16/03/2017 TheGreatRealEstateBubbleofthe1920's|TheD&SBlog

TheGreatRealEstateBubbleofthe1920's
EconomistsconventionallyattributetheGreatDepressiontoblundersbythethennewFederalReserveBank.Accordingtothisstory,
promotedbyMiltonFriedmanandtheChicagoSchool,afterthestockmarketcrashof1929,theFedkeptinterestratestoohigh,
stranglingtheeconomy.Thisstorymademosteconomistsconfidentthatitcouldnthappenagain.

Buttheresadifferentstory:thestoryofthegiant1920srealestatebubble.Itbeganwithcars.

Startingin1899,theautoindustrytookoffexponentially,dippedfortwoyearsduringWorldWarI,thentookoffexponentiallyagainduring
the1920s.Productionreachedapeakofover4millionvehiclesin1929,beforecollapsing.Itdidnotagainpass4millionuntil1949!

Theautosuddenlyopenedupvastsuburbanandruralareastohousing.Developerslegitimateandbogusleaptattheopportunity.
Banksjumpedintoo,creatingsocalledshoestringmortgageseffectivelyallowingpropertypurchasesonmargin.Withinafewyears,
tensofthousandsofacresaroundmajorcitieshadbeensubdividedandsold.Inruralareas,developersboughtupfarms,dugapond,
builtaclubhouseandsoldcheapvacationlots.AsreportedinHomerHoytsclassicOneHundredYearsofLandValuesinChicago,
from1918to1926Chicagopopulationincreased35%andlandvaluesrose150%,orabout12%ayear.

In1926,landvaluesstagnated,thenfell.By1933,Chicagolandvalueshadfallensome70%overallperipheralareasfellevenmore
dramatically.After1929,homeconstructioncollapsed,andparallelingtheautoindustrydidnotagainpassthe1926leveluntil1950.
AroundDetroit,over95%ofrecordedlotswerevacantasof1938.Nationally,therewereanestimated20to30millionvacantlots,
comparedtoabout30millionoccupiedhousingunits.AccordingtoeconomichistorianAlexField,thebarrensubdivisionsringingthe
citieshinderedtherecoveryofconstruction:Missingtitlesofdefaultedownersandpoorphysicallayoutcreateddefactobrownfields.

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TherealestatebubblehelpedsetoffandthenworsentheDepression.Collapsinglandvaluesleftpeoplesuddenlymuchpoorer,sothey
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cutspending.Theyalsodefaultedonmortgages,stickingthebankswithtoxicassets:liensonnearworthlessproperty.Thestruggling

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16/03/2017 TheGreatRealEstateBubbleofthe1920's|TheD&SBlog

banksinturncutofflendingeventogoodcustomers.Bankrunspanickydepositorswithdrawingcashfurthercrippledthebanking
system.Betweendropsinspendingandlending,businessesfailed,unemploymentsoared,andpricesfell.

Thusaradicalinnovationoftheearly1900stheautomobilesetoffadestructiverealestatebubbleinthe1920s.Anotherradical
innovationtookholdinthelate1990s:securitization,thatis,theaggregationofconsumerdebts,especiallymortgages,intomarketable
packagesknownascollateralizeddebtobligationsorCDOs.CDOssetoffanothergiantrealestatebubblebymakinghouses
affordabletopoorerAmericans.ThecollapseoftheCDObubblestuckbanksonceagainwithtoxicrealestate.

Fortunately,economistsandmarketsnowrecognizethattolimitdamage,wemustforcebankstowritedownthegarbagequickly.But
writedownswillrevealthatsomebigbanksliabilitiesexceedtheirassets,requiringdrasticremedies,includingrestructuring,breakup,
andpossiblytemporarynationalization.Unfortunately,sofarournewTreasurySecretary,TimGeithner,eitherlacksthenerveorthe
authorization.Unlessheactssoon,wefaceanotherlostdecadelikethe1930s.

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February23,2009 ChrisSturr

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3 thoughts on The Great Real Estate Bubble of the 1920's
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16/03/2017 TheGreatRealEstateBubbleofthe1920's|TheD&SBlog

Tim
February24,2009at5:30pm

Verygoodsummary.Theinvvestmentinsurancecompaniesbankshaveworthlesspaperpositions.Governmentistakingtaxmoneyto
keepthepaperliesalive.Why?ItdoesntbenefitworkingAmericans.

FD
February25,2009at2:14pm

Everythingtakesoffexponentially.Stopusingweaselwords.

Anonymous
May5,2009at7:16pm

Splendidarticleontheautomobilecausingthedepression.Iwouldliketopointoutthoughthatoveralltheautomobilehadapositiveeffect
onlandvalues,IEitsuppressedrent.Theprincipleutilityofurbanlandisitslocation,ormorepreciselyproximity.Landisthesubstitute
goodfortransportationcosts.Sobybringingdowntransportationcosts,renteverywhereisreduced.Iseethisasthemajorreasonthe
gildedagedidnotreturninthenextlandcycle.

ThegeometryofproximityforAmericancitieswasthatofapoint,andnewusefullandswereaddedwiththesquareoftheexpanding
radiusacarcouldprovideaccesstoo.Theintroductionoffreewaysextendedthiseffect.

Buteventuallytheeffectivegeometryofcitiesmeantthatthemarginallandsattheperipherycouldnolongersubstitutewithadditional
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transportationcosts.Thereareonlysomanyhoursinthedaytodevotetothecommute.Freewayscloggedandtheoriginalproblemof
thegildedageandhightransportationcostsstartstoreturn.
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16/03/2017 TheGreatRealEstateBubbleofthe1920's|TheD&SBlog

IseethisasthereasonthatdespitesolidgainsinproductivitysinceReagan,thatworkingwagesaredown.Theextraandmorewas
consumedbygrowingrent.Andthetrendcontinuestoday.Therecentdropinlandpriceshasbeenthefirsttimeforanyrealgainin
wagessincethen.Anditwillbereversedasthecycleprogresses.Withthetransportation/renttrendincreasingtheircostaswell.

Thiscouldbedelayedbyagainincreasingtheefficiencyofthetransportationnetworksthroughoutthecountry.Butvotersarewaryof
suchprojectsastheyenduppayingmorethenthebenefit.

When,asusual,thetransportationprojectisfinancedbyproductiontaxeslikesalesorincome,thetaxpayersarehittwice.Oncein
taxesforthecostoftheproject,andthenagaininrents.Landsservedbytheprojectarequicktoaddallthevaluecreatedbytheproject
intotheirrents.Iffewcitiesgetthisimprovementeachyearfromfederallargess,thenthelandsaddedincompetitionbythecitiesnewly
extendedreach,willonlyaccommodatethecountriesgrowth,andnotmakeanylocalreductionsinrent.Therecanbenonetbenefitto
taxpayers.

Howeverifallthefinancingisdonebylandtaxation,thentheprojectisselffinancing.Landrentsgoupanyway,butthetaxpayersarent
seriouslybilked,andtheadditionallandsaddedbymovingouttheradiusofthecitesenmass,willcountersomeoftheincreasedland
rents.Andsoanactualprofittotheworkers,andcapitalistinvestorsisproduced.

Econ_Amateur

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