Renegade Economist: The Michael Hudson Series

[c1ue]

Re: Why the land went up

The land increased in value because it was close to silicon valley. It was not because of public works or any tax paid expenditure. So I don't see why the government should get the windfall.

Actually, it is very clear that Silicon Valley exists in significant part because of massive government expenditures on defense. It wasn't infrastructure spending in the road building sense, but then again the Department of Defense buying all of Intel's early output (and Fairchild's, etc etc) is very much a purse string to government.

Be that as it may, it is not clear at all to me that the value of San Francisco real estate was only because of Silicon Valley. SF has major tourism, corporate headquarters, and FIRE activity as well.

If I count property taxes paid over 50 years, the return would be closer to 5%, in the range of what stocks could provide.

I find it difficult to see how you can go from a 9.1% annual return from 1959 to present, to a 5% return, given a 1% property tax in 1973. This tax in turn could increase no more than 2% a year. I guess the property tax was much higher prior to 1973? Certainly the property taxes being paid for 2012 would comprise only less than .3% of the value of the property, much less the land alone.

The mortgage holders got an incredible deal. The inflation of the 1970's devalued their monthly payments, at the same time the land appreciated in real terms. When they retired in 80's and 90's, those people could sell their house and live on the proceeds.

I think that would be true for someone who bought in the '70s, but is much less true for someone who bought in earlier periods. Even if your parents had bought said land with a mortgage, by 1973 (when inflation really started) I'd think that most of the interest had already been paid. So there would be some benefit from paying off principle with devalued dollars, but not clear to me at first glance that this offsets the interest payments.

No question the appreciation made the above calculation moot, however.

Then again, the victims of financialization aren't the people who are adult at the time, they are the ensuing generations. You personally are less affected, but your kids certainly are in a much more difficult situation.

I pity the 18 to 25 year olds now - between student loans, high housing costs, and poor job prospects.

[Polish_Silver]

Re: Why the land went up

[QUOTE=c1ue;227487]Actually, it is very clear that Silicon Valley exists in significant part because of massive government expenditures on defense. [Quote]

I am not convinced that defense spending caused silicon valley. Could you give me a reference on intel's first products being sold primarily to the military?

Hewlett Packard got going long before WW II, and Apple got big without any military products. The defense oriented companies like Raytheon and Texas Instruments never had much footprint in silicon valley.

Be that as it may, it is not clear at all to me that the value of San Francisco real estate was only because of Silicon Valley. SF has major tourism, corporate headquarters, and FIRE activity as well.

Bay area real estate was not pricey at all before the early 1970's. During that time San Jose's population grew very quickly,
while San Francisco barely grew. The biggest price increases happened in the 1970's, before the FIRE economy got going.

I find it difficult to see how you can go from a 9.1% annual return from 1959 to present, to a 5% return, given a 1% property tax in 1973.

Proposition 13 took effect in 1978, and reset assessed values to the 1975 value.
I am claiming a 5% inflation adjusted return.

Even if your parents had bought said land with a mortgage, by 1973 (when inflation really started) I'd think that most of the interest had already been paid.

No way. They bought the lot in about 1959. 14 years into a 30 year mortgage, the bulk of the monthly payment is still interest.

I pity the 18 to 25 year olds now - between student loans, high housing costs, and poor job prospects.

The poor job prospects are certainly a problem. Housing costs are reasonable in many non-bubble areas, like where I live now. I just overheard two young people discussing nice apartments they could get for $450/month.

[charliebrown]

Re: Why the land went up

During the early 90's I was told that keeping my condo and renting it out was the thing to do. I live in the Chicago suburbs.

When I did the math, I like you, found that the rent I receive would only give me a few percent over my costs. If I get a bad renter
that trashes the place or association fees or holding costs increase or local property taxes increase, I could suffer years of lost profit.
This also meant handling the maintenance myself too, which means calls in the middle of the night on weekends etc. Hire a
maintenance man to do this and I'm cash flow negative.

The only way to really make
money was on price appreciation. I was not ready to gamble on that, and did not take the dive.

My exact condo that I sold for 70K, is now 140K even after the decline. I don't know how the economics look now, prop tax, assessments etc.

[Milton Kuo]

Re: Why the land went up

The only way to really make money was on price appreciation. I was not ready to gamble on that, and did not take the dive.

That is is exactly the FIRE economy real estate game: capital appreciation with almost no regard for being cash-flow positive. I seem to recall that Dr. Hudson's comment about the FIRE economy's policy on real estate as an investment is, "Rent is for paying interest." That is: get an interest-only loan with as little down payment as possible (maximize leverage); use the rent from the property to pay the interest while waiting for the real estate to bubble (make absolutely no real improvements to the real estate); and finally, sell the real estate, often at a preferential tax rate, for a massive, unearned profit.

[Polish_Silver]

Re: Why the land went up

real estate to bubble (make absolutely no real improvements to the real estate); and finally, sell the real estate, often at a preferential tax rate, for a massive, unearned profit.

On this, I would say Hudson hit a bullseye. The FIRE interest manipulate the system to foment bubbles, then time their purchases and sales to exploit the less savvy individuals. The bubble causes the price to appreciate at a very high rate, and they have leveraged their capital to magnify the gains. According to me, the solution would be to prevent bubbles through interest rate policy, taking leverage away from the banks, etc. Without the bubble, it is not lucrative and not exploitative.

However, this is quite different from the gradual price appreciation observed in San Francisco over the last 50 years, which is now, quite obviously, at an end.

CB, when did you sell the condo? I am betting the price has barely kept pace with inflation, and far underperformed gold or silver. Not to mention the significant carrying costs of taxes, insurance, maintenance, etc.

[c1ue]

Re: Why the land went up

I am not convinced that defense spending caused silicon valley. Could you give me a reference on intel's first products being sold primarily to the military?

Intel's microprocessor division didn't start to dominate Intel's overall revenues until the '80s. Prior to that, Intel made and sold various forms of memory, primarily for defense applications (think ICBM/guidance/satellite) but also significant government work. Intel's founders both come from Fairchild, which prior to entering the semiconductor business was a camera company selling its products for satellites and plane reconnaissance. The semiconductor industry started in the '60s, thus for 20+ years was sustained almost exclusively by defense and government.

From Fairchild you can trace the roots of a large percentage of the major companies in the semiconductor business today.

Hewlett Packard got going long before WW II, and Apple got big without any military products. The defense oriented companies like Raytheon and Texas Instruments never had much footprint in silicon valley.

HP existed before World War II, but didn't actually make any transistors until the '60s. They have been an electronics company for a long time. As for Raytheon - Raytheon makes systems but hasn't made components for a while. Equally TI was also a major recipient of defense spending, but unlike most of the rest of the semiconductor industry, chose to base itself in Texas. TI was known for guidance systems for missiles and bombs in the '50s and 60s, for example.

Bay area real estate was not pricey at all before the early 1970's. During that time San Jose's population grew very quickly,
while San Francisco barely grew. The biggest price increases happened in the 1970's, before the FIRE economy got going.

I do agree major price increases occurred in the 1970s due to the high inflation of the pre-Volcker shock. Certainly by the mid '90s, real estate in the Bay Area was already unaffordable. However, it is not clear to me that the financialization did not occur until later; many of the financing methods and laws like Proposition 13 were in place long before the 'big bubble', if not necessarily due to direct bankster action.

Proposition 13, for example, was not clearly funded by banksters, though there was a very clear demographic split between owners/rents, conservative/liberal, older/younger in the vote to approve it.

No way. They bought the lot in about 1959. 14 years into a 30 year mortgage, the bulk of the monthly payment is still interest.

14 years into a mortgage, the total interest paid out to date out of the total interest to be paid ranges from 61% to 65%. The higher the rate, the lower the percentage paid to date. So while you are correct that the majority of the monthly payment is still interest, the majority of the interest has already been paid. Furthermore in the ensuing 7 years (15 to 21), the interest to principal ratio rapidly shifts to 1 to 1. Thus while the inflation of the mid to late '70s certainly did devalue the dollars being used to repay the mortgage, the effect was on increasing less of the outstanding interest, though the inflation did significantly affect the principal. Then again, what exactly would a 30 year loan interest rate be in 1959?

FHA loans appeared to be 5.75%, so presumably investor rates would be higher:

http://fraser.stlouisfed.org/docs/pu...0/Chapter3.pdf

The poor job prospects are certainly a problem. Housing costs are reasonable in many non-bubble areas, like where I live now. I just overheard two young people discussing nice apartments they could get for $450/month.

I guess it all depends on what you mean by non-bubble areas - presumably in the Bay Area. I don't doubt it is possible to find apartments for $450/month in the far reaches of the suburbs or perhaps pockets in the East Bay, but then again the closer areas are quite possibly due to other factors like safety or difficulty of access/distance from jobs.

[Polish_Silver]

Good point about fairchild!

I guess it all depends on what you mean by non-bubble areas -

I am talking about South Carolina.

Excellent point about fairchild. However, there was significant private sector of use semiconductors from the 1960's on.
The usual story was that the military was willing to pay for "cutting edge" technology, which later became commercial.
However, that is a very expensive way to develop commercial technologies.

Another good example might be some of the Analog Devices products, like OP-07. One of it's first uses was in INS navigation of ICBM's, I think. However, ADI had many private sector products.

[Milton Kuo]

Re: Good point about fairchild!

I am talking about South Carolina.

Excellent point about fairchild. However, there was significant private sector of use semiconductors from the 1960's on.
The usual story was that the military was willing to pay for "cutting edge" technology, which later became commercial.
However, that is a very expensive way to develop commercial technologies.

For difficult (long development cycle), capital-intensive technologies, is there a better way that would actually work? Things such as the semiconductor industry, DARPA, and the interstate highway system have to be viewed as long-term investments that are strategically important to the nation and should have federal support to at least get them boot-strapped.

With the ways things are in the capital markets, I don't think the private sources of money would have the funds or the patience to allow such industries to ever get off the ground before they pulled the plug.

[Polish_Silver]

Could private sector do it?

It is a very interesting question whether difficult technologies could be developed in the private sector.

I'd say there is definitely a lack of leadership and willingness to take meaningful risk now. Most companies have very superficial, short term goals. A lot of tax payer money has also been wasted on stupid stuff, too.

Certainly companies and individuals have had the patience to do it in the past. I'll here list some examples:

Sony spent years making the trinitron TV picture tube technology practical. The idea came out of RCA, but they thought it was too difficult to put into production, so they sold the technology to Sony.

Ampex tried to invent video recording. They gave up on it. But one engineer worked on it in spare time until it was working.

Farnsworth spent years working on TV technology. His patents expired before he could really exploit it.
It took much longer than he first thought. He was the last "lone inventor", and never got the fame or fortune he deserved.

Harrison built the first clocks accurate enough for maritime navigation. He spent decades working on the accuracy, and later the miniaturization. It was not "capital intensive" but it sure took patience. There was government support for this, but it was a piddling amount, really.

There is also a "broken windows" problem. The government diverts resources to technological areas. Some of them work. Then the analysis is "we wouldn't have this without tax paid subsidy". But you never know what those resources would have turned into otherwise. The taxes don't cause more creative people, they just focus resources on certain areas chosen by the bureaucracy.

[c1ue]

Re: Could private sector do it?

For difficult (long development cycle), capital-intensive technologies, is there a better way that would actually work? Things such as the semiconductor industry, DARPA, and the interstate highway system have to be viewed as long-term investments that are strategically important to the nation and should have federal support to at least get them boot-strapped.

I would distinguish between difficult to develop technologies and highly capital intensive deployment.

The semiconductor industry falls into the former category; only relatively recently has it morphed into a highly capital intensive deployment, even then the ROI is still very respectable compared to almost any other PC industry.

The distinction is important because in the case of a difficult to develop technology, it is possible for individuals to take the risks in order to develop the technology. The track record for companies doing so is poor and in general established companies don't like taking on the huge risks associated with spending lots of money on speculative development.

However, the track record for corporate speculative development is positively glowing compared to the track record for corporate capital investment on speculative deployment.

Dr. Michael Hudson has mentioned many times that no major deployments of highly capital intensive infrastructure ever occurred without major government guarantees and/or direct investment. This isn't correct - the fiber optic/internet deployment was largely private though significantly funded by the dotcom bubble, but in general I agree with his view. It is certainly correct for railroads, highways, public utility buildouts, and so forth.

[Polish_Silver]

Re: Could private sector do it?

highly capital intensive infrastructure ever occurred without major government guarantees and/or direct investment

.

The internet could be done piecemeal. You don't need a national network for a small piece to be worthwhile.
That idea also applies to roads. The interstates could possibly have been built on a private sector basis, it would just take longer.

Part of the reason government involvement is needed is that the emminent domain, legal, and environmental issues make a strictly private sector development almost impossible. There is also the question of risk/return
and whether user fees correctly capture the net advantage of the infra structure.

Take something like the TVA damn of the 1930's, or the interstates, built during the 1960's.
Couldn't the money have been returned to the federal government by a surcharge on the electricity, road tolls , or a fuel tax?
If the electricity buyers could not return the cost back to the government, it's hard to see that the project was worthwhile in the first place.

In Taiwan they try to use a "build and transfer" model. Public funds are used for construction, then it is sold/transferred to a separate entity for operation, with the idea that it can run in the black and return some or all of the cost back to the government.
I have yet to see a subway in this country turn a profit. But that is probably due to weak administration.
They have really cut back on the employees needed in some places.

[Polish_Silver]

Re: Could private sector do it?

However, the track record for corporate speculative development is positively glowing compared to the track record for corporate capital investment on speculative deployment.

What are some examples of deployment that the private sector failed to do?

Thornton discusses this in "what if boomers can't retire". He thinks it is the short term thinking of corporate leadership in the last few decades. They won't spend this year if the payoff is more than 1 year out. The result is that Japan used those ideas and kicked our butt.

Hudson mentions one explanation for this: corporate finances are dependent on bonds. The company can't miss a bond payment -- Hence the focus on making the numbers this quarter. However, a lot of silicon valley companies used a "stock only" financing paradigm, and really obsessed about the quarterly results. We need incentive structures that get people focused on the long run, and that applies to both public and private sectors.

[c1ue]

Re: Could private sector do it?

The internet could be done piecemeal. You don't need a national network for a small piece to be worthwhile.

As I noted above, I don't agree with Dr. Hudson's statement entirely as there is a single exception - the internet. To some extent this is a poor example, however, because one major reason why the internet was so easily deployed is that it piggybacked on the existing phone networks' transition from analog to digital. For a baby bell to add extra capacity onto its existing communications networks in the form of fiber optics is a very small incremental cost, and the threat of competing private networks removed any complacency on their part.

What are some examples of deployment that the private sector failed to do?

The deployment of the electrical grid is an excellent example. It was chaotic and driven by personalities, and didn't achieve any degree of scale out until the government stepped in.

As for roads - the track record for private ownership of roads is very poor. There is very little reason to think that any corporation would be so visionary as to build a road network that would only gradually increase monetization via network effects. Private road ownership has been historically characterized by monopoly - as have bridges, river locks, and so forth. An examination of the effects of the Wehrluecken on German river transport in the 1600s will give an idea on how negative this can be.

[Milton Kuo]

Re: Could private sector do it?

As I noted above, I don't agree with Dr. Hudson's statement entirely as there is a single exception - the internet. To some extent this is a poor example, however, because one major reason why the internet was so easily deployed is that it piggybacked on the existing phone networks' transition from analog to digital. For a baby bell to add extra capacity onto its existing communications networks in the form of fiber optics is a very small incremental cost, and the threat of competing private networks removed any complacency on their part.

I'm not entirely certain that the Internet can be considered an exception. There were a lot of elements early on in the creation of the Internet that either involved direct government subsidy or something approaching such.* By the time the major build-out of the Internet occurred during the tech stock bubble, most of the R&D and real-life deployment as a substantial proof-of-concept had already been completed.

It's not clear to me that, in a hypothetical world where the Internet does not yet exist, any private company or companies would be willing to spend the time and money to:

• Hire scientists to develop the networking hardware
• Hire scientists to design and develop the robust network protocols
• Build out a backbone of a network with high-speed connections
• Develop applications, even Unix command-line programs
• Wait for a critical mass of user base to enable profitability

As I'm sure you know, it took roughly thirty years for the Internet to reach a state where it was relatively usable by a large number of people. For a private company to be willing to wait that long for an investment to pay off (all the while burning money to build out and maintain the network as well as keep a governing IETF staffed), it would have had to have management that foresaw the World Wide Web; inexpensive, networked computers available to most of the populace; and e-commerce before even the basic infrastructure for these things existed.

Granted, a private company probably wouldn't take thirty years to build out (technology infrastructure and user base) an Internet but it would probably still take at least ten years or more. In today's high-frequency trading environment, you'd be very lucky to get five years before they pulled the plug. Even in the good ol' days of investing, a grand Internet project would probably get its plug pulled before it was allowed to compete.

--

* Off the top of my head, these are some of the elements that were key to the development of the Internet which had either direct government subsidies or substantial, indirect government subsidies: ARPANET (U.S. military), NSFNET (universities), and Unix (Bell Labs and the AT&T monopoly).

[Polish_Silver]

Re: Could private sector do it?

• Hire scientists to develop the networking hardware
• Hire scientists to design and develop the robust network protocols
• Build out a backbone of a network with high-speed connections
• Develop applications, even Unix command-line programs
• Wait for a critical mass of user base to enable profitability

These things are costly on the scale they are done today. But the internet came about very gradually. The early steps were what garage level hackers could do. They used the existing telephone infrastructure, which I think was almost entirely financed by the private sector, with regulation.

For the electric power grid, wasn't it also done with private sector money, with utilities regulated by local governments? A lot of the "chaos" of the early grid was evolutionary--it took time for AC to demonstrate superiority to DC. Governments are not good at deciding technical questions like that. They would tend to decide in favor of existing interests, and prevent the creative destruction.