August 16, 2007

Lessons From the Great Depression: A Letter from a former Banking President Discussing the Bubble.


As we hit record lows with the markets, it is clear that we are entering a correction phase. With the incredible response we had to a personal letter from a lawyer discussing in great deal, the failures of the previous Great Depression bubble we can see many parallels emerge to our current potential future. For one, the wanton greed and disregard of financial prudence. The inability to see beyond the current market and realize that history has a mischievous way of sneaking up on those who forget her. There is no longer a debate regarding the once fabled housing bubble. We can all take off our tinfoil hats off and begin to construct a vision of the future in the midst of a collapsing housing market. Today I’ll be posting an article that came out in the Saturday Evening Post in November of 1932 from a former bank president in New York, three years after the crash, highlighting the economic situation of a post bubble world. This is an old article so I retyped the important paragraphs:

“If I draw illustrations from the banking field to indicate the limits to which the depression reached, it is only because I am writing about banks and not because the banks are the one glaring example marking the extent of the financial cataclysm. The railroads, the insurance companies, the building-and-loan societies and mortgage companies would quite as well depict the situation.”

The collective memories of many Americans believe and associate the Great Depression igniting from the heart of Wall Street. However, it is clear that many industries built around financial imprudence also failed during the Great Depression. Think of the many industries currently facing hard times with the housing decline: insurance companies, mortgage lenders, hedge funds, the auto industry, home remodeling centers, and many other housing associated industries. Can it be that for the past decade, we have been using the home as a center of economic prosperity? Clearly it has helped to a certain extent with unparalleled amounts of mortgage equity withdrawals. There are estimates from the FDIC that $5 trillion in wealth has been directly linked to this housing boom. How much was really lost during the three years following the Crash?:

“The decline in the price of bank stocks was only a minor phase of our debacle. The quoted value of all stocks listed on the New York Stock Exchange was, on September 1, 1929, $89,668,276,854. By July 1, 1932, the quoted value of all stocks had fallen to $15,633,479,577.”

“Stockholders had lost $74,000,000,000. This figure is so large that not many minds can grasp it. It is $616 for every one of us in America. It is, roughly, three times what we spent in fighting the World War. The bursting of the South Sea Bubble concerned a single company. In the bursting of the New York Stock Exchange bubble, the value of all stocks fell to 17 per cent of their September 1, 1929, price – almost as great a drop as the South Sea Company stock, with its fall to 13 per cent of its top price. Remember that this calculation is not a selected example. It is made from the average of all stocks listed on the Exchange.”

So $74 billion was lost. A massive amount. What would happen if say the $5 trillion in housing wealth would suddenly disappear? Instead of bank failures we are now facing hedge fund debacles and everyday it appears that another mortgage outfit is closing shop. Mortgage resets are hitting the market to the tune of $30 billion a month with our peak month hitting in October with $50 billion resetting. We will not fall below the $30 billion monthly mark until September of 2008. Most experts are now predicting a declining market until 2009 and these are optimistic projections.

“The South Sea Bubble wasn’t so much! We have done pretty well in the way of bubbles in our own time. All financial history shows no parallel to what we have been going through. Never before, in this country or anywhere else, has there been such a general loss in “security” values.”

Bubbles will always occur in profit driven systems because of human nature and bubbles will bust when they reach a Minsky Moment. In addition, the psychology at a certain point tips and the market no longer follows previous rules. The system was built on consistently appreciating real estate and when this ended, it turns out that millions of people were swimming naked. The only question now is how long will the market retrench. Unbelievably, those that pumped up the bubble are crying for compassion for the desolate homeowner now losing his home even though he is laughing all the way to the bank. Since he is partly responsible for the massive speculation, why doesn't he cut a check from his decade long bubble profits if he feels so bad? Instead, they want the entire nation to carry the burden of this massive credit orgy. If they truly believe in free market capitalism, then what is currently happening is the end result; the market is washing out all the excess from the system. Yet the Fed injecting liquidity amounts to corporate welfare and is only prolonging the inevitable decline.

“The decline in the quoted value of New York listed stocks is only part of the story. The total of real-estate mortgages in default, particularly mortgages on city property, is unexampled. The value of real estate can no longer be accurately appraised, because the market for real estate has been practically paralyzed.”


We are already seeing this. Many REO properties are simply sitting on the market and stubborn lenders and sellers are refusing to lower prices. Buyers are refusing to buy or are unable to get loans. It is a Catch-22 that is accelerating the market on a downward spiral. People realize that housing is going down and are suddenly reluctant to buy. The MBS market now seeing the intestines of their portfolios is realizing that some overpricing may have occurred. I’m not sure if any of you have seen the new housing syndicate marketing angle (I caught a glimpse of this on late night infomercial happy television). They are now pushing, get this, FHA loans! Suddenly, the industry that pumped interest only, hybrid, reverse mortgage, 2/28 loans, stated income, and every other weird concoction of loans is coming home to the safest of the safe. But the scary implication here is they are touting, “no need to worry here, these are government insured.” Guess that means the American tax payer is going to bail out the housing industry. At least this is what the housing industry expects.

“The loss of $74,000,000,000 in the value of New York listed stocks is something more than a mere item of financial data. Implicated in it are ten million cruel heartaches. I am using “million” as an adjective, and making an understatement. The laborious savings of an uncounted number of lifetimes have been swept away. Prudent provisions for the future has been made to contrast unfavorably with the pleasures of spendthrift waste…”

The real pain is in what happens on a micro level. Like the couple earning $130,000 a year that lost their home to foreclosure and is now facing hard times; these are the real stories behind the bursting bubble. What is the psychological and financial impact of those put into 2/28 homes and are now facing foreclosure? There is no financial benefit to the buyer for jumping into a 2/28 loan aside from squeezing into a home they cannot afford over the long run. The only one benefiting from this is the mortgage broker who gets a stronger kick back for putting you into a risky loan and the agent from getting a commission check after escrow closes. What do they care? The loan is getting an extreme makeover on Wall Street and they'll never see it again. The transparency legislation now being pushed is 7 years too late. Wall Street has turned off the spigots earlier in the year. Don’t worry about the large mortgage outfits, many top CEOs and executives actually sold out [are in the process of selling out] near the peak.

“Not only did our investments shrivel in the last three years but we even frequently lost our pocketbooks. Cash in hand, left for safekeeping in a bank, often went the way of our investments, and worse. Almost $3,000,000,000 of our daily-used cash funds were sequestered in the doubtful assets of the 4835 insolvent banks. Widespread communities were left with only the mattress as a safe depository, and with little to put into it. People became so frightened in regard to the safety of the banks that they locked up in safe-deposit vaults, or selected elsewhere, more than $1,500,000,000.”

We don't have to worry much about losing savings accounts considering Americans now have a negative savings rate. Try imagining you are now in 2009. What do you think the sentiment of the American public will be when trials are going on regarding shady lending practices? Many defunct companies are now getting their legal houses in order preparing for this. Even with the previous scandals such as Enron, many folks saw this as something far and away since few even understood what Enron did or what laws they broke. But everyone will understand the debacle of the housing industry because it hits every American. It is a simple story of greed and financial negligence. And one thing is certain, Americans do not like gambling with their homes unless they are winning. Now that many are losing, they’ll be out for blood. The Democrats are already taking aim and claiming it is the mortgage brokers fault for putting us in this mess. Of course there are other major players including the Fed, hedge funds, buyers/sellers, agents, appraisers, and flat out greed.

“This is a shameful and humiliating exhibition. It is uniquely bad. Across the border in Canada, there was not a single bank failure during our period of depression, and one must go back to 1923 to find even a small one. Nowhere else in the world at any time, were it a time of war, or of famine, or of disaster, has any other people recorded so many bank failures in a similar period as did we. We were not experiencing a war, a famine or any other natural disaster. All the economic tribulations we have undergone in the past three years have been man-made troubles, and Nature has continued to shower us with an easy abundance – more, indeed, than we have known how to distribute with economic wisdom.”

We are facing a healthy economy as well. Unemployment is low. Wages are holding steady. GDP is still growing. Too bad most of this growth is heavily influenced by the credit bubble. Like the former banking president states, this credit bubble mess is another "man made problem" as well. Where this market will take us is anyone’s guess but I’ll leave you with the final paragraph of the article:

“Human stupidity and cupidity were the taproots of this great financial disaster. Those are evils which will always best us. There have, however, been revealed faults and weaknesses in our banking and investment practices that account in part for the extreme nature of this experience. Isn’t it about time that we began thoughtfully to examine some of the fundamentals of our banking and investment theories and methods?”



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26 Comments:

Kevin said...

The Great Depression of 2009

Dr Housing Bubble said...

Rumor is that there will be an emergency rate cut coming up before the September meeting. One of the reason for the last minute market heroics today.

The Fed has pushed itself into a corner however since they have publicly commented that they wouldn't issue a rate cut unless the market was in serious "calamity." So a rate cut probably wouldn't help the market because if they do cut, then they are admitting to the fact that we are in a troubled market.

Interesting volume and buying behavior at the end of the day. We were down 300 at one point, then with less than 1 hour down around 200 points and all of a sudden end 15 points below.

Megan said...

On my last day at New Century, I made the following comment, "10 years from now, do you think we'll be looking back and saying that the end of New Century was the beginning of the Depression?"

The beginning of the end began long before that, as your blog illustrates. I'll be an avid reader from now on.

I wonder what is going to happen to Orange County? Not only is there an exploding housing bubble, but the County is a major hub of the mortgage industry. There is going to be a lot of office space going begging soon.

Peppermint Hippo said...

A rate cut will probably create a big bounce in the stock market, but my guess is that it will be short lived. Pushing on a string. Hold onto your hats!

Steve said...

Fear and greed is all the US Stock market is running on. Actually I don't think the market is overvalued when you consider how devalued our currency is, but it is WAY overvalued when you consider that many of the companies would be gone if money wasn't effectively free. The FED can lower short term rates all they want, but eventually paying $500,000 for a crap shack with high taxes and high insurance means that the consumer has nothing left to spend elsewhere. Lower earnings will equal lower stocks, but not for awhile.

formul8 said...

I forgot who said this:

"A recession is when your neighbor loses his job. A depression is when you lose yours."

james said...

"Interesting volume and buying behavior at the end of the day. We were down 300 at one point, then with less than 1 hour down around 200 points and all of a sudden end 15 points below."

I have seen 2 explanationsla for this. !. The PPT. 2. Some funds who need to make a buy, facing a day that they think is gonna be real volatile, make the buy at teh end, rather than the beginning because the tracking is easier or something.

Adam said...

I posted this earlier from my blog on the "right coast" and thought I would share.

http://bubblemore.blogspot.com

Countrywide getting out of the Jumbo Market will likely cause others to follow suit, at least temporarily. I kinda see something very interesting brewing. We are in the midst of the creation of a funding donut hole similar to the Medicare Prescription Drug Program.
Traditional Conforming loans (below 417k) will be available and those in the $2+ market that are usually privately funded loans only available to CRG's (Certified Rich Guy's) are going to be made available. Stuff in the middle? Well it is either put up a lot of cash or drop your price till you get to the conforming limit.

Dr Housing Bubble said...

@megan,

Welcome on board. Drop me an e-mail if you get a chance, I have a couple of questions for you.

@peppermint hippo,

I guess the rumor was true. Of course this is only the discount rate and largely symbolic. The more important factor is the Fed is eating their own words and acknowledging that we are in a financial mess. Either way, let the party begin for the short-term! More irresponsible lending coming your way.

@steve,

I agree that the overall market really isn’t up that much if you take into the account that the dollar has lost so much ground over the past 10 years. Japan had a similar situation where they had to drop rates at a radical pace but an overpriced asset even at 0 percent is still overpriced.

@formul8,

President Reagan said that.

@james,

I’ve looked into that as well. Either way, all this injecting at the last minute is going to buoy some stocks. And I would also venture to say that some automatic computer trading occurs at the last few minutes of the day as well.

@adam,

$417,000 is essentially the entire California market. It’ll be interesting to see how long the Fed can give life support to this declining bubble. The big test will be in October when Q3 results hit and $50 billion in mortgages reset. In addition, the market will realize that summer did not bring a housing bounce and fall/winter are typically slower housing months.

Juli said...

I've been an avid fan of your blog for months. Always insightful and insanely on point.

The quote from the Bank President recapping the losses sustained during the Great Depression:

“Human stupidity and cupidity were the taproots of this great financial disaster. Those are evils which will always best us. There have, however, been revealed faults and weaknesses in our banking and investment practices that account in part for the extreme nature of this experience. Isn’t it about time that we began thoughtfully to examine some of the fundamentals of our banking and investment theories and methods."

Rewind to 2002-2003: the smart, sophisticated money dumped their 30-year fixed (many of which had amortized down by 10-15 years) and jumped into the 3.750% 5/1 ARM -- thinking they were onto something so incredibly brilliant they would be nominated for the Nobel Prize in Economics.

I saw this by the hundreds. These were the sound, resourceful neighbors next door. They took out cash... not alot... but just enough to require them to "State" their W-2 income.

Fast-forward to 2007-2008: these same sound, resourceful neighbors are facing down a credit crunch that will bury them. I don't care how much equity they have in their home, the rules have changed, and their W-2 will not support a refinance. How sad is that!

Dr Housing Bubble said...

@juli,

Back in 2002-2006 you could go stated income and get ridiculous amounts of credit on practically any income. Need we remember our friend?

$14,000 a year farmer able to buy $720,000 home

Either way, now lenders are scrutinizing loans so even a rate cut won't do much. After all, the problem is stemming from subprime and Alt-A borrowers who purchased over inflated houses. Unless the Fed has the ability to make homes appreciate, we are still in a multi-year housing decline.

All,

Speaking of the Depression, did you guys read about the run at Countrywide Bank?

A rush to pull out cash

Worried about the stability of mortgage giant Countrywide Financial, depositors crowd branches.


A quote from the article:

"Bill Ashmore drove his Porsche Cayenne to Countrywide's Laguna Niguel office and waited half an hour to cash out $500,000, which he then wired to an account at Bank of America.

"It's because of the fear of the bankruptcy," said Ashmore, president of Irvine's Impac Mortgage Holdings, which escaped bankruptcy itself recently by shutting down virtually all its lending and laying off hundreds of employees.

"It's got my wife totally freaked out," he said. "I just don't want to deal with it. I don't care about losing 90 days' interest, I don't care if it's FDIC-insured -- I just want it out."


The Depression may not occur again but Depression like behavior will always happen in panics.

Megan said...

Dr b, I would email you but I don't know your the address. Am I a total idiot? Is it staring me in the face and I just can't see it (like I should have when I had a chance to exit the mortgage industry 5 years ago?)?

Dr Housing Bubble said...

@megan,

No worries. You can e-mail me at:

drhousingbubble at homtail dot com.

Liberal said...

I wonder if there is any information how many ex-employees of the imploded mortgage companies invested their 401k in the high flying stocks of these companies. Even 2 years after the Internet bubble I met several older managers who had almost all their 401k savings in our company stocks and couldn't retire because the stock was down and flat lined for over 10 years. One guy was looking at 2 million paper loss after working there for 32 years.
People will never learn.

Dr Housing Bubble said...

@liberal,

It is similar to folks that had all their retirement funds in Enron stock. These stocks were high flying for many years but again, the adage of putting all your eggs in one basket comes to mind.

The only issue here is that housing is much more prevalent and many retirement funds include hedge funds who dabbled in the black magic of collateralized debt obligation.

TechGromit said...

A recession is when your neighbor loses his job. A depression is when you lose yours. And recovery is when Jimmy Carter loses his. - Ronald Reagan

drshke said...

Dr. HBB,
I've been reading your blog for some time now. I live in Santa Barbara, the home of the amazing bubble. Originally, I come from a country that does not have the 'American Dream' concept, and I still cannot believe what is going on.
Here we are, at the verge of the next depression, and today, I ran into our neighbors (we rent, of course), and they told us they bought a house !??!
They make less money than we do, drive 2 Volvos, have a baby, and he is a lawyer, so you would think that he would be smart. And yet, they've been drinking the Santa Barbara Coolaid, and bought into this market. This is the fourth case this year - we know 3 more couples with advanced degrees who have bought into this market, 2 in our area, and my own first cousin in Washington DC. What is wrong with these people? Or is something wrong with me? How can this not be obvious to everyone with a little bit of brain and education? How can they still be buying the c**p about 'the special place' and 'real estate being local'?
In any case, keep up doing the good work, it feels good not to be alone.
Best regards from Dr. Shke

Steve said...

@drshke

Rule #1 - You and I might be the dumb ones. No way to know for sure until a few years pass.

Rule #2 - There are MANY MANY people that are dumber than us.

Rule #3 - Financial intelligence has very little to do with any other type of intelligence.

A great example is KMart stock. Hours before KMart stock was delisted completely and dissolved due to bankruptcy, people were still buying it thinking they were getting in on the ground floor of the new company.

Liberal said...

Watch out for this two companies to implode soon. Every time I do a search in my greater area looking for zero down, adjustable, balloons, liar, fraudsters, hidden investor mortgages I come across these two.
I'm not talking of a house here and there, they all over the spectrum and usually the mortgage are in the 700-800k range. I cannot belief this is still going on, one just closed 7-29. One of them a outstanding pillar of society had foreclosures dating back to 1995 and a resent HOA lien for $780.
Anyone posting and reading here should go to the barricades if our moron politicians calling for a "poor, taken advantage home owners" bailout.
It is an absolute shame!
LEHMAN BROTHERS BANK FSB
KEY BANK NATIONAL ASSOCIATION

Steve said...

More lemmings off the cliff....

http://www.detnews.com/apps/pbcs.dll/article?AID=/20070818/OPINION03/708180378&imw=Y

v said...

I wonder what the next bubble will be after the housing bubble bursts.

Stuart said...

I was watching Glenn Beck the other day and he was speaking with a "financial expert". This expert said he has recently been liquidating his client's US dollar investments into foregin stock and currency. The reason for this is, he predicts, that the US dollar is going to fall greatly (speculating that it will decrease in value at least by half over the next few years).

This is VERY scary. If the Dollar is worthless, our buying power goes down tremendously.

I was hoping for your thoughts on this, as I enjoy everyones comments at Dr. Housing Bubble.

Stu.

jason said...

Great post! I am gonna share it with my own blog readers at jason.landbrokr.com ! Thanks.

Graff said...

Really a nice blog, written in a very gud manner and also very informatic. All information on
>equity release
is their in this blog. So very help full for visitors

Jacquie said...

Hi Dr,HB!
I actually love your site. I thought I signed up back in my but I guess I was somewhere else

Anyway....
I don't get to sign in daily, however I do read the information on the site every other day:).
I want to know if you could tell me where I could start to look for forclosure information(NOPE NOT A FLIPPER FROM COMPTON:)
I have been giving the run around with obtaining information on short sales any leads would be great
By the way you are doing a fantastic job,and even though I grew up in South Central and not the OC, I appreciate the fact that you tell it like it is whether it's LA,OC,SB,And even Ventura county where you can buy a 700k home for 14k a year(I LOVE IT!!!)
KEEP UP THE GOOD WORK
Thanks
Travelchick

Marty said...

I work as a CPA in CT here in the northeast. This is more than about a housing bubble. The sub-prime mess is just a symptom of a bigger problem of rampant inflation that is announced as no inflation. The cost of everything people really have to pay money for has risen dramatically. Housing, heating oil, gas, groceries , medical care, utilities etc.The Sub-primers are just the first domino. I know lots of foreclosures here and few are subprime at all. Heck I have clients in paid off homes downsizing due to tax and utility increases.

There is no way inflation is 3%. The dollar is now on par with the Canadian currency and Gold is soaring. We need to open up this mess and discuss it.

In the late 70s to early 80s during the last period of inflation the cost of living index increased 75% over 8 years. This means if you were receiving 10,000 in Social security at the start you were making 17,500 by the end of that cycle. This is how things recovered, Social security, pensions , Govt jobs and employers were paying higher wages. Now we have a COLA of 25% or so over the last 8 years, way below the inflation rate of real items we pay for AND incomes are stagnant or declining.

There is no surging job market, there is no 3% inflation. The sub-prime mess is just a symptom of a much bigger problem.

Savings turned negative before the subprime disaster because people could not save and were drawing down savingst to pay bills.

Id love to talk with anyone about this and do an article with someone.

Martin

clhct1@aol.com