San Diego Housing Market News and Analysis
Comparison between the Great Depression and Now
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Submitted by Ex-SD on October 5, 2008 - 4:44pm
ENTIRE ARTICLE HERE: http://www.signonsandiego.com/news/busin...
Excerpts are worth reading......................
"Nevertheless, some of the similarities between 1929 and 2008 are eerie.
Not unlike today, the crash of 1929 was preceded by a decade of deregulation, cheap credit, housing bubbles, rising inflation, rampant stock market speculation, faltering employment, stagnant wages and a growing gap between the wealth of executives on Wall Street and the cash-strapped consumers on Main Street.
To jump-start the economy after a recession in 1920-21, the Federal Reserve slashed interest rates, similar to what then-Fed Chairman Alan Greenspan did following the recession of 2001.
Although wages for most workers were stagnant during the 1920s, Americans tried to keep pace with rising inflation by borrowing money. They used credit for such newfangled gadgets as cars, radios, refrigerators, washers, dryers and vacuum cleaners.
Lawrence Mishel, who heads the Economic Policy Institute, said that such overreliance on credit – similar to the recent reliance on credit cards and home equity loans – could not be sustained over the long run.
“You can't run an economy without having enough income for workers to spend on consumption,” Mishel said. “It's important to grow an economy the old-fashioned way: earning money, and then spending what you've earned.”
As in the recent past, the cheap credit in the 1920s led to a housing boom, fueled by five-year, balloon-payment mortgages. When the mortgages came due, the homeowners had the choice of paying the balance, refinancing, selling the property or going into default – similar to the choices facing adjustable-rate mortgage holders today.
Of course, as long as interest rates were low and real estate prices were going up, there was no reason to default. A mania for real estate developed, especially in Florida and Southern California.
In San Diego, for instance, the total value of building permits jumped 80 percent between 1920 and 1926. The supply of homes soon outstripped demand. In 1927, five times as many homes were built in San Diego as were sold. Home values dropped and construction faltered. Between 1927 and 1928, the value of building permits in San Diego plummeted 86 percent.
By 1929, homeowners could not keep up with their payments. Months before the stock market crashed, home-sale ads in The San Diego Union were full of phrases such as “price slashed,” “must sacrifice all,” “big reduction” and “must sell immediately.”
“Asking 60 percent of what property is worth,” a homeowner in Hillcrest wrote back then. “Any offer above 1/2 considered.”
By that point, the “smart money” of investors and speculators had left the housing market in favor of the stock market – a reverse of what happened this decade, when the smart money left the stock market after the dot-com crash of 2000-01 and started flooding the housing market.
The speculators were aided by the close ties between banks and Wall Street investment firms. When the home mortgage market was drying up, banks built a new line of business by lending money to stock investors.
By early 1929, the skyrocketing prices caused a number of economists to worry that a bubble was forming in the stock market, fueled by credit. The Fed tried to choke off speculative trading by raising interest rates on the loans that investors used to buy stocks.
In late summer 1929, stock prices began to fall. Banks stopped lending to investors, jacked up interest rates to cover the risk and began calling in loans. This credit crunch accelerated the downturn on Wall Street, just like the current credit crunch, which is related to fears about the value of mortgage-backed securities.
Between September and October 1929, the market lost 40 percent of its value. The decline continued through 1933, when the Dow was 89 percent below its peak. Hundreds of companies went out of business. Others were forced to shed workers. Jittery bank customers, concerned about the safety of the financial system, cashed out their savings accounts, causing widespread bank failures.
With those runs on banks, which occurred months after the stock market collapsed, the Great Depression had begun.
Most economists doubt that the nation could see a repeat of that kind of economic collapse.
Most important, economists say, Treasury Secretary Henry Paulson and Fed Chairman Ben Bernanke have studied the Depression and are working to avoid its pitfalls. Bernanke's studies concluded that the Great Depression could have been blunted if the government had pumped more money into the financial system.
Bolstered by that belief, Bernanke and Paulson have adopted a much more activist stance than their counterparts did in the 1930s – pumping hundreds of billions of dollars into the market, bailing out failing financial firms and keeping interest rates low to ward off a credit crunch.
Ross Starr, an economist at the University of California San Diego who knew Bernanke during his days at Stanford in the 1980s, said that if the Fed had not taken the type of action it has in recent months, “you would be faced with a lot of businesses going under and a rise in bankruptcies, since capital could not be mobilized to help the economy.”
Under a best-case scenario, Starr said, the economy may be in a recession that lasts through the end of this year or the beginning of 2009. “If we're lucky, that's all we'll get,” he said. “But if we're unlucky, it will probably be the worst thing we've seen since the 1940s.”
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