(Jan.-Feb. 2009 GroundSwell)
THE GREAT REAL ESTATE BUBBLE OF THE ROARING TWENTIES
By Mary ?Polly ? Cleveland, New York,
NY
Economists conventionally
attribute the Great Depression to blunders by the then-new Federal Reserve
Bank. According to this story, promoted by Milton Friedman and the
Chicago School, after the stock market crash of 1929, the Fed kept
interest rates too high, strangling the economy. This story made most
economists confident that it couldn't happen again.
But there's a different story: the story of
the great 1920's real estate bubble. It began with cars.
Starting in 1899, the auto industry took off
exponentially, dipped for two years during World War I, then took off
exponentially again during the 1920's. Production reached a peak of
over 4 million vehicles in 1929, before collapsing. It did not again
pass 4 million until 1949!
The auto suddenly opened up vast suburban and
rural areas to housing. Developers--legitimate and bogus--leapt at the
opportunity. Banks jumped in too, creating so-called "shoestring
mortgages"--effectively allowing property purchases on margin.
Within a few years, tens of thousands of acres around major cities had
been subdivided and sold. In rural areas, developers bought up farms, dug
a pond, built a "club house" and sold cheap "vacation" lots. As
reported in Homer Hoyt's classic One Hundred Years of Land Values in
Chicago, from 1918 to 1926 Chicago population increased 35% and land
values rose 150%, or about 12% a year.
In 1926, land values stagnated, then
fell. After 1929, home construction collapsed, and--paralleling the
auto industry--did not again pass the 1926 level until 1950. Around
Detroit, over 95% of recorded lots were vacant as of 1938.
Nationally, there were an estimated 20 to 30 million vacant lots, compared
to about 30 million occupied housing units. According to economic
historian Alex Field,
the barren subdivisions ringing the cities
hindered the recovery of construction: Missing titles of defaulted
owners and poor physical layout created de facto brownfields.
The real estate bubble helped set off and
then worsen the Depression. Collapsing land values left people
suddenly much poorer, so they cut spending. They also defaulted on
mortgages, sticking the banks with "toxic" assets: liens on
near-worthless property. The struggling banks in turn cut off lending even
to good customers. Bank runs--panicky depositors withdrawing
cash--further crippled the banking system. Between drops in spending and
lending, businesses failed, unemployment soared, and prices fell.
Thus a radical innovation of the early
1900's--the automobile--set off a destructive real estate bubble in the
1920's. Another radical innovation took hold in the late
1990's: "securitization", that is, the aggregation of consumer
debts, especially mortgages, into marketable packages known as
"collateralized debt obligations" or "CDO's." CDO's set off another
giant real estate bubble by making houses "affordable" to poorer
Americans. The collapse of the CDO bubble stuck banks once
again with "toxic" real estate.
Fortunately, economists--and markets--now
recognize that to limit damage, we must force banks to write down the
garbage quickly. But write-downs will reveal that some big
banks' liabilities exceed their assets, requiring drastic remedies, including
restructuring, breakup, and possibly temporary nationalization.
Unfortunately, so far our new Treasury Secretary, Tim Geithner,
either lacks the nerve or the authorization. Unless he acts soon, we
face another "lost decade" like the 1930's.