Last, the service flow of land may rise because the land actually becomes more productive, e.g. from the spillover benefits of surrounding urban growth. This may represent a rise of real social wealth - I leave the question moot. The main point here is that most changes in land prices do not represent changes of real social wealth.
IMPLICATIONS.
A. Land is dangerous to use as debt collateral, because its price is so highly sensitive to i.r. changes. It is even more dangerous to let it become the collateral backing demand deposits. [6]
B. Selective controls on credit extended by commercial banks may be used to prevent collateralizing land values. Another method would be to make mortgages taxable property, as provided for, for example, in the 1879 California Constitution. Such a provision is enforceable because mortgages (or deeds of trust) are always publicly recorded, along with land titles themselves. Such a provision would also ease the political case for raising property taxes, which otherwise fall solely on equity holders, and appear to exempt lenders (except as they erode collateral security).
Why are banks not lending much in early 1993? Interest rates (at least short-term rates) are low, but collateral requirements are very high. There are 3 problems, at least. 1, Banks are leery of any real estate collateral now. 2, They lack the needed capital. (They also may lack reserves). Both of those result from their recent losses. 3, Real interest rates are higher than they look when we factor falling land prices into the c.o.l index used to deflate nominal i.r.s into real i.r.s. This is a variation on Keynes' perception of a liquidity trap. By "variation" I mean it is the same phenomenon, only differently perceived and expressed.
Here is the sequence of a combined, reverberating land and banking crash. Land boom fizzles. Banks take losses. Their reserves and surpluses (capital) dwindle. They stop making loans and investments. By a process of positive feedback ("vicious spiral") this stoppage aggravates its own cause, viz. the fall of land prices.
7. A rise of i.r.s tends to raise savings rates via a strong wealth (or portfolio) effect. It lowers the current market price of land, especially. To a lesser extent it lowers the prices of items of durable capital.
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