The Great Real Estate Bubble of the Roaring Twenties
GroundSwell, January-February 2009]
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
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"
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.