August 02, 2007

Personal Story by a Lawyer from a Previous Asset Bubble. Can we Learn from the Past and How will the Housing Decline Impact You?


When you think of the credit bubble, what comes to mind? Overpriced Homes? The subprime implosion? Massive credit? Or are you simply indifferent to it? The housing and credit bubble will have a long lasting impact on an entire generation of people living through it. When we see that a certain company has self-destructed or foreclosures are skyrocketing, what does this mean on a personal level for society? In the case study of a couple making $130,000 a year and going into foreclosure, we see that this bubble will impact the rich and the poor including the farmer making $14,000 a year and buying a $720,000 home. These stories drive the point home and make the credit bubble discernable to people from all sectors of society. It is easy for most people that understand housing to assume everyone can read a 30 year mortgage statement or has substantial knowledge regarding investing in the stock market. However, we have examined that the majority of the population is not affluent or what we consider to be really rich.


Very rarely do I come across a personal account that encompasses the entire scope of what a bursting bubble can do to an economy and the people living in it. Bubbles, as examined from the past, have a very similar pattern in the stages they progress. Mass euphoria leads to a case of mass resentment and depression both economically and personally for many families. I came across a letter written from a lawyer from Mason City, Iowa in the Corn Belt recounting the impact of the Great Depression on his town. It is a poignant and somewhat eerie story to read considering the date of writing is 1933. The similarities of what happens in the past raises many questions that I hope to discuss at length and how it will influence our future as a nation. These are things that as a society we will face. Foreclosures, larger numbers of families facing economic problems, and the repercussions of another bubble bursting. Since I found this letter in a very old file, I have decided to type up the large part of the letter since it is a necessary read for anyone trying to diagnosis potential issues we will face. Of course, times are different. We are not in the late 1920s or early 1930s, but human nature, bubble psychology, and the essence of being a person are timeless. Below are paragraphs of the entire letter:

“The boom period of the last years of the World War and the extremely inflationary period of 1919 and 1920 were like the Mississippi Bubble and the Tulip Craze in Holland in their effect upon the general public. Farm prices shot sky high almost over night. The town barber and the small-town merchant bought and sold options until every town square was a real estate exchange. Bankers and lawyers, doctors and ministers left their offices and clients and drove pell mell over the country to procure options and contracts upon this farm and that, paying a few hundred dollars down and expecting to sell the rights before the following March brought settlement day. Not to be in the game marked one as an old fogy, while paper profits were pyramided and Cadillac cars and pleasure trips to the cities took the place of Fords and Sunday afternoon picnics. Everyone then maintained that there was only a little land as fertile as the fields of Iowa, Illinois, and Minnesota, and everyone sought to get his part before it was all gone. Like gold, it was limited in extent and of great potential value. Prices skyrocketed from $100 to $250 and $400 per acre without regard to the producing power of the land.”

Real estate speculation is not a new subject. As noted by the lawyer, people from all segments of the economy were playing the real estate speculation game. If you didn’t play the game, you were considered old school and lacked the intelligence to be financially savvy. Bringing this to the current market, we can see how someone driving a Mercedes may hold a view of someone driving a Honda Civic. Clearly, the person driving the Civic isn’t playing the real estate game or has an understanding of how to manage their finances. Sadly, a large percentage of those in the Civic will perceive the person driving the Mercedes as wealthier even though they have an $800 a month lease and in fact may have a net worth in the negative territory. So many people decided to jump into the game and this is noted by the large increase of employment related to the housing complex in the past decade. The letter continues:

“During this period insurance companies were bidding against one another for the privilege of making loans on Iowa farms at $90 or $100 or $150 per acre. Prices of products were soaring. Everyone was on the highroad not only to comfort, but to wealth and luxury. Second, third, and fourth mortgages were considered just as good as government bonds. Money was easy, and every bank was ready and anxious to loan money to any Tom, Dick, or Harry on the possibility that he would make enough in these trades to repay the loans almost before the day was over. Every country bank and every county-seat town was a replica in miniature of brisk day on the board of trade.”

Many housing pundits would like you to believe that modern real estate products are somehow superior to past products. Either way, you are securing a note onto an asset and the basic concepts still apply. As you can read from the letter, second, third, and even forth mortgages were common in the 1920s. The perception, just like in better housing days, that housing was an absolute secure investment was something held very near to the heart during the lead up to the Great Depression. We also notice that lending institutions were just as eager then as they are today to loan money out to anyone with a pulse. How quickly did the tide turn after the Crash of 1929? It did not happen overnight:

“The drastic deflation of Iowa loans under the orders from the Federal Reserve Board, upon which Smith Wildman Brookhart, depression Senator from Iowa, poured forth his venom, definitely marked the downward turn in the mythical prosperity of boom days. Despite our hopes for the better, conditions have grown steadily worse.”

“During the year after the great debacle of 1929 the flood of foreclosure actions did not reach any great peak, but in the years 1931 and 1932 the tidal wave was upon us. Insurance companies and large investors had not as yet realized (and in some instances do not yet realize) that, with the low price of farm commodities and the gradual exhaustion of savings and reserves, the formerly safe and sane investments in farm mortgages could not be worked out, taxes and interest could not be paid, and liquidation could not be made. With an utter disregard of the possibilities of payment or refinancing, the large loan companies plunged ahead to make the Iowa farmer pay his loans in full or turn over the real estate to the mortgage holder. Deficiency judgments and the resultant receivership were the clubs they used to make the honest but indigent farm owners yield immediate possession of the farms.”

So we realize after the “great debacle” that foreclosures did not peak until 1931 or 1932. So it took 2 to 3 years for the pent up excess credit to hit the market. With our 24/7 media coverage and online to the nanosecond updates, most people think the bubble burst or later recovery will happen tomorrow. Unfortunately, it will occur over a long and drawn out period while people silently scream. The denial of the current credit bubble is extremely similar. By looking at the numbers conservatively, we see that we are going to have much of the same in 2008 and 2009. Not only will it be the same, but we are eliminating the “safety” feel of real estate and compounding it with growing foreclosures and declining prices. We recently had a first national housing median price decline since - guess when - The Great Depression. And it is not uncommon for people to start taking sides at this point. Some want to call bottom and those financially conservative realize we have a long way down before we hit bottom. The letter also highlights the sucking dry of savings and reserves of many families. Well, we already know that we have a negative savings rate so I’m not sure how long a family could stay afloat without using credit cards or blowing through their retirement funds (if they have any). How did this impact society’s view on real estate?:

“Men who had sunk every dollar they possessed in the purchase, upkeep, and improvement of their home places were turned out with small amounts of personal property as their only assets. Landowners who regarded farm land as the ultimate in safety, after using their outside resources in vain attempts to hold their lands, saw these assets go under the sheriff’s hammer on the courthouse steps.”

We have this mentality in the current market place. The majority of folks that invest heavily into renovating their homes are looking to flip the property for a larger profit. Not everyone, but with shows like Flip This House you begin to realize that home is a temporary pit stop for many in our society. And then we have the generational psychology shift that housing isn’t a safe investment in every circumstance. Foreclosures started going through the roof shortly after the psychological shift:

“During the two-year period of 1931-32, in this formerly prosperous Iowa county, twelve and a half per cent of farms went under the hammer, and almost twenty-five per cent of the mortgaged farm real estate was foreclosed. And the conditions in my home county have been substantially duplicated in every one of the ninety-nine counties of Iowa and in those of the surrounding states.”

Growing foreclosures start to hit multiple counties in Iowa during the tidal wave period of 1931-32. Currently we are facing incredibly large foreclosure jumps in California, Colorado, Arizona, Florida, and Michigan to name a few states. This is something that has only started. It has moved from the center of wealth in the 20s of the farm and industrial cities, to the urban metro centers of the 2000s. Like the previous bust, it took about 3 years for the general market to realize there were major issues. When times change they change quickly:

”We lawyers of the Corn Belt have had to develop a new type of practice, for in pre-war days foreclosure litigation amounted to but a small part of the general practice. In these years of the depression almost one-third of the cases filed have to do with the situation. Our courts are clogged with such matters.”

“Gone, too, is that pride of ownership which made possible the development of stock and dairy farms with their herds of fat cattle and hogs, their Jersey cows, their well-kept groves and buildings which beautified and developed the countryside. The former owners were willing to use a large part of receipts from a farm’s income to increase its value and appearance but the present absentee owner regards it only as a source of possible dividends.”

“From a lawyer’s point of view, one of the most serious effects of the economics crisis lies in the rapid and permanent disintegration of established estates throughout the Corn Belt. Families of moderate means as well as those of considerable fortunes who have been clients of my particular office for three to four generations in many instances have lost their savings, their investments, and their homes; while their business, which for many years has been a continuous source of income, has become merely an additional responsibility as we strive to protect them from foreclosures, judicial receivership, deficiency judgments, and probably bankruptcy.”

“The old maxim of three generations between shirt sleeves and shirt sleeves is finding a new meaning out here in the Corn Belt, when return to very limited means in a formerly prosperous population is the result not of high living and spending, but of high taxes, high dollars, and radically reduced income from the sale of basic products.”

A few things to note. The impact on a societal level is time and productivity will shift into protecting faltering estates. Folks will try to save their homes, try to avoid bankruptcy, and we will have collectors focusing on bringing accounts current (if they can). This is time spent from other economically productive activities. However, it is an unavoidable evil of any bubble to wash out the excess liquidity. The letter also discusses the loss of homeownership pride. I’ve thought about this many times here in Southern California. Most of the time, I hear folks saying, “do you know I have $300,000 in equity and if I upgrade the bathroom, it’ll be worth an additional $25,000?” I ask them if they are upgrading for their family but normally it is to sell it off to the next highest bidder. We are starting to see dents in this mentality. Why invest so much in your home if appreciation is stagnant or declining? If you really wanted to be a proud homeowner, you would do these things simply for improving your home. Many did upgrade via mortgage equity withdrawals and second mortgages. However, when the market bottoms out you realize that many did it as a ploy to inflate the value of their home for a future time to market and not for the betterment of their families' well being. Either way, folks can do whatever they want with their home and money but clearly, homeownership pride for many in Southern California and other large metro areas is based on how much equity you have amassed. The lawyer recounts a sad story of a client:

“George Warner, aged seventy-four, who had for years operated one hundred and sixty acres in the northeast corner of the county and in the early boom days had purchased an additional quarter section, is typical of hundreds in the Corn Belt. He had retired and with his wife was living comfortably in his square white house in town a few blocks from my home. Sober, industrious, pillars of the church and active in good works, he and his wife may well be considered typical retired farmers. Their three boys wanted to get started in business after they were graduated from high school, and George, to finance their endeavors, put a mortgage, reasonable in amount, on his two places. Last fall a son out of a job brought his family and came home to live with the old people. The tenants on the farms could not pay their rent, and George could not pay interest and taxes. George’s land was sold at tax sale and a foreclosure action was brought against the farms by the insurance company which held the mortgage. I did the best I could for him in the settlement, but to escape a deficiency judgment he surrendered the places beginning in March 1st of this year, and a few days ago I saw a mortgage recorded on his home in town. As he told me of it, the next day, tears came to his eyes and his lips trembled and he and I both thought of the years he had spent in building up the estate and making those acres bear fruit abundantly. Like another Job, he murmured “The Lord gave and the Lord hath taken away”; but I wondered if it was proper to place the responsibility for the breakdown of a faulty human economic system on the shoulders of the Lord.”

“When my friend George passes over the Jordan and I have to turn over to his wife the little that is left in accordance with the terms of his will drawn in more prosperous days, I presume I shall send his widow a receipted bill for services rendered during many years, and gaze again on the wreckage of a ruined estate.”

“I have represented bankrupt farmers and holders of claims for rent, notes, and mortgages against such farmers in dozens of bankruptcy hearings and court actions, and the most discouraging, disheartening experiences of my legal life have occurred when men of middle age, with families, go out of the bankruptcy court with furniture, team of horses and wagon, and a little stock as all that is left from twenty-five years of work, to try once more – not to build an estate – for that is usually impossible – but to provide clothing and food and shelter for the wife and children. And the powers that be seem to demand that these not only accept this situation but shall like it.”

Powerful writing isn’t it? Hard to believe and even conceptualize a time when prudence and financial discipline were esteemed. This is the sad account of many folks being demoralized and unable to recuperate a substantial nest egg to retire. Their main concern shifted to providing the basic necessities for their family. Keep in mind that the majority of Americans store their wealth in home equity. Many people that grew up during the depression seem frugal and downright strict with their budgets and lifestyles. It left a visual scar on their psyche. How could it not? We look at our current culture and hear prominent financial gurus telling people to walk away from their home if they have no equity. Just leave. Don’t try to fight to keep it. Default and declare bankruptcy if necessary. My main question is who will pay the eventual bill? If you say the government then that means you will be paying back for the mass irresponsibility of financial institutions, imprudent government policy, and the mass greed of many. Unfortunately, this bubble will affect everyone in some form since all of us need shelter and this credit bubble was built on the over appraisal of a shingled laden roof over your head.


What do you think of the lawyer’s letter in relation to our current economic situation?

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37 Comments:

Ms. Chambers said...

Can you verify the authenticity of the lawyer letter? You didn't provide information about the author to verify on my own; otherwise a very good read.

Thanks

Steve said...

The letter is spooky and will most likely be a very accurate account of 2008/9/10. The end of this bubble is very near and my primary indicator is the psychological value of money.

Here is my test.. Think of a friend or family member. Now imagine mailing them $2000 in cash anonymously, no strings attached and no way for them to know where it came from.

Now consider the person and imagine what happens next... Do they even mention it when you see them next? Do they just deposit it in the checking account and 2 weeks later have it spent 4 times over and have no idea where it went? Did the husband find it and hide it from the wife or vice versa?

Or

Do they buy a CD and 10 years later explain to little Johnny that his first car was paid for by an anonymous person and that he needs to return the favor somehow.

Money has been effectively free for many years and this has confused people's perceptions of being rich versus being wealthy...

Michael Vick is (soon to be "was") rich but didn't value the money very much so he pissed it away... The owner of the Atlanta Falcons is (and will be for a long time) wealthy.

Here is a another brain teaser... Has the entire hip-hop sub-culture simply been an expression of free money?

Bling - Bling!

Pop Goes the Bubble!

bearmaster said...

What a fantastic piece of writing. Having been an economic grizzly for some years now, this writing reflects my worst fears about what major economic collapse would do to us psychologically and as a society. Even though it's 70+ years later people are the same.

When major turns like the Great Depression occur, there are many undeserving victims, as well as the deserving ones that go from screwing people on Wall Street to washing dishes in a restaurant.

Nate said...

Of course all the folks who left the farmland due to the debt crisis and dustbowl caused by overfarming became like the okies the basis of the whole californian migration, now the whole cycle revisits their progeny in the OC. Of course some became reverse okies and moved bake to OK, KC, and TX californicating the real estate markets there as well

Steve said...

@Nate

Actually the real estate markets in TX and OK seem to be doing pretty well. Very good values in the $80-$100 per square ft range throughout both states and across the board on the housing stock from 800-4000 sq ft. homes.

From what I can tell, people in general get a bit nuts whenever the right mixture of greed and opportunity is presented. Cheap money is just a key enabler of the opportunity side.

Just check out any Wal-Mart at 4AM on the day after Thanksgiving. Greed is drives them to the store for the "Fantastic Deal!!!" Now that they are in the store, if they had a limit of say $100 in cash, the opportunity side of the equation would kick in and stop the madness.

Then out come the credit cards and opportunity becomes nearly infinite.. Now you've got a bubble on your hands...

Pop Goes the Bubble!

mikey said...

Excellent, Doc. Thanks for exposing the raw shimmer of life's tawdry neon as it beckons our souls with stick and carrot.

Dr Housing Bubble said...

@ms. chambers,

I'll post more details of the letter.

@steve,

What you describe is the difference between being wealthy and earning a high income. The two don't necessarily correlate. Of course if you have a higher income the easier it is for you to become wealthy. I know many people making six figures yet have very little in what we would consider wealth. They have the artifacts of wealth, (i.e., fancy cars and expensive homes) but a very low net worth.

So again, the appearance of wealth can be very deceiving.

@bearmaster,

It seems as a society we have a collective short-term memory. Even the last housing downturn in Southern California seems a century ago and it only happened in the last decade. So something like the Great Depression seems so far away from our consciousness; in most cases, it almost seems improbable to most that we will ever see a bear market in real estate.

@nate,

That was an interesting phenomenon during the time. Those in cities left to rural areas to try to make a living and those from the farms tried to make it in urban areas. Heck, even 100,000 people applied to Russia for jobs! Interesting times.

@steve,

I agree that many parts of the South and Midwest are fairly priced in terms of housing. But cost of living is still going up. That is, food, education, and healthcare all have gone up. And credit card debt is universally maxed out across the nation. Everyone wants a plasma right? And I've been to many Southern states and I've seen the exact $40,000 SUVs and Mercedes hugging the highways.

All,

Be cautious about the housing rhetoric. Take a look at some select quotes prior to the Great Depression:

1927-1933 Chart of Pompous Prognosticators

Jim said...

I have a news paper from 1933 discussing the high level of foreclosures, credit, spending, speculation, etc. just as this cited letter recounts. I have been considering an article on the folly of humans to learn from the past. After all, aren’t we the enlightened generation with superior knowledge and vastly superior communication tools capable of performing comprehensive research? Right.

Tyrone said...

Off-topic, but related. Guy at work tells me he bought a house. I didn't press for the price, but he said he "got a good deal." I asked him if he was familiar with mortgage-backed securties or CDOs. Answer: no. I asked him if he was aware of foreclosure statistics, hedge funds, or subprime lender going under. Answer: no. I even asked him if he ever heard of New Century Financial. Answer: no.

He is what I would consider an average person. Frightening.

tpir said...

American Home Mortgage is the latest casualty.

This is on their website...

"American Home Mortgage is no longer taking mortgage loan applications."

Gaudia Ray said...

Thirty-five years ago, I purchased a Notice of Foreclosure Sale taking place in a midwest state. The year was 1934.

My point is that while the lawyer stopped observing in 1931-32, the debacle continued well into 1934. A prior poster, above, indicates he has record of it being extant in 1933.

IMO, the populace are unwilling to accept the change which has occurred. We are in an increasing state of fear and consequential loss of jobs, income, properties and a spiral based on fear which has no end but for exhaustion accompanied by minimal levels of purchase and sale as the majority will be too frightened to act either way.

Few will have resources with which to purchase. Many will have acted way too soon. We'll all know when it's all over. Most will be frozen in fear, unable economically and unwilling emotionally to "gamble" any of their then scarce resources.

Without a firm belief in the repetitiveness of human behavior, one cannot see the opportunities as they will evolve.

Bernard Baruch wrote two things I will never forget (in "My Private Years" and in "My Public Years"):
2 + 2 = 4; and, human behavior changes ever so slightly every few thousand years. Baruch is the man responsible for the reprinting and distribution in the 1930's (now available free, online) of Mackay, C. 1852. Memoirs of Extraordinary Popular Delusions and the Madness of Crowds Volume 2. London: Office of the National Illustrated Library. Baruch "knew", and he taught all those who would read and listen, as long ago have I, patience and cautious denial to participate in irrational risk will yield the best opportunities for reward.

The feast table is being set. Passage of time, more patience, and the desserts will go to the wise and long waiting.

planobcl said...

Just saw the scariest and most disturbing movie/documentary ever in my life. It is call Maxed Out. I now lost all faith in our government. It is about our addiction to credit. I cannot relate in any remote ways to the tragic stories feature in this doc, but I can definitely sympathize.

Lesson learn: If you are a narcissist, you are in for a rude awaking.

Poor Montanan,

R said...

Yes, this is a housing bubble. We've survived housing crashes before and I see no reason why we couldn't survive this one.

It's fashionable to label every bubble crash as the next Depression. The Internet bubble was supposed to bring a depression, so was Black Friday in Oct 87, the OPEC problems before then.

Just b/c this is a bubble, doesn't mean the country will go to "hell in a henbasket". The U.S. will survive this like it survives everything else.

ooloo said...

doc, thanks for the enlightening articles. been lurking for months and i think your site is one of the best source for bubble info. very good mix of humor and sobering information.

"The U.S. will survive this like it survives everything else."

famous last words? i remember in my social studies class that all great empires fall. romans, mongols, chinese, russian...i find it hard to believe that the US can withstand everything and remain a world leader forever. perhaps the US will survive this bubble, but what about the next? even if we don't go into depression, a series of bubbles will probably be as devastating if not more. buckle up people and remember to keep your ass-ets inside the rollercoaster cart unless you want to be spanked hard before it comes to a complete stop.

Abrey said...

Dear Dr. Housing Bubble:

The Book is by Dr. Charles L. MacKay, 'Extraordinary Popular Delusions and the Madness of Crowds', published in 1841 and revised in the 1850s. Still in print and still essential reading. In the original introduction, Dr. MacKay quotes a local wit (Pourson?) who said that if he ever wanted to write a history of human folly, it would require 500 volumes! I think that number now needs to be revised upward.

I have been waiting online not only for someone to start making the connection between now and The Great Depression, but to discuss the lessons of the past in terms of human cost and the intergenerational conflicts, and whether we will be learning those lessons now. Kudos to you. If we are so lucky, I think those lessons shall be learned for a short while. If this unprecedented bubble causes enough people to lose enough money and suffer enough misery then perhaps those lessons shall be retained for a while longer. For how long, though, nobody knows.

You should consider that during the Great Depression, the United States had far more positive fundamentals than it does now. We were a vigorous, manufacturing nation, oil was cheap and plentiful, we still were largely a rural country, we had savings, such as it was, and thrift, prudence and hard work were prized values; yet there was 'poverty in the midst of plenty'. Can't recall who said it, (president Hoover?) as this appears to be attributed to several people. This is how our national food stamp program got started, for one thing. Various other Government assistance programs were started and many of them were middling at best.

Thanks again for a very enlightening post.

Abrey

Peppermint Hippo said...

One issue we have to address is the interconnectiveness of the global economy now compared to the 1930s. IMO, a US Depression in the near future will not be as severe because the rest of the world will keep things chugging along. Yes, the US is the world's largest and flagship economy. Yes, we consume more than any other country. But you have to acknowledge that other countries are catching up (China, India, EU, etc.) and will pick up much of the slack. I agree that we are due for a major recession/depression in the next few years, but all you need to do is travel to some of these rapidly growing economies to see that there's real growth going on outside our borders. This growth may temporarily stall with a US led recession, but there is too much momentum and human need for it to completely derail.

chopcut said...

Um, that "letter" is a fake. Anybody else catch that the author used the verb SKYROCKET???!!!! There were no skyrockets in 1933! Doh!!

John said...

Chopcut, I beg to differ.
Aren't the words "rockets red glare" used in one of the oldest songs of our Country?

Anyhoo....that was a very moving story. You just have to wonder how it could be any worse this time.

John said...

On being wealthy vs. being rich.

Wealthy means you don't have to work; a condition where your assets earn enough interest/dividends to cover your living expenses.

Being Rich, on the other hand, is only somebody else's perception of your wealth.

Dr Housing Bubble said...

All,

This letter seems to strike a chord with many people. Here is the information should you wish to dig up the entire old article:

"Gentlemen, the Corn Belt!" Harper's, July 1933 pp. 200-206

I know most people find it hard to believe that this is actually real. Again, denial is something that runs very deep in the human psyche. Most people have never lived through a real estate down turn and the Great Depression seems like such a far off event.

Will something like this happen again? I sure hope not. But we are in a massive credit bubble and the bursting of this bubble will have seismic repercussions throughout the economy.

11:46 AM, August 03, 2007

tpir said...

Interesting: There is also an article from 1933 that's titled "the wall street debt machine: A study of the stock exchange"

http://www.harpers.org/archive/1933/07/0018534

Ms. Chambers said...

Thank you for the reference; people pay more attention to the original source.

Dr Housing Bubble said...

You have to watch this video:

Cramer: Bernanke, Wake Up

Oh boy. Here we go with the blame game. Think about the nature of subprime mortgages; you are giving people with a demonstrated inability of managing finances a large amount of money. And you are surprised when they don't pay?

Even if rates are lowered, subprime loans will always carry a higher rate simply because of the risk. So lowering the rate will only encourage more frivolous spending. That is what got us in this mess.

Interesting times...

Liberal said...

Two years ago in the Arizona Republic one of the headlines:
Juanita Lopez and Shawanda Brown, single mothers no husband in sight are left out of owning a house because the prices increased so much. After reading the article I wanted to throw up. Both worked minimum wage jobs, had no savings, credit card debt up to their ears, no man around taking responsibility for the kids. BUT, the only issue liberal press was concerned about was that these "pillars" of society couldn't own a house.
I think they must have finally got "their" house, it foreclosed last week, together with other low life's, shysters, gamblers (they call them investors)and other trash who couldn't keep a tent if they had to.
You want to know what I really think...just ask me...

Robert said...

I never heard of anyone borrowing himself into wealth and prosperity.

Flipping overpriced houses isn't "wealth creation." It's INFLATION.

Samuel Adams said...

The naysayers are hilarious. They must think that the country never had a depression. My great grandmother weathered it on the farm. She was born in 1899, so she was an adult with quite a few children in those days. I asked a lot of questions when I was a kid about the Great Depression and I remember well her stories.

We live in a society where people are more concerned about who got kicked off the island than world events or even national ones. People buy cigarettes on their credit card and do lots of other stupid things. There will be a day of reckoning and it has begun. Those doing the stupid things are the same kinds of people who keep just enough food in the pantry to make it through the week and just enough gas in their car to get to the mall.

I don't feel sorry for them. They have no survival instinct. There is enough inverse Darwinism in the country right now.

America needs an enema.

The North Coast said...

The letter you published is very moving, and very instructive. What it ought to teach us is that humans do not change.

I have witnessed a number of spates of financial hysteria over tha past 30 years, and every damn time it's "this time things are different" or a "new parameter".

It's never long after the "new parameter" stage that things start ratcheting down the other side of the slope.

Spates of financial euphoria have played out the same way for thousands of years, clear back to the Roman times, when financial markets first formed.

We have seen more of this in the past 30 years than in the tame,stable 50s and 60s for two reasons, I believe.

The first is that we ceased to be a productive economy about 30 years ago, and instead of making our livings by producing goods and delivering valuable services, we are living by generating financial chuck-and-jive games.

The second is that, after 1970 or thereabouts, we lost our collective memory of the chaos and misery wrought by the financial irrationality and malfeasance of the 20s. We lost it when we lost the leadership of my grandparents' generation, that came of age about 1928 or so, and who were quickly handed very hard lessons in what happens to people who evade reality and live on fantasy. It was people like my grandparents who sat in brokerage firms on that dreadful day in 1929, till 1 AM , trying to clear all the trades that were never going to clear because the money to settle them just wasn't there. It was they who lost 10 years out of their lives for the next decade, during which you had no chance of advancement and were damn glad you were even employed.

These were the people who ran things in the 40s, 50s, and 60s, and they never lost sight of what could happen as a result of lunacy and dishonesty, and as long as they were in charge, we were in good hands. They were extremely conservative and very caring, because they knew the consequences, which were not paper losses, but lost lives and an entire generation of people growing up in poverty and another spending their old age in deeper poverty.

You can't read this letter and contemplate our current situation without a sense of forboding that not only will the careless, the greedy, and the delusional suffer, but the prudent and honest will suffer with them. We all dwell downstream from the people, and forces, that created this debacle. We might not lose over-levereged homes, but we could see our jobs wiped out as the credit crisis cascades throughout every industry in the country.

It's great to see good places dropping back into my price range, but when the moment to buy arrives, will I still be employed? Will you?

Jim in San Marcos said...

Here's a link to a similar article written in the 30's
Link

formul8 said...

Notice a theme here and a similar theme in the current bubble?

No one wants to see their neighbor make an easy fortune while they sit on the sidelines and watch.

Same in the 1920's and 30's and the same today.

I had a client when I was an insurance agent who had 200+ rental homes that I insured. He lived in a modest home worth about $300K and drove a 10yr old Jeep Grand Cherokee. Worth at least $20m if he liquidated.

I learned alot from that guy. You would NEVER know he was worth that kind of dough by looking at or talking to him.

Too many people these days are "All hat, no cattle."

maq said...

I seem to remember stories from my Father that the Second World War solved the problem of the Great Depression.

Maybe this Iraq and Afghanistan War is the economic engine which will power the national economy out of the Housing Bubble/depression.

Regina said...

Steve why are you so jealous of black people. Why is it any concern of yours what black people buy. What in world does Michael Vick have to do with what is going on in the world today. He is just a media diversion. Why are you so concerned that black people buy jewelery with thier money. Maybe they don't buy stock and bonds perhaps jewelery is more tangible than money. I see enough white folks telling everyone to buy gold. What is the difference. You probably sit around watching pimp my ride, or the shows on MTV about living in a big house and while you are drinking a brewski lament that you don't understand how the nggrs got so much and you don't have it and you can't stand that f'n rap music nothin but noise although I agree with Simon Cowell Country music is horrid. So what makes you so right and black people so wrong and you can't understand why muslims want to blow your white asses up. Because you base everyone elses standards like you know everything and they know nothing. You need to get over yourself call the white way a antiquated way and the way of the world and joining in is the new way. Your ways are over. You are truly the pot calling the kettle black. As long as you were doing it (as white america) it was okay but when others did it their way it wasn't the American way (the white way). Well 9-11 showed a whole bunch of people those other people weren't having it and it's people like you who are going to be the last one to learn that lesson. It has been forever whites have locked blacks out of the housing market and job market. Kept them in ghettos and always the custodian or the garbage man but never the CEO or the head of a department. Hell you go into a bank or up scale boutique you never see black faces but now given an opportunity to buy a house to get away from the ghetto they were lied to and another hope for a better life dashed (don't we hear mexicans say that all the time and it gets you white folks weeping) but for black people we don't know our place and that is in the ghetto and that is where we will return. What about our better life. What about a hope for our kids future. Isn't that what Mexicans say all the time. Oh yeah black people are ignorant they don't know what a better life is. We thought they like living in those nasty, violent ghetto's. Dreams taken away by greedy white folks. Why white people are so persistant in ruining black people I do not know. But perhaps you all are beginning to get your comeupance because your dirty deeds are rotting and now the whole world can smell the stink. Steve you are a racist asshole and I hope you have a Alt-A, a disposable company and a wife who is screwing the gardener JOSE and a crook for a business partner. If you aren't one yourself. When your world starts crashing around you I hope you understand how out of control some peoples lives are and it is all because of others and in black people cases the others are white people. Now KMA a big fat nasty smelly black one.

Liberal said...

Regina.... reading Steve's and your post clearly tells me that you are the racist and your liberal self serving, ignorant drivel is exactly what is making this country so bad!!!!
Just this one sentence:
What in world does Michael Vick have to do with what is going on in the world today.....
tells me that you are either completely stupid or to put it simple, you are exactly one of these self-victimizing NIGGERS who ruin everything for descent black people.

Vern Wichers said...

Doc, thanks for the excellent posts. You are a very good writer.
You might find this article interesting, concerning the Dutch tulip bubble of the 1630s. There are also many similarities to the current bubble. http://bloggersbubble.blogspot.com/2007/04/lessons-from-another-bubble.html

Jim in San Marcos said...

Regina, you might want to know that Ghetto is a Jewish word. Hitler wiped out the Warsaw Ghetto.

A lot of us in this country are Americans, race doesn't matter to us. In order to be successful, you have to help other people become successful and there is no room for bigotry.

There are a lot of people in jail that drank a 6 pack, had a hand gun and were mad at the world. Try calming down.

Remember one thing "Life is not fair." Once you figure that out things get simpler

Mike said...

In-Line text ads? How obseen.

MRLEND said...

My mother owned a home in the middle of Los Angeles, just south of Hollywood. It was nothing fancy remodled at that time, Single family 3 beds 2.0 bath 2,125 sqft Lot 7,500 sqft Built in 1920.

She sold this home in the late 1980's for $465,000 which was a record at that time when the Japanese were buying anything they could in Los Angeles.

When the market tanked in the mid 1990's this same house sold for $238,000. The guy lost money.

Today the Zillow estimate is for $970,000.

The market, especially in that neighborhood, can't sustain such a drastic price increase. The prices need to come back down to afforable prices. Many of the price increases over the last few years has happened strictly because of the "Herd" mindset and investors and wannabe investors. They drove the market using easy, little or no down loans betting the prices will keep going up.

Flow5 said...

Economists have long sought to buttress their forecasts with various cycle theories. Kondratieff, a Soviet economist of the 1920’s, promulgated a cycle of approximately fifty years. Professor Batra of Southern Methodist University, who, with selected data, announced a thirty year cycle.
Great Depressions presume catastrophic financial events: not just a panic on Wall Street, but the actual collapse of the U.S. monetary system.
The loss of faith in the private commercial banks had become so pervasive by the end of 1932; banks were being forced to liquidate by the thousands. People everywhere were attempting to convert their demand and time deposits into currency. Thousands of towns and cities throughout the country were attempting to finance their daily commerce without a single operating bank. And by March, 1933, just before Roosevelt’s “banking holiday” there were even entire states without a single operating bank.
in the first 20 years of the Federal Reserve Act of 1913, there were over 20,000 bank failures. The intention of the framers of the Act was to establish a unified banking system under 12 central banks. There were many flaws in the original Act, one being the establishment of 12 rather than one central bank. The fatal flaw was not making membership in the System compulsory for all money creating institutions. And had not Franklin Roosevelt declared a “banking holiday” in March 1933, the lack of confidence in the banking system would have resulted in the failure of virtually every bank in the United States.
Some unprecedented things have been happening since the coming of the “New Deal” in 1933. On a year-to-year basis, Federal Reserve Bank credit has always expanded. The same applies to commercial bank credit, and the means-of-payment money supply. The consumer price index has fallen on a year-to-year basis in only two years, 1937 and 1949. The chief factor affecting the level of long term interest rates since the early 1950’s is inflation expectations, not the level of business activity.
We now actually have a central bank. It is called the Federal Reserve Bank of New York. An amendment to the Federal Reserve Act in 1933 established The Federal Open-Market Committee and gave it the power to control Total Reserve Bank Credit. The Fed can now buy an unlimited volume of earning assets. (With the federal debt at over 8.9 trillion, and expanding, and billions of dollars of “eligible paper” available, the term “unlimited” is not an exaggeration in terms of any potential needs of the Fed.) In the process of buying Treasury Bills etc., new Inter-Bank Demand Deposits (IBDDs) are created. These deposits can be cashed by the banks into Federal Reserve Notes, without limit, on a dollar-to-dollar basis.
Today, the public, seeking to cash their deposits, would soon have a surfeit of paper money. A general run on the banks is impossibility. Where the Federal Deposit Insurance Corporation cannot handle the situation (Continental Illinois, for example), the Fed will guarantee the liquidity of the bank’s deposits. In other words, a liquidity crisis leading to the wholesale failure of commercial banks is impossible. Where banks are allowed to fail, or are absorbed into solvent banks, customers never suffer losses if their deposit does not exceed $100,000. The fed intervened in the Continental case because many corporations, foreign and domestic, had deposits far in excess of $100,000.
These institutional changes plus the numerous “safety nets” now provided business and consumers preclude a recurrence of a “Great Depression”.
In the period from 1929 – 1932 stocks were spiraling down, unemployment was becoming endemic, businesses were failing in increasing numbers, bank failures were accelerating, and millions of people were suffering severe malnutrition, there was not a single piece of legislation passed by Congress or action taken by the administration which had any significant effect in stemming the tide of economic disaster.
In retrospect, the answers to the depression seem simple. We needed a central bank that could and would pump IBDDs into the commercial banks in a volume sufficient to satisfy the public’s demand for currency, specifically paper money (currency is an asset the Fed does not, should not, and cannot control). In the control of the monetary aggregates, the monetary authorities are completely dependent on their power to control the volume of bank credit. They have no power over the volume of the Treasury’s General Fund Account or the currency holdings of the public.
It was not until 1933 that we began to unshackle our paper money from the numerous and unnecessary restrictions pertaining to its issuance. With the numerous types of paper money in circulation at the time, this would seem to have been a non-problem. Here is the list: gold certificates, silver certificates, national bank notes, United States notes, Treasury notes of 1890, Federal Reserve Bank notes, and Federal Reserve notes. With that array of paper money there should have been plenty to meet the liquidity demands placed on the banks by the public. But the volume of each type that could be issued was so circumscribed by restrictions that even the aggregate group could not begin to meet the panic demands of the public.
Today we have only the Federal Reserve Note, and there is only one restriction placed upon its issuance. No Federal Reserve Note can be put into circulation unless there is a prior transaction involving the relinquishing by the public of an equal volume of bank deposits, and an equal diminution of the holdings of IBDDs on deposit with the Federal Reserve Banks; In other words, the issuance of our paper money contains no inflationary bias. Its issuance does not increase the volume of money. It merely substitutes one form of money for another form
The last vestige of legal reserve and reserve ratio requirements against the Federal Reserve Note, demand deposit, and inter-banks demand deposit liabilities of the Reserve banks was eliminated in 1968. Today the Federal Reserve Note has no legal reserve requirements, and the capacity of the Fed to create IBDDs has no legal limit. These IBDDs are owned by commercial banks; they are bank legal free reserves and can be converted dollar-for-dollar into Federal Reserve Notes. The volume of IBDDs is almost exclusively related to the volume of Reserve Bank credit. When Federal Reserve Banks expand credit, for example by buying U.S. obligations, the balance sheets of the Banks reflect an increase in earning assets and an equal increase in IBDD liabilities, i.e., legal free reserves
Actually the issuance of Federal Reserve Notes is deflationary, other things being equal, since the issuance diminishes the clearing balances and legal free reserves of the commercial banks. The Fed recognizes this fact and uses its open market power to replenish bank free reserves and prevent any unwarranted contraction of bank credit.
In 1933 the Federal Reserve Note had to be collateralized by at least 40 percent in gold bullion or coin, and the remaining collateral had to consist of eligible comer paper, principally Trade and Banker’s Acceptances. The problem was the banks had practically no eligible collateral.
The first tentative step was to reduce the gold requirement to 25 percent and allow U.S. government obligations to provide the remaining collateral. The framers of the Federal Reserve Act did not believe that the credit of the U.S. government was inferior to that of the Federal Reserve Banks and the short term commercial paper of business; they merely believed that the volume of paper money should rise and fall with the level of business activity. They also had the naïve belief that this country was so big, so diverse in its commercial needs, that it needed twelve central banks.
Had the present Federal Reserve System been in place at the beginning of the Great Depression, there would have been no Great Depression. We were not reduced to practically a barter economy because the banks were insolvent; we needed that condition because perfectly sound banks could not meet the liquidity tests imposed upon them by a panic-stricken public.
One of the preconditions the U.S. needed in 1929 was a much larger national debt, and a willingness on the part of the Congress, the Administration, and the business community to tolerate an adequate expansion of the national debt. In 1929 the national debt was less than $17 billion, and the banks held only a small proportion of that amount. We needed a larger debt and a much more rapidly expanding debt in the 1930’s, not only to “prime-the pump”, but to meet the monetary management needs of the Fed. Note: Both Roosevelt and Hoover in 1932 ran on platforms calling for balanced budgets.
The open market operations of the Fed require a depth of market that will enable the Fed to buy or sell billions of dollars worth of treasury bills on any given day without deeply disturbing the bill rates. Another of the many lessons from the Great Depression was the realization that if a financial panic is allowed to reach crisis proportions, monetary policy becomes useless, totally ineffective.
For all of the Great Depression legal reserve management was impossible even though the Banking Act of 1933 provided for the coordination of all open market operations through the New York Reserve bank. (that is to say, before 1933 one FRB could be conducting operations of the buying type -- expanding credit, creating bank free reserves and laying the foundation for a multiple expansion of money, while another FRB was doing the opposite, -- conducting open market operations of the selling type) Before April 1933 any excess free reserves in the system were quickly wiped out by the massive “runs” on the banks.
But even after bank failures were brought under control business confidence remained so traumatized the expansion of legal free reserves remained to a large extent excess free reserves. There were not enough credit worthy borrowers in the private sector (according to the bankers), and in the public sector there was an insufficient volume of government debt to absorb excess bank lending capacity. From 1933-1942 the centralization of the open market power was of little consequence. It was not until about 1942 that the member banks operated with no excessive amount of excess free reserves.
After 1933, after we had a central bank and a coordinated Fed credit policy, the Fed pumped billions of dollars of free reserves into the banks; and nothing happened. There were years during this period when the excess legal free reserves held by the member banks were larger than the volume of required free reserves. The exercise of Fed policy was likened “to pushing on a string”. Note: before 1942, and before the federal debt became a controlling economic factor, demand deposits fluctuated up and down with the business cycle. Commercial banks were commercial banks and when business demand for loans increased, demand deposits increased, and vice versa. Now the banks always remain fully “lent-up”, they hold no excessive amount of excess legal lending capacity to finance business (or consumers), it is now used to acquire a piece of the national debt or other creditor ship obligations that are eligible for bank investment.
World War II changed this and since 1942 the member commercial banks have operated with no significant amount of excess legal free reserves. Excess free reserves were, and should be, made equal to total free reserves minus the product of all deposit liabilities times the reserve ratios.
Today, the monetary authorities use two tools to control the money supply, legal free reserves and reserve ratios. Furthermore, the reserve assets that all money creating institutions are required to hold, should be of a type the monetary authorities can quickly ascertain and absolutely control. The only type of bank asset that fulfills this requirement is interbank demand deposits in the Federal Reserve Banks owned by the member banks. This was the original definition of the legal free reserves of member banks in the Federal Reserve Act on Dec. 23, 1913 –(Owen-Glass Act) and it is still the only viable definition (pre-Dec 1959 requirements pertaining to assets). The time is long past for the Congress to require that balances (IBDDs) in the Federal Reserve Banks be the sole legal free reserves of all banks. If this reform is not made all other reforms will be of little consequence.
Similarly the monetary authorities have to have complete discretion over changes in reserve ratios. Note: required free reserves were 20 percent of demand deposits (for central reserve cities) in 1958 and are 10 percent today. This is essential since under fractional reserve banking (the essence of commercial banking) these ratios determine the minimum volume of legal free reserves a bank must hold against a specified volume and type of deposit liability
Note :deposit classification for reserve ratio purposes is based on the false premise that the purpose of legal free reserves is to provide bank liquidity. As a consequence of the abuse and laxity now surrounding the administration of monetary policy, commercial banks since 1994, have been permitted to arbitrage –that is to sweep (reclassify), checking accounts into savings accounts, overnight to circumvent required free reserves.
Rather than discipline the member commercial banks the reserve authorities have become increasingly lenient, resulting in many undesirable forms, including allowing member banks to count vault cash as a part of their legal free reserves, thus confusing liquidity (liquid assets to meet seasonal and other “extra” demands on their clearing balances) and legal free reserves and making the Fed’s job of monitoring the volume of legal free reserves more difficult to predict.. Required reserve balances at the Federal Reserve Banks are now only 15 percent of their level at the end of the 1980s. Today 85 percent of commercial bank legal free reserves is now applied vault cash. Since the beginning of the 1990s IBDDs at the Reserve Banks have declined by 83 percent, and lagged reserve requirements have replaced contemporaneous reserve requirements as a result (see numerous reserve figure revisions and bankers inability to determine requirements pertaining to assets ).
The monetary authorities have long recognized that the volume of bank legal free reserves, combined with the reserve ratios applicable to various class of bank deposits, determined the limits and, since 1942, the amounts of bank credit creation (Member commercial banks have maintained negligible excess free reserves since 1942) Bank credit creation is a “system” process. No bank or minority group (from an asset standpoint) can expand credit (and the money supply) significantly faster than the majority group are expanding. Prior to the DICMCA of 1980 member banks held only 65 percent of total bank assets, (after holding 85 percent in the late 1950’s), thus creating the need for new legislation to reign in the state chartered banks that had lower reserve requirements.
With deposit classifications reduced, reserve ratios reduced, non-bound CBs, and a 30 day lagged reserve maintenance; this all adds up to a legal reserve apparatus that the Fed cannot monitor, much less control, even on a month-to-month basis. And the Fed cannot know, in a meaningful administrative sense, the current volume of depository institution legal free reserves. What the net expansion of money will be, as a consequence of a given injection of additional free reserves, nobody knows until long after the fact. The consequence is a volatile, delayed, remote, and approximate control over the lending and money-creating capacity of the banking system. The rationale for this particular form of “accommodation” originates from the Fed’s technical staff, by adhering to the false Keynesian theory – that the money supply could be properly controlled through the manipulation of interest rates (specifically the federal funds “bracket racket”) – lost control of both the money supply and the federal funds rate. The Fed cannot control interest rates, even in the short end of the market except temporarily.
The first order of business should be to require all banks to have the same legal reserve requirements, both as to types of assets eligible for reserves and the level of reserve ratios. The Fed should limit all reserves, to balances in the Federal Reserve banks, and have uniform reserve ratios, for all deposits, in all banks, irrespective of size.
From a systems viewpoint, commercial banks as contrasted to financial intermediaries, never loan out existing deposits (saved or otherwise) including existing DDs, or TDs or the owner’s equity or any liability item. When CBs grant loans to or purchase securities from the non-bank public (which includes every institution and every person except the commercial and the reserve banks), they acquire title to earning assets by the creation of NEW money-DDs.
From the standpoint of the individual banker his institution is an intermediary. An inflow of deposits increases his bank’s clearing balances, and probably its legal reserves – and thereby its lending capacity. But all such inflows involve a decrease in the lending capacity of other banks, unless the inflow results from a return flow of currency to the banking system or is a consequence of an expansion of Reserve Bank credit.
It was true, as the Keynesians insisted, that monetary policy didn’t matter; fiscal policy was everything. No more. Never will we allow a financial panic to get out of hand, and never will we have another Great Depression. That does no mean the future is rosy. The future holds the prospect of sharply declining levels of consumption for the vast majority of the American people, who will be facing years of stagflation. It is probable that we will never be able to dig ourselves out of the present morass of debt and still operate the economy within the framework of a free capitalistic system.