F. Forecasting the future from the cycles of the past.

Only Gypsies predict: economists forecast. Projecting trends is the first forecasting fallacy to foreswear, of course. Projecting cycles is safer because any wave can be called a cycle, but mechanical projection of cycles is as bad as any other mindless procedure. But having said that it is essential to have a good historical data base on which to build. Lacking that we have little basis for forecasting except some totally unrealistic a priori assumption such as that expectations are rational. The most cursory review of economic history and social psychology dispels that.

An excellent review of relevant economic history is Homer Hoyt's classic 100 Years of Land Values in Chicago, 1833-1933. Here we learn that there was a land value cycle whose amplitude, in the appropriate relative terms, far exceeds that of any other cycle of comparable weight. There is a cycle of value; a cycle of sales (measured by deeds recorded); and a cycle of subdivision or platting, the last being the wildest of all, a matter also researched by Lewis Maverick, Ernest M. Fisher, Herbert D. Simpson, Philip H. Cornick, Benjamin Hibbard, Arthur H. Cole, and others.

Hoyt also documents a social-psychological process of increasing credit financing of land purchases, and monetization of land value collateral, during the upswing of a cycle. In Chicago School terms you could say that an upswing is a period during which the views of Lloyd Mints become increasingly accepted until they totally undermine the quality of bank credit and bring on a collapse. For Lloyd Mints' position, which is central Chicago orthodoxy, is to heap scorn and opprobrium on any concern about qualitative credit control or the vulnerability of banks that borrow short to lend long, especially on the collateral of real estate.

I put more stock in Hoyt, whose analysis suggests we may gauge the vulnerability of both land markets and the banks that finance them by the degree of over-mortgaging. How much land is over-mortgaged today, and what share of our money supply -is based on it? After a decade of creative financing and deals with negative cash flows, obviously a lot. In a recent case the Bank of America foreclosed on a vineyard in the County (not the City) of Fresno on which it held notes for $18,000 per acre -- at least twice the market value.

Would it be useful to have more data on such matters? Would it be useful to study how the crowd has reacted to similar stresses in past episodes? Clearly yes, except for those who still believe that sterile postulates about hypothetical rational investors can penetrate the fogs of reality.

G. Finding the real interest rate.

During the soaring seventies it was quite a game to guess at the real interest rate. Hardly anyone noticed that it pops right out of the standard formula for capitalizing land values under the assumption of steady future inflation. I will assume you know or can derive the formula:

(Equation 1) V = a / (i-g)

where a is annual cash flow in the first year;
i is the nominal interest rate; and
g is the annual growth rate of a, in this case the inflation rate

The real interest rate is the denominator, (i-g). We can immediately solve for (i-g): it is a/V. Therefore the real interest rate is the current cash flow of durable real estate divided by its selling price.

Of course it is not that simple, nothing ever is. But it is the obvious starting place that mainstream economists have missed in their fruitless quests for the real interest rate. And it immediately dispels the notion that so often falls out of mainstream essays that real interest rates are or could be zero or negative. Try solving for V when g=i.

H. Assessment discrimination.

We need better land value data to monitor and correct assessment discrimination. The U.S. Census of Governments has performed a signal service, since beginning in 1957 under the leadership of Allen Manvel, by collecting and publishing assessment/sales ratios, classified by jurisdiction and class of property. Most of you know that this has become a most basic tool to evaluate the accuracy of valuations and the performance of assessors. But the old order passeth, giving way to new, and God fulfills Himself in many ways, lest one good custom should corrupt the world. The Census needs to be improved. It puts too much emphasis on owner-occupied residences; too little elsewhere.

The kind of assessment reform that the last generation gave us has, in my state, led to catastrophe. Assessors just laughed at the bumper stickers reading "BRING BACK THE CROOKED ASSESSOR" and the frustrated fulminations of Howard Jarvis and went back to professionalizing and computerizing and shortening the reassessment cycle and all those good things that would raise their scores in the quinquennial federal Census of Governments. But all this time they were increasingly discriminating against owner-occupied real estate and setting us up for Proposition 13.

Discrimination against owner-occupied real estate is the result, during a long inflationary period, of two factors: differential turnover; and the use of capitalized income for assessing business property in tandem with comparable sales for residential property.

Differential turnover rates during an inflationary period obviously work a bias against the kind of taxable property that turns over faster. Ordinary inventories have always suffered most acutely from this bias, where ownership turnover is inherent in the constant physical turnover. There is constant market evidence of inflation. But the bias has been ameliorated by various kinds of exemption and evasion.

The marathon inflation of the period 1965-81, however, exacerbated a bias, formerly more tolerable, against middle class housing, which turns over faster than commercial and especially industrial holdings.

Coupled with that was the custom of using capitalized income to assess commercial and industrial and "income" property. Perhaps it would have worked out fairly had assessors used cap rates of 3% and 4% as the market was doing, using something like our Eqn. 1.

They should also have taken account of tax shelter values and resale plans and techniques to avoid capital gains taxes and leverage and prepaid interest and so on and on and on. But it is so much easier just to divide by .09, or whatever lenders were asking that year, and so much easier to defend in court. So non-residential assessments lagged behind. (Obviously, anything assessed by the third traditional method, historical cost, got a free ride.)

The results are documented in a recent paper by John Behrens, "Assessors, Recorders, and Computers, and Where They Now Stand", August, 1984. It is not entirely clear if Behrens is making his point advertently. His text might illustrate Winston Churchill's quip that, "Many a man stumbles over the truth only to pick himself up and hurry along as though nothing had happened."

Nevertheless he does supply numbers from which we can exhume the following data. From 1956 to 1981 overall assessment ratios in the United States rose from .30 to .37; but ratios for single-family dwellings rose from .30 to .44. (Calculated from the third and fourth pages of Behrens' paper, which lacks page numbers.) Since Behrens is Chief of the Taxation Branch of the U.S. Bureau of the Census his numbers carry authority, and the numbers speak volumes with no further help from me.

I. Planning public works.

The main payoff from many public works is their enhancement and sustenance of land values. Benefit/cost analysis, properly pursued, often boils down to finding that the net social benefit of a project is the difference in net land values with and without the project. We are all painfully aware that political forces often make a mockery of economic analysis but, to the extent that economics sways the course of action, it needs land value data.

But if politics be held to be the key, let no one allege that the pursuit of land value enhancement is less than a major force in that field. TIME Magazine has called politics "The Great American System of Public Works for Private Profit", and who can say it better?

This article is an excerpt from an invited paper presented at the Assessment Workshop cosponsored by USDA-ERS-NRED and the International Association of Assessing Officers, Chicago, IL, June 25-26, 1985. The paper was published in Almy, Richard R., and T.A. Majchrowitz (eds.), Property Tax Assessment (Chicago: U.S. Department of Agriculture, International Association of Assessing Officers, and The Farm Foundation, 1985), pp. 91-109. The whole paper will be published daily in increments over this week and part of next week. This is excerpt 3 of 9.

© Text Copyright Mason Gaffney, Ph.D. rights reserved.
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