Friday, November 14, 2008

Deja Vu All Over Again

So I'm reading Amity Shlaes' "The Forgotten Man" last night, and I get to this paragraph and something jumps out at me.

The book is a history of the Great Depression, with background on the lead-up to it and the cast of characters involved.

Anyway, this jumped off the page:
As the productivity gains sank in, the Dow marched upward still more aggressively, from 155 in February of 1927 to 200 by the end of that year. Many investors were now wilder than Wilson. New investors had discovered that they could buy shares without the cash to pay for those shares -- they simply borrowed on margin and hoped that the rise in the stock prices would cover their loans. The margin rule was not new, but the investors were. [my emphasis]
This is not all that dissimilar to what just happened in the real-estate/mortgage market. Real-estate prices were rising so fast and so steadily that people would buy property they couldn't afford, figuring the could sell it at a profit and cover the original loan. Combine this with the government, ahem, "encouraging" (closer to coercing) banks to give loans to people who wouldn't qualify for loans on their own merits out of some sense of "social justice". My guess is that nobody worried too much about it because a) real estate prices were spiraling upward, and b) the government implicitly guaranteed the loans anyway.

I noticed here in my own town over at least the last 10 years -- and at an even more frenzied pace the past 5 or so years -- housing going up everywhere as fast as it could be built. Huge condo complexes and apartment complexes. Big subdivisions with gigantic expensive homes. My wife and I often wondered aloud where all these people were going to come from. With the more upscale neighborhoods, we wondered aloud about where all the people worked in our community of ~100-150,000 that had jobs that paid well enough for them to afford these homes. We'd drive through or by 5 or 6 of these neighborhoods and say, "Ok, that accounts for bankers, doctors, and bigger business owners... where do all the rest of these people work, and what do they do?"

In short, since real estate was a sure bet and paid off big, people went nuts developing it. Too nuts. They overbuilt. And the dirty little secret here in America is this: population isn' t increasing that fast anymore. Over supply. Slowdown in demand. Prices crashed. People who had borrowed assuming that their equity would cover their losses in a worse-case scenario suddenly discovered they had ... miscalculated. Balloon payments came due. Variable interest rates (for those who financed at the bottom of the money market and at the same time maxed out their budgets) couldn't afford payments when the interest rates rose.

Packages of loans bought up by big banks and Fannie & Freddie suddenly had significant numbers of loans going bad, and the promise of the value of the real estate that backed them weren't looking good. And nobody wanted to get left with a rotten egg, so credit among the big banks that lend to each other got tight as each feared what the other wasn't telling them about their state of affairs. If I give you a billion dollar loan today, will you declare bankruptcy tomorrow?

Anyway, guess things really haven't changed much.

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