Big Problems Rarely Begin Big

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1. RHPZero says:

   12/1/2008 at 11:09 pm

   David Wheelock of the St. Louis Fed would seem to disagree. Some selected quotes from his paper on the lessons of the Great Depression:

   “Some authors have argued that the growth in housing investment during the 1920s outstripped demand. The infamous Florida land and construction boom, which ended with a hurricane in September 1926, is the most-often cited occurrence of a housing bubble. However, many authors contend that real estate speculation was widespread, fueled by lax lending standards and the ease with which securities could be sold to finance construction (e.g., Gordon, 1974, p. 35)Some authors have argued that the growth in housing investment during the 1920s outstripped demand.”

   …

   “The rapid increases in building activity, house prices, and mortgage debt during the 1920s are characteristics shared with the recent U.S. housing boom. The 1920s witnessed an increase in loan-to-value ratios and frequent use of high interest rate secondary loans, which is also reminiscent of the recent experience (Doan, 1997, p. 35; Dovenmuehle, 1965, p. 2). Further, according to some commentators, lending standards in the 1920s were unusually lax (Saulnier, 1956, p. 10). Thus, on the eve of the Great Depression, many homeowners were not well positioned to withstand the substantial decline in income or house prices that would occur over the next three years.”

   …

   “Although falling household incomes and house prices were the principal causes of mortgage distress during the Great Depression, lax underwriting may have contributed to the high rate of mortgage delinquency. A National Bureau of Economic Research (NBER) survey found that, during the Depression, foreclosure rates were higher for loans made later in the 1920s than for those made earlier in the decade, suggesting that underwriting standards had deteriorated over time. Delinquency rates were also higher for non-amortizing and high loan-to-value loans (Morton, 1956, p. 100).”

   ….

   “The recent distress in the U.S. home mortgage market has parallels in the experience of the Great Depression. Like the recent episode, the increase in mortgage defaults during the Depression coincided with a sharp decline in house prices after a period of rapid gains. Also
   like the recent experience, mortgage defaults during the Depression were more prevalent on mortgages with unconventional terms, such as short-term, non-amortizing loans. Furthermore, mortgage underwriting standards appear to have deteriorated before the downturn of the 1930s, as they did toward the end of the recent housing boom. However, unlike the recent experience, the main cause of mortgage loan distress during the 1930s was the sharply contracting economy and falling price level.”

   Note that last line. He wrote this stuff for the May/June report, before our own sharply contracting economy hit.

   Overall a fascinating article on the similarities to today’s situation. And very worrisome. I respect Bernanke’s academic credentials. But I also understand that his position requires him to say things he may not believe.

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