Part 2: Equality of Resources” Philosophy and Public Affairs 10 (1981), pp. 283-345.

10. Ackerman, Op. cit., pp. 132-33.

11. John Locke, Second Treatise of Government, paragraph 27.

12. Ibid., paragraph 36.

13. Murray Rothbard, The Ethics of Liberty, Atlantic Highlands: Humanities Press, 1982.

14. For a concise statement by Henry George, see his Progress and Poverty, Book VII, Ch. 1.

What happens when a state radically slashes its property tax?

California can show you 17 years of experience. Here is what has happened since California passed Proposition 13 in 1978.

The obvious direct results have been to cut public services, raise other taxes, and lose credit rating.

Our school support fell from #5, nationally, to #40 in 1985 when last seen, still falling. County road maintenance is down to where my county (Riverside) is repaving its roads at an annual rate of once every 130 years. Once in 20 years is recommended here, and up north you generally need higher frequency. You can’t just build infrastructure and then stop paying for it, it’s a perpetual commitment. Thanks to urban scatter, a high fraction of our population now depends on these county roads.

In 1978 we had a surplus in Sacramento. Since then we have raised business taxes, income taxes, sales taxes and gas taxes, but go broke every June, even as other states are in the black again. Now our State bond rating is last among the states. One of our richest counties (Orange) has gone bankrupt; Los Angeles is on the brink of it, saving itself by closing emergency rooms and hospitals that serve as a last resort for the uninsured poor. We are ill-prepared for Congress’ current move (right or wrong) to shift more functions back to the states.

The private sector fares no better. Raising income taxes, business taxes, and sales taxes is no way to stimulate an economy; each is a drag on work and enterprise. Our income per capita was down from #7 to #12 among the states by 1992, then fell more: from 1992-94, California was one of three states where median household income fell. Our unemployment rate is 9%, 50% higher than the national mean of 6%. Our poverty rate is 18%, compared to 14.5% nationally. That helps explain why the only government function that grows now is building and operating prisons. One of our few rebounding industries is cinema. Another thriving trade is auctioning off used machinery for export to the east.

In 1993 there was net out-migration (including international migration) from this state that has symbolized American growth since time immemorial. It is unheard of: 426,000 people were lost, nearly 2% of the population. This is a watershed change: imagine, of all states California, America’s trend-setter, our El Dorado, The Golden State, our Horn of Plenty, the safety-valve for job-seekers and retirees and entrepreneurs from everywhere, the end of the rainbow, losing population! It’s enough to make a person ask “What are we doing wrong?”.

The fall of our income per capita is greater than appears from the purely monetary measure. Real pay (in constant $) has fallen more, because of the drastic rise of shelter prices. In San Francisco, shelter takes 50% of the median income, with many other cities, especially coastal ones, not far behind. It is unusual to find livable quarters for less than $600/month. The median home price rose 163% during the 1980s, to $258,000 (that is just the median - the mean is higher). These rises are part of the C.O.L. of all renters and new buyers, a part not fully incorporated in standard CPI measures (for various foolish reasons too technical to open up now).

Some cities are in desperate straits. San Bernardino in 1976 was chosen an “All-America City, a City on the Go.” Go it did: today, 40% of its people are on welfare.

California has always been earthquake country, but has always renewed itself, routinely. It was different after the Northridge quake in the San Fernando Valley, January, 1994. This is the upper-middle neighborhood of Los Angeles, but now large pockets of ruined buildings remain, unreconstructed, inhabited only by vagrants and criminals: an instant Bronx West. These blighted sections, ominous portents, spread more blight around them.

It should give one pause. It is, however, if you think about it, the expectable result of what the voters did. They turned property from a functional concept into a sacred one; from a commission to be enterprising, hire people, produce goods, and pay taxes into a welfare entitlement. They rejected the concept of taxing inert wealth in favor of the alternative: taxing liquidity, cash flow, work, production, and commerce. The predictable result is to inhibit economic activity, and encourage holding wealth inert and stagnant

We had a construction boom in the 1980s, but it was not healthy. It was marked by extreme scatter, and extreme instability. Downtown L.A. was to become a great new financial capital, but now has nearly the highest office vacancy rate in the U.S., with of course a high rate of builder bankruptcies. Speculative builders were led on to overbuild, in part, by anticipated higher land rents and prices. This Lorelei effect was magnified by national income-tax provisions, luring on speculative builders, but we have to ask why California fell harder than other states, even with the object-lessons of the oil states in clear view.

David Shulman tersely summarized the distributive effects of Prop. 13 as he left us to become Chief Equity Strategist for Salamon Brothers in Manhattan: “it breached the social compact.” Alienation is the result, and the results of alienation are the Rodney King riots, arson and looting. The Watts riots, you may object, preceded Prop. 13, and you are right.

However, the Watts riots were part of a national epidemic. By 1967 there were riots with arson and looting in 70 or more American cities. The Rodney King riots were endemic to California, and they spread over a much wider area of Los Angeles than the Watts riots did. The looters and arsonists were not all black, and the targets were not all white, but mainly Korean-Americans who just happened to be there minding their stores.

Conventional wisdom now blames our California bust on the end of the Cold War. Surely that is a factor, but as a causal explanation it is too pat, too easy, and too convenient. It shifts the load off ourselves onto impersonal historical forces - the Marxist world view. Let us see if it can survive analysis.

Compare today with 1945.

Los Angeles’ economy depended much more on The Hot War, 1940-1945, than it ever did on The Cold War. Los Angeles’ wartime boom had swelled its population as no other great city, 1940-45. After 1945 the U.S. pulled the plug on defense spending, more than today. Jane Jacobs, in The Economy of Cities, tells us what happened to military spending in Los Angeles after 1945. It lost 3/4 of its aircraft workers, and 80% of its shipbuilders. It lost its military and naval overseas supply and replacement businesses. Troops stopped funneling through. It got worse: petroleum and cinema and citrus, its traditional exports, all declined.

Pundits then forecast a regional collapse, but Los Angeles boomed, instead. The wartime immigrants stayed. They formed creative, innovative small businesses in large numbers, giving L.A. its deserved reputation for having the most dynamic, flexible, adaptable industrial base in the nation. Besides exporting goods, L.A. also became more self-contained, providing itself with more of the goods it previously imported. How could this be? Angelenos had access to land, the basis of all supply and demand in any economy.

1/8 of all new businesses started in the U.S. were in L.A., 1945-50. These were small, creative, flexible, miscellaneous, and too varied and dynamic to classify. No Linnaeus could sort them in static conventional boxes; they were the despair of traditional economic geographers and base theorists, who were at a loss to explain the region’s thriving economy. The new Angelenos stayed and started producing everything for themselves, some things previously imported, and others never seen before.

Eastern firms established branch plants here. Top eastern students came to California’s great university system, and stayed behind to make careers and jobs here, and send their children through California’s excellent public schools. California became famous for supporting outstanding higher education at three tiers, K-12 education, adult education, highways, water supplies, public health, public safety, and other public services, all without repelling business by taxation. There was a kind of regional “El Dorado Effect,” as demand and supply grew together, and growing local demand allowed for economies of scale serving local markets. Food and shelter were cheap and abundant. Land for business was accessible, providing a basis for the whole self-contained phenomenon. A “continental tilt” developed in both interest rates and wage rates, drawing in eastern capital and labor.

Why is that not happening today, 1995? An invisible, pervasive change is Proposition 13, which makes it possible to hold land at negligible tax cost.

In 1945 land was taxed at 3% every year, building a fire under holdouts to turn their land to use. Today that same tax cost is well below 1%. Using Gwartney’s Rule of Thumb (see below under #2,A, “Reassessing Land Frequently”) it is about 1/8 of 1%: a rate of 1% applied to 1/8 of the true value.

Landowners are only taxed now if they use their land to hire people and produce something useful. Then they meet the drag of our high business and employment and sales taxes, necessitated by the fall of property taxes. A handful of oligopolistic landowners control most of the market; small businesses are squeezed out.

This helps us segue from being at the cutting edge of industrial progress to a third-world economy - with little relief in sight.

What was different then? One obvious difference was the lower burdens of sales tax, business tax, and income tax. We had high property tax rates, but they were more focused on land than now, less on new buildings. California was more hospitable to Georgist thinking than perhaps any other state then, shown by its long run of Georgist political action in the prior thirty years. Most people today are totally numb on this subject, which has been blanked out of our history books.

A Brief Historical Review

Several states had “single-tax” movements and initiatives, 1910-14, but most of them petered out. In California they continued through 1924, and then popped up again in 1934-38. In 1934 the “EPIC” campaign of Upton Sinclair included a strong Georgist element - he proposed to set up new factories and farms on idle land. Meantime, Jackson Ralston was pushing a pure land tax initiative, 1934-38.

Sinclair and Ralston lost, but the mere existence of such political action in California, when the movement was torpid elsewhere, tells us a lot. It reveals a large matrix of supportive voters and workers, with effective leaders, to whom politicians (including elected County Assessors) would naturally respond by focusing on land assessments. Politicians survive by accommodating and absorbing dissident movements. Even while “losing,” such campaigns raise consciousness of the issue. Thus, in California, 1917, land value constituted 72% of the assessment roll for property taxation.

This remained the California tendency for years.

California was different. Even into the 1960s, Sacramento County elected an avowed single-tax Assessor, Irene Hickman; San Diego County harbored an active movement for raising land assessments. The Henry George Schools of San Francisco, San Diego, Los Angeles, and Sacramento were the most active such schools in the country: four in one state, when most had none. State Senator Al Rodda, Chair of the Senate Finance Committee, held hearings and tried to push land tax legislation through his Committee in the 1960s and early 1970s. He assigned a staffer, Jack Massen, to spend a year working out the detailed effects on intergovernmental relations. Assemblyman Dr. William Filante, from a base of Georgist support in Marin County, picked up the torch, too.

California displayed amazing prosperity and growth up to 1978. It had the resilience to shrug off the loss of war industries after 1945 and still grow “explosively” (as Jane Jacobs put it). After 1978 we have had, instead, a string of reverses. The timing, along with a priori causative analysis, plus various direct observations too numerous for this time-slot, support an hypothesis that the reverses were aggravated by Prop. 13.

Enforcing good laws we already have

A. Reassessing land frequently

It is important to assess land for tax purposes early and often, especially on a rising market. (Landowners will see to it you do so on a falling market.) Over time, land appreciates more years than not, while buildings depreciate physically every year. Lagging assessments therefore automatically overtax buildings relative to land.

New Hampshire Assemblyman Richard Noyes has circulated data on the effect of reassessment in NH.

The land fraction of assessed value rises each time there is a reassessment. Keene, NH, is in the lead, with frequent reassessments, a high fraction of land in the mix, and a strong track record attracting enterprise and jobs.

In California, where we used to have good assessment, we now have bad assessment legally mandated by Prop. 13. So long as land is unsold, and/or not newly improved, its assessment rise is capped at 2% a year, while market prices soar. Here is one example of the results. This year the Metro Water District of Southern California (MWD) condemned 410 acres for its new Domenigoni Reservoir to expand the system (to accommodate land speculators in the desert boonies). The jury hit them for $43 millions, which works out to about $1.95 a square foot.

The question occurred to me, how does that square with the assessed value for property taxation? I asked Ted Gwartney, a professional appraiser with the Bank of America, to check the assessed value. It is about 7 cents a square foot. The condemnation price, supposedly based on market value, is about 28 times the assessed value.

This is not the result of fractional assessment.

In California we assess property at 100% when land changes ownership, or there is new building. Rather, this is the result of Prop. 13 and its prohibition of market reassessment until land sells.

I thought that was startling, but Mr. Gwartney’s reaction was “Ho-hum, what else is new?” He, who works with such data every day, has a rule of thumb that market land value in California today is about 8 times assessed value. That is important enough to repeat: our assessed land values are routinely at 1/8 of true land value. I wouldn’t dare say that on my own authority, but Mr. Gwartney is here to confirm it. He is a veteran appraiser; for many years he was Director of Assessments for the entire Province of British Columbia.

Does this help you understand why California landowners are now so slow to adapt to new demands, and respond so slowly to the withdrawal of old military demands? In 1945 the assessors were building fires under them, so they sought new uses to meet new needs.

Today there remains a weak incentive to improve to improve property: tax collectors generally cost them money when they make improvements. Sit still, lie low, hire no one, hang on, produce nothing, and your holding costs are negligible.

A little of the old magic lingers. In October, 1995, a 225 acre parcel in Corona, the Chase Ranch, was sold to a builder, Coscan Davidson Homes, for building 967 units. The previous owners, “GGS,” including a Japanese insurance firm, were “seeking a way out. They were behind in tax payments, and GGS was losing its staying power …” quoth Stephen Doyle, spokesman for the buyer. It is that “staying power” that stifles land use and production. Coscan wants to build immediately. Even so, though, they plan to take 5 years to build out the project - if everything goes well. This is the new, post-Prop.13 meaning of “immediately.”

In spite of extreme under-assessment, the assessed value of taxable land in California is 40% of the total real estate value. Imagine what it would be if assessed values were real values, “marked-to-market,” as the law used to stipulate. It would be over 70%, as in 1917. “Staying power” would go down; land use, jobs and production would rise.

B. Using the building-residual method

It is equally important to use the “Building-Residual Method” of allocating value between land and buildings. This means you value the land first, as though it were vacant, based on highest and best use.

You subtract this land value from the total value of land-cum-building as currently improved: the residual, if any, is building value.

Valuing one lot or parcel this way, you have information needed for valuing neighboring and other comparable parcels. Using a map with value contours, you can value a whole city this way with surprising ease and speed.
Using this method, I valued Milwaukee land in 1963 and 1967. The building-residual method nearly tripled the land values reported by the City Assessor, who was using the assessor’s usual inconsistent mix of various other methods. How’s that again? Did I say tripled?

Yes, I really said “tripled.” By his methods, buildings on the eve of demolition were carrying values higher than their sites; by the building-residual method these old buildings had no value at all, which of course is why they were being torn down. Besides depreciation and technological obsolescence, many buildings suffered severe “locational obsolescence,” owing to shifting demand patterns. The land was re-usable, and had as much or more value without the extant buildings.

Using the building-residual method requires no change in present laws. It is within the latitude of assessing officials. These worthies, in turn, respond to public opinion. The conscientious citizens’ move is to raise consciousness and bring pressure, just as the old single-tax campaigners like Jackson Ralston did.

In the process of “losing” they won over half of what they sought, just by taking a stand and making the effort.

C. Federal income taxes

Assessors’ problem today is that the strongest pressures they feel are from owners wanting to allocate as much value as possible to buildings that they may depreciate for federal income tax purposes. Here is where we must study how the parts fit together to form the big p