Santa Clara University



Real Estate and Recession A Peak in Land Values Can Predict the Next Downturn

Fred Foldvary
Lecturer in Economics

You could look it up. Back in 1997, Fred Foldvary published an article in the American Journal of Economics and Sociology that predicted a recession in 2008.

Now that it seems he’s right, Foldvary, lecturer in Economics at SCU’s Leavey School of Business, allows that the prediction could have been off by a year or two, but that the reason for making it — the connection between real estate cycles and the general business cycle — still holds true.

“Macroeconomists are not always familiar with the real estate literature,” Foldvary observes, “and I wanted to use it to come up with a better explanation for the causes of business downturns.” Not all are real estate-related, he says, but there is a clear connection between the end of a real estate boom and the start of a recession.

Foldvary outlined his analysis in a paper called “The Real Estate Cycle and the Depression of 2008,” published in the journal GroundSwell. It was adapted from a talk he gave to the graduate business student Real Estate Network in the spring of 2007. He had previously presented a “Yellow Pad” economics-department paper and seminar, ”A Synthesis of the Austrian-school and the Georgist Theories of the Business Cycle, and its Empirical Testing” in Fall quarter 2007.

Drawing on the studies of real estate economist Homer Hoyt, who identified an 18-year cycle of real estate in Chicago, Foldvary looked at the year of the last real estate bust and came up with the prediction for 2008.

Typically, Foldvary says, real estate values have peaked a year or two before a recession. Up to that point they have dominated the economic boom that preceded the depression, so a real estate slowdown is a harbinger of things to come for the overall economy.

A variety of factors drive the overall real estate boom, including low interest rates, a limited supply of land, and the “humongous” public subsidy in the form of taxpayer-supported infrastructure and tax breaks for homeowners, Foldvary argues.

Through all this, however, it is the price of land that’s going up, not the buildings, and the continued increase in prices can be maintained only if there is a belief that it will continue.

Of course, Foldvary writes, it always runs into a reality check. “Mortgages are paid from wages and profits, so eventually real estate prices stop rising.” When that happens, sales volume drops, new construction is dampened, the demand for furniture, appliances and office equipment goes down, unemployment and interest rates rise, and a recession is around the corner.

In the current situation it’s apt to be a nasty one, he predicts, because the growth in secondary loan markets made the boom bigger than usual, so the downturn is apt to be correspondingly more severe.

While he expects the recession to play itself out in the absence of bad policy decisions, Foldvary doesn’t expect policymakers to learn much from it. “One thing I can predict with absolute confidence,” he writes, “is that government chiefs and even most economists will not learn the right lessons from the collapse, and history will repeat itself as it always has.”

What are the right lessons? Foldvary says many are contained in the work of the 19th century author Henry George, who wrote a book, Progress and Poverty, that called for a single tax on land. While that may be too simple, Foldvary says a higher tax on land would have the benefit of dampening fluctuations in the real estate cycle and creating less of a boom-and-bust situation.

But given the lobbying power of the real estate industry and the voting power of mortgage-deducting homeowners, is there any chance of that happening?

“No,” Foldvary says. “Zero.”

Learn More

Fred Foldvary Profile

The Measurement of Inequality, Concentration, and Diversification
Indian Economic Journal, Vol. 54, No. 3
September-December 2006
SSRN Abstract # 1104829

Planning by Freehold
Economic Affairs, Vol. 25, No. 4, pp. 11-15
December 2005
SSRN Abstract # 857526

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