The Great Real Estate Bubble of the 1920's

Economists conventionally attribute the Great Depression to blunders by the then-new Federal Reserve Bank. According to this story, promoted by Milton Friedman and the Chicago School, after the stock market crash of 1929, the Fed kept interest rates too high, strangling the economy. This story made most economists confident that it couldn’t happen again.

But there’s a different story: the story of the giant 1920’s real estate bubble. It began with cars.

Starting in 1899, the auto industry took off exponentially, dipped for two years during World War I, then took off exponentially again during the 1920’s. Production reached a peak of over 4 million vehicles in 1929, before collapsing. It did not again pass 4 million until 1949!

The auto suddenly opened up vast suburban and rural areas to housing. Developers–legitimate and bogus–leapt at the opportunity. Banks jumped in too, creating so-called “shoestring mortgages”–effectively allowing property purchases on margin. Within a few years, tens of thousands of acres around major cities had been subdivided and sold. In rural areas, developers bought up farms, dug a pond, built a “club house” and sold cheap “vacation” lots. As reported in Homer Hoyt’s classic One Hundred Years of Land Values in Chicago, from 1918 to 1926 Chicago population increased 35% and land values rose 150%, or about 12% a year.

In 1926, land values stagnated, then fell. By 1933, Chicago land values had fallen some 70% overall; peripheral areas fell even more dramatically. After 1929, home construction collapsed, and–paralleling the auto industry–did not again pass the 1926 level until 1950. Around Detroit, over 95% of recorded lots were vacant as of 1938. Nationally, there were an estimated 20 to 30 million vacant lots, compared to about 30 million occupied housing units. According to economic historian Alex Field, the barren subdivisions ringing the cities hindered the recovery of construction: Missing titles of defaulted owners and poor physical layout created de facto brownfields.

The real estate bubble helped set off and then worsen the Depression. Collapsing land values left people suddenly much poorer, so they cut spending. They also defaulted on mortgages, sticking the banks with “toxic” assets: liens on near-worthless property. The struggling banks in turn cut off lending even to good customers. Bank runs–panicky depositors withdrawing cash–further crippled the banking system. Between drops in spending and lending, businesses failed, unemployment soared, and prices fell.

Thus a radical innovation of the early 1900’s–the automobile–set off a destructive real estate bubble in the 1920’s. Another radical innovation took hold in the late 1990’s: “securitization”, that is, the aggregation of consumer debts, especially mortgages, into marketable packages known as “collateralized debt obligations” or “CDO’s.” CDO’s set off another giant real estate bubble by making houses “affordable” to poorer Americans. The collapse of the CDO bubble stuck banks once again with “toxic” real estate.

Fortunately, economists–and markets– now recognize that to limit damage, we must force banks to write down the garbage quickly. But write-downs will reveal that some big banks’ liabilities exceed their assets, requiring drastic remedies, including restructuring, breakup, and possibly temporary nationalization. Unfortunately, so far our new Treasury Secretary, Tim Geithner, either lacks the nerve or the authorization. Unless he acts soon, we face another “lost decade” like the 1930’s.

4 thoughts on “The Great Real Estate Bubble of the 1920's”

  1. Very good summary. The invvestment-insurance-companies-banks have worthless paper positions. Government is taking tax money to keep the paper lies alive. Why? It doesn’t benefit working Americans.

  2. Splendid article on the automobile causing the depression. I would like to point out though that overall the automobile had a positive effect on land values, IE it suppressed rent. The principle utility of urban land is its location, or more precisely proximity. Land is the substitute good for transportation costs. So by bringing down transportation costs, rent everywhere is reduced. I see this as the major reason the gilded age did not return in the next land cycle.

    The geometry of “proximity” for American cities was that of a point, and new useful lands were added with the square of the expanding radius a car could provide access too. The introduction of freeways extended this effect.

    But eventually the effective geometry of cities meant that the marginal lands at the periphery could no longer substitute with additional transportation costs. There are only so many hours in the day to devote to the commute. Freeways clogged and the original problem of the gilded age and high transportation costs starts to return.

    I see this as the reason that despite solid gains in productivity since Reagan, that working wages are down. The extra and more was consumed by growing rent. And the trend continues today. The recent drop in land prices has been the first time for any real gain in wages since then. And it will be reversed as the cycle progresses. With the transportation/rent trend increasing their ‘cost’ as well.

    This could be delayed by again increasing the efficiency of the transportation networks throughout the country. But voters are wary of such projects as they end up paying more then the benefit.

    When, as usual, the transportation project is financed by production taxes like sales or income, the taxpayers are hit twice. Once in taxes for the cost of the project, and then again in rents. Lands served by the project are quick to add all the value created by the project into their rents. If few cities get this improvement each year from federal largess, then the lands added in competition by the cities newly extended reach, will only accommodate the countries growth, and not make any local reductions in rent. There can be no net benefit to taxpayers.

    However if all the financing is done by land taxation, then the project is self financing. Land rents go up anyway, but the taxpayers aren’t seriously bilked, and the additional lands added by moving out the radius of the cites en-mass, will counter some of the increased land rents. And so an actual profit to the workers, and capitalist investors is produced.


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