The gentrification of ‘toxic waste’

Paul Krugman’s “The Big Dither” column in yesterday’s New York Times expressed his concern for the Obama administration’s inability to offer a credible (read politically sellable) solution to the mountains of bad debt still concealed within the US financial system. If one agrees with the premise that the financial system, despite its now well-documented culture of greed, blind faith and incompetence, is the beating heart and circulatory system of the economy, then no broader economic recovery can take place without the equivalence of a quadruple bypass that would purge the system of these bad debts that are now routinely referred to as toxic waste. On a side note, this crisis has generated an entirely new lexicon: from John McCain’s (via David Letterman) ‘the economy is cratering’ (now ubiquitous in contemporary commentary), to the ‘bad bank’ British solution, and last but not least ‘zombie banks’. The dithering of the Fed and the Obama administration, Krugman suspects, results from a conviction that these distressed assets are “really worth much more than anyone is actually willing to pay for them.” This is where I see comparisons to both gentrification and Japan’s ‘lost decade’.

Neil Smith’s Marxist reading of gentrification, suggests that it marks the return of capital to the distressed (and hence undervalued) inner city. Smith uses the concept of the rent gap, the difference between the actual value of ungentrified land under its present use, and the potential price that could be achieved if the parcel of land was transformed into a higher and better use. At some threshold, the rent gap becomes the irresistible motive for speculators to buy-in, upgrade and reap the profits of a gentrified inner city. (In contrast to Smith’s production-side explanation, David Ley’s work has drawn attention to consumption-side factors, namely the social, cultural and political characteristics of the gentrifiers themselves, a group that in the Canadian case at least Ley refers to as the New Middle Class. NB: It is now generally acknowledge that gentrification is driven by both production-side and consumption-side factors.)

It would seem that what the Bernanke-Geithner plan – which aims to rehabilitate the bad debt swashing about the bilge of the financial system - amounts to is the gentrification of toxic waste. But are there any brave souls willing to colonize and fix-up this hard-knock stretch of Wall Street? ‘Nothing shaking on Shakedown Street’, as the Grateful Dead once sang ‘used to be the heart of town.’ The crux of the matter is that there is still not a viable plan to create the right incentive environment to coax shell-shocked investors to ante up and gamble on these great unknowns. Krugman is rightly concerned about any plan in which investors who would purchase bad debts pass on any future losses to the taxpayer but appropriate any gains privately. That, of course, is one of the dynamics that generated this whole problem in the first place. But how else might a solution work? There are limits, after all, to the extent to which the financial system can be nationalized – although nobody much knows what these might be, yet.

This is why it is still worthwhile to return to the great deleveraging that accompanied Japan’s lost decade, a parallel that is credited to Nomura Securities’ Richard Koo, who catalogued the long run impacts and government responses to the ‘balance sheet recession’ experienced by Japan through and beyond the 1990s. The Japanese case proved the impotence of monetary policy – they effectively had a zero interest rate for the better part of a decade – in the face of structural (as opposed to cyclical) crisis. And to some degree the Japanese case might give us room for guarded optimism in noting the success of fiscal policy as manifested, for example, in massive government expenditures in construction. Japan, through this period became known as a ‘kensetsu kokka’, or ‘construction state’ for its paved-over riverbeds and bridges to nowhere (for a reading of this policy impact on the landscape, see Alex Kerr’s Dogs and Demons). Make fun of it if you will, but Japan’s fiscal policy seemed to stave off a much harsher scenario. So instead of merely flat-lining for fifteen years, Japan might have experienced a more prolonged and biting contraction had it not primed the pump to the degree that it did. After witnessing the serial over-employment on most Japanese construction sites when I lived there between 2001 and 2003, I grew to somehow appreciate the version of Japanese Keynsianism.

What did the Japanese do with their own financial toxic waste? Well they didn’t try to gentrify it. For a very long time, everyone knew of the huge stock of troubled assets concealed within the Japanese economy, but perhaps for reasons of social dignity, the banks were very slow to call in their bad loans. As a result, though there was a significant and prolonged slump in real estate, there was nothing similar to the massive foreclosure problem we see in the US. Why was this the case? Well for starters, housing in Japan has a much higher rate of rental accommodation. Indeed, in many Japanese cities there are often cases of twin rents where the land is owned by one person, the structure on it another. The point is that though both the Japanese bubble and the current global crisis were triggered by real estate, the economic geographies of housing in both cases were quite different, with nowhere near the degree of (sometimes irresponsible) encouragement to become a homeowner that we saw in the Anglo-American world.

If there was ever an excuse for dithering, the opaqueness and intractability of the current mess looks like one to me. Which is maybe why it is a good, if distracting, thing that Phish is back to lighten the mood.