The new millennium was a time of great progress. New technology ushered in a wave of growth.
But it also brought with it, the biggest collapse in history.
Behind it all, loose lending and new innovations such as mortgage-backed securities. It led to a meltdown epic in scale.
Of course, I’m talking about the crash of 2008.
Well think again…
The new technology?
The mass-produced motor car.
And we think of mortgage-backed securities as a new innovation. But it may surprise you to know, the same thing went on during the 1920s.
The mainstream view is that the Great Depression was brought about by a stock market bubble.
However, much less is written about the real estate bubble of the 1920s.
The real estate bubble of the 1920s
When things got back to normal after the First World War, mass production of the motor car got into full swing. The auto got cheaper every year. Suddenly it was opening up vast suburban and rural areas to housing.
The land speculation was massive.
Developers were quick to move on the rising land values. Banks likewise chimed in right on cue, with ever looser lending. They were called ‘shoestring mortgages’ back then. But they weren’t a lot different to the subprime mortgages of the 2000s.
Land around major cities sold like hotcakes. Between 1918 and 1926, house values rose by more than 400%. That’s the figure for around the nation. But it hides the full story. Land price in certain states and cities, went much higher than that. Most notably in Florida.
Between 1919 and 1925, the average value of a building permit in Miami grew from $89,000 to $7,993,500. Do the maths, that’s a rise of 8,881% in only six years.
But it wasn’t just residential housing that surged.
Commercial real estate also boomed. More buildings taller than 70 meters were constructed in New York between 1922 and 1931 than in any other 10-year period. Before or since!
But building tall had less to do with making some sort of architectural statement. It was more to do with economics.
Cass Gilbert, designer of the Woolworth Building in New York, described this new trend of building tall as, ‘a machine that makes the land pay’.
Inner city land values skyrocketed. Developers had to build tall to maximise the rents and turn a profit.
And there was good reason to be bullish about rents during the boom years. This is a summary of the times from the chairman of the Real Estate Securities Committee.
‘With the war over in the fall of 1918, a great shortage of space became evident. The average rents all over the country went up… 10% in 1918, 20% in 1920, 10% in 1921, gradually increasing another 8% during 1922, 1923 and 1924, reaching 168% of the pre-war base. During this same period everyone capitalized real estate values on the basis of the high rents and by 1926 the average value of Chicago improved city real estate reached 194% of the pre-war value.’
No wonder there was a strong appetite for mortgage-backed securities. Demand was so strong, that mortgage-backed securities quickly grew into one of the largest classes of investment assets in the 1920s. And it financed most of the construction of US skyscrapers of the time.
It wasn’t just inner commercial real estate that boomed.
Rural farm values also went through the roof. Tractors all of a sudden became cheap to buy and widely available. That increased the productivity of farms and decreased food prices across the board.
New technology bringing huge gains. A surge in economic growth. You could always know, where the gains are going to end up.
See how the last crisis was not an isolated event. The same thing went on during the 1920s. Loose lending practices, mortgage backed securities. The common element between the two? A binge in land speculation.
How does this relate to the 2008 financial crisis?
The parallels are uncanny. And the real estate securities turned out to be as toxic back in the 1929, as they were in 2008.
Just as much of the blame for the crisis in in 1929, has been misdirected at the stock market, much of the blame in 2008 was misdirected at the financial sector.
What is underneath it all, what were the financial institutions loaning on?
An ever-rising, speculative land price.
Whether it be the shoestring mortgages of the 1920s. Or the subprime loans of the 2000s, it’s critical to realise, this is not the root cause of the downturn.
At its heart 2008 was not a financial crisis. It was a land crisis.
When you look at it from that angle it becomes less about how to reform the financial sector and more about how to stop the speculation in land.
That’s why the financial reforms put in place after 2008 have only ensured another boom bust.
We’ve never dealt with the underlying problem.
How to deal with the speculation in land price?
Well, this is the very problem our own founding fathers of federation had. When they made plans for the new Federal city, eventually to be located in Canberra.
They knew what would happen, once the location of the new capital city became known. Speculators (really insiders) would buy up all the land beforehand for a song. Then just sit back and reap the profits. Capturing all of the increase in land value that came with population increase, public services and infrastructure building.
You know what? They found a solution.
Our founding fathers of federation found a way.
But because it took so long to agree on the site for the new city, the original vision of our founding fathers got lost. And their plan never got put in place as they saw it. There was the passing of decades and the personnel had all changed by the time Canberra had started to be built.
But the answers are there for anyone who wants to follow it through. It’s not impossible to stop the speculation in land.
It really is the missing piece of the puzzle, as to why we’re locked into this boom bust cycle.
Only it’s not really missing.
Our economy is driven by real estate and banking. Property finance is at the very heart of modern economic policy.
Governments are most unlikely to rock that boat.
So, it’s carry on as we always have.
As an investor that’s good to know. It sets us up for yet another real estate cycle. A boom bust most likely bigger than the last one.
Chartist, Phil Anderson’s Time Trader