Doctor Housing Bubble

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					Personal Story by a Lawyer from a Previous Asset Bubble. Can we Learn from the Past
and How will the Housing Decline Impact You? ............................................................... 2
Lessons From the Great Depression: A Letter from a former Banking President
Discussing the Bubble......................................................................................................... 8
Florida Housing 1920s Redux: History repeating in Florida and Lessons from the Roaring
20s. .................................................................................................................................... 12
The Menace of Mortgage Debts: Lessons from the Great Depression Series: Part IV:
Where do we go After the Housing Crash? ...................................................................... 22
Business Devours its Young: Lessons from the Great Depression: Part V: Destroying the
Working Class. .................................................................................................................. 28
Crash! The Housing Market Free Fall and Client #10 Contagion. Lessons From the Great
Depression: Part VI. .......................................................................................................... 36
Winston Smith and the Bailouts in Oceania: Lessons from the Great Depression Part VII.
........................................................................................................................................... 44
Sheep Back to the Slaughter: Lessons from the Great Depression Part VIII: All the
Change and Bear Market Rallies. ..................................................................................... 52
A Bubble That Broke the World: Lessons from the Great Depression Part IX. When
Credit is Debt. ................................................................................................................... 63
Bipolar Housing: Lessons from the Great Depression: Part XI. Understanding the Impact
of Asset Deflation and Consumer Inflation. ..................................................................... 75

Personal Story by a Lawyer from a Previous Asset Bubble.
Can we Learn from the Past and How will the Housing
Decline Impact You?
Overpriced Homes? The subprime implosion? Massive credit? Or are you simply
indifferent to it? The housing and credit bubble will have a long lasting impact on an
entire generation of people living through it. When we see that a certain company has
self-destructed or foreclosures are skyrocketing, what does this mean on a personal level
for society? In the case study of a couple making $130,000 a year and going into
foreclosure, we see that this bubble will impact the rich and the poor including the farmer
making $14,000 a year and buying a $720,000 home. These stories drive the point home
and make the credit bubble discernable to people from all sectors of society. It is easy for
most people that understand housing to assume everyone can read a 30 year mortgage
statement or has substantial knowledge regarding investing in the stock market. However,
we have examined that the majority of the population is not affluent or what we consider
to be really rich.

Very rarely do I come across a personal account that encompasses the entire scope of
what a bursting bubble can do to an economy and the people living in it. Bubbles, as
examined from the past, have a very similar pattern in the stages they progress. Mass
euphoria leads to a case of mass resentment and depression both economically and
personally for many families. I came across a letter written from a lawyer from Mason
City, Iowa in the Corn Belt recounting the impact of the Great Depression on his town. It
is a poignant and somewhat eerie story to read considering the date of writing is 1933.
The similarities of what happens in the past raises many questions that I hope to discuss
at length and how it will influence our future as a nation. These are things that as a
society we will face. Foreclosures, larger numbers of families facing economic problems,
and the repercussions of another bubble bursting. Since I found this letter in a very old
file, I have decided to type up the large part of the letter since it is a necessary read for
anyone trying to diagnosis potential issues we will face. Of course, times are different.
We are not in the late 1920s or early 1930s, but human nature, bubble psychology, and
the essence of being a person are timeless. Below are paragraphs of the entire letter:

“The boom period of the last years of the World War and the extremely inflationary
period of 1919 and 1920 were like the Mississippi Bubble and the Tulip Craze in
Holland in their effect upon the general public. Farm prices shot sky high almost over
night. The town barber and the small-town merchant bought and sold options until
every town square was a real estate exchange. Bankers and lawyers, doctors and
ministers left their offices and clients and drove pell mell over the country to procure
options and contracts upon this farm and that, paying a few hundred dollars down and
expecting to sell the rights before the following March brought settlement day. Not to
be in the game marked one as an old fogy, while paper profits were pyramided and
Cadillac cars and pleasure trips to the cities took the place of Fords and Sunday
afternoon picnics. Everyone then maintained that there was only a little land as fertile
as the fields of Iowa, Illinois, and Minnesota, and everyone sought to get his part
before it was all gone. Like gold, it was limited in extent and of great potential value.
Prices skyrocketed from $100 to $250 and $400 per acre without regard to the
producing power of the land.”

Real estate speculation is not a new subject. As noted by the lawyer, people from all
segments of the economy were playing the real estate speculation game. If you didn‘t
play the game, you were considered old school and lacked the intelligence to be
financially savvy. Bringing this to the current market, we can see how someone driving a
Mercedes may hold a view of someone driving a Honda Civic. Clearly, the person
driving the Civic isn‘t playing the real estate game or has an understanding of how to
manage their finances. Sadly, a large percentage of those in the Civic will perceive the
person driving the Mercedes as wealthier even though they have an $800 a month lease
and in fact may have a net worth in the negative territory. So many people decided to
jump into the game and this is noted by the large increase of employment related to the
housing complex in the past decade. The letter continues:

“During this period insurance companies were bidding against one another for the
privilege of making loans on Iowa farms at $90 or $100 or $150 per acre. Prices of
products were soaring. Everyone was on the highroad not only to comfort, but to
wealth and luxury. Second, third, and fourth mortgages were considered just as good
as government bonds. Money was easy, and every bank was ready and anxious to loan
money to any Tom, Dick, or Harry on the possibility that he would make enough in
these trades to repay the loans almost before the day was over. Every country bank and
every county-seat town was a replica in miniature of brisk day on the board of trade.”

Many housing pundits would like you to believe that modern real estate products are
somehow superior to past products. Either way, you are securing a note onto an asset and
the basic concepts still apply. As you can read from the letter, second, third, and even
forth mortgages were common in the 1920s. The perception, just like in better housing
days, that housing was an absolute secure investment was something held very near to the
heart during the lead up to the Great Depression. We also notice that lending institutions
were just as eager then as they are today to loan money out to anyone with a pulse. How
quickly did the tide turn after the Crash of 1929? It did not happen overnight:

“The drastic deflation of Iowa loans under the orders from the Federal Reserve Board,
upon which Smith Wildman Brookhart, depression Senator from Iowa, poured forth
his venom, definitely marked the downward turn in the mythical prosperity of boom
days. Despite our hopes for the better, conditions have grown steadily worse.”

“During the year after the great debacle of 1929 the flood of foreclosure actions did
not reach any great peak, but in the years 1931 and 1932 the tidal wave was upon us.
Insurance companies and large investors had not as yet realized (and in some
instances do not yet realize) that, with the low price of farm commodities and the
gradual exhaustion of savings and reserves, the formerly safe and sane investments in
farm mortgages could not be worked out, taxes and interest could not be paid, and
liquidation could not be made. With an utter disregard of the possibilities of payment
or refinancing, the large loan companies plunged ahead to make the Iowa farmer pay
his loans in full or turn over the real estate to the mortgage holder. Deficiency
judgments and the resultant receivership were the clubs they used to make the honest
but indigent farm owners yield immediate possession of the farms.”

So we realize after the ―great debacle‖ that foreclosures did not peak until 1931 or 1932.
So it took 2 to 3 years for the pent up excess credit to hit the market. With our 24/7 media
coverage and online to the nanosecond updates, most people think the bubble burst or
later recovery will happen tomorrow. Unfortunately, it will occur over a long and drawn
out period while people silently scream. The denial of the current credit bubble is
extremely similar. By looking at the numbers conservatively, we see that we are going to
have much of the same in 2008 and 2009. Not only will it be the same, but we are
eliminating the ―safety‖ feel of real estate and compounding it with growing foreclosures
and declining prices. We recently had a first national housing median price decline since
- guess when - The Great Depression. And it is not uncommon for people to start taking
sides at this point. Some want to call bottom and those financially conservative realize we
have a long way down before we hit bottom. The letter also highlights the sucking dry of
savings and reserves of many families. Well, we already know that we have a negative
savings rate so I‘m not sure how long a family could stay afloat without using credit
cards or blowing through their retirement funds (if they have any). How did this impact
society‘s view on real estate?:

“Men who had sunk every dollar they possessed in the purchase, upkeep, and
improvement of their home places were turned out with small amounts of personal
property as their only assets. Landowners who regarded farm land as the ultimate in
safety, after using their outside resources in vain attempts to hold their lands, saw these
assets go under the sheriff’s hammer on the courthouse steps.”

We have this mentality in the current market place. The majority of folks that invest
heavily into renovating their homes are looking to flip the property for a larger profit. Not
everyone, but with shows like Flip This House you begin to realize that home is a
temporary pit stop for many in our society. And then we have the generational
psychology shift that housing isn‘t a safe investment in every circumstance. Foreclosures
started going through the roof shortly after the psychological shift:

“During the two-year period of 1931-32, in this formerly prosperous Iowa county,
twelve and a half per cent of farms went under the hammer, and almost twenty-five per
cent of the mortgaged farm real estate was foreclosed. And the conditions in my home
county have been substantially duplicated in every one of the ninety-nine counties of
Iowa and in those of the surrounding states.”
Growing foreclosures start to hit multiple counties in Iowa during the tidal wave period
of 1931-32. Currently we are facing incredibly large foreclosure jumps in California,
Colorado, Arizona, Florida, and Michigan to name a few states. This is something that
has only started. It has moved from the center of wealth in the 20s of the farm and
industrial cities, to the urban metro centers of the 2000s. Like the previous bust, it took
about 3 years for the general market to realize there were major issues. When times
change they change quickly:

”We lawyers of the Corn Belt have had to develop a new type of practice, for in pre-war
days foreclosure litigation amounted to but a small part of the general practice. In
these years of the depression almost one-third of the cases filed have to do with the
situation. Our courts are clogged with such matters.”

“Gone, too, is that pride of ownership which made possible the development of stock
and dairy farms with their herds of fat cattle and hogs, their Jersey cows, their well-
kept groves and buildings which beautified and developed the countryside. The former
owners were willing to use a large part of receipts from a farm’s income to increase its
value and appearance but the present absentee owner regards it only as a source of
possible dividends.”

“From a lawyer’s point of view, one of the most serious effects of the economics crisis
lies in the rapid and permanent disintegration of established estates throughout the
Corn Belt. Families of moderate means as well as those of considerable fortunes who
have been clients of my particular office for three to four generations in many
instances have lost their savings, their investments, and their homes; while their
business, which for many years has been a continuous source of income, has become
merely an additional responsibility as we strive to protect them from foreclosures,
judicial receivership, deficiency judgments, and probably bankruptcy.”

“The old maxim of three generations between shirt sleeves and shirt sleeves is finding a
new meaning out here in the Corn Belt, when return to very limited means in a
formerly prosperous population is the result not of high living and spending, but of
high taxes, high dollars, and radically reduced income from the sale of basic

A few things to note. The impact on a societal level is time and productivity will shift
into protecting faltering estates. Folks will try to save their homes, try to avoid
bankruptcy, and we will have collectors focusing on bringing accounts current (if they
can). This is time spent from other economically productive activities. However, it is an
unavoidable evil of any bubble to wash out the excess liquidity. The letter also discusses
the loss of homeownership pride. I‘ve thought about this many times here in Southern
California. Most of the time, I hear folks saying, “do you know I have $300,000 in equity
and if I upgrade the bathroom, it’ll be worth an additional $25,000?” I ask them if they
are upgrading for their family but normally it is to sell it off to the next highest bidder.
We are starting to see dents in this mentality. Why invest so much in your home if
appreciation is stagnant or declining? If you really wanted to be a proud homeowner, you
would do these things simply for improving your home. Many did upgrade via mortgage
equity withdrawals and second mortgages. However, when the market bottoms out you
realize that many did it as a ploy to inflate the value of their home for a future time to
market and not for the betterment of their families‘ well being. Either way, folks can do
whatever they want with their home and money but clearly, homeownership pride for
many in Southern California and other large metro areas is based on how much equity
you have amassed. The lawyer recounts a sad story of a client:

“George Warner, aged seventy-four, who had for years operated one hundred and sixty
acres in the northeast corner of the county and in the early boom days had purchased
an additional quarter section, is typical of hundreds in the Corn Belt. He had retired
and with his wife was living comfortably in his square white house in town a few
blocks from my home. Sober, industrious, pillars of the church and active in good
works, he and his wife may well be considered typical retired farmers. Their three boys
wanted to get started in business after they were graduated from high school, and
George, to finance their endeavors, put a mortgage, reasonable in amount, on his two
places. Last fall a son out of a job brought his family and came home to live with the
old people. The tenants on the farms could not pay their rent, and George could not
pay interest and taxes. George’s land was sold at tax sale and a foreclosure action was
brought against the farms by the insurance company which held the mortgage. I did
the best I could for him in the settlement, but to escape a deficiency judgment he
surrendered the places beginning in March 1st of this year, and a few days ago I saw a
mortgage recorded on his home in town. As he told me of it, the next day, tears came to
his eyes and his lips trembled and he and I both thought of the years he had spent in
building up the estate and making those acres bear fruit abundantly. Like another Job,
he murmured “The Lord gave and the Lord hath taken away”; but I wondered if it was
proper to place the responsibility for the breakdown of a faulty human economic
system on the shoulders of the Lord.”

“When my friend George passes over the Jordan and I have to turn over to his wife the
little that is left in accordance with the terms of his will drawn in more prosperous
days, I presume I shall send his widow a receipted bill for services rendered during
many years, and gaze again on the wreckage of a ruined estate.”

“I have represented bankrupt farmers and holders of claims for rent, notes, and
mortgages against such farmers in dozens of bankruptcy hearings and court actions,
and the most discouraging, disheartening experiences of my legal life have occurred
when men of middle age, with families, go out of the bankruptcy court with furniture,
team of horses and wagon, and a little stock as all that is left from twenty-five years of
work, to try once more – not to build an estate – for that is usually impossible – but to
provide clothing and food and shelter for the wife and children. And the powers that be
seem to demand that these not only accept this situation but shall like it.”

Powerful writing isn‘t it? Hard to believe and even conceptualize a time when prudence
and financial discipline were esteemed. This is the sad account of many folks being
demoralized and unable to recuperate a substantial nest egg to retire. Their main concern
shifted to providing the basic necessities for their family. Keep in mind that the majority
of Americans store their wealth in home equity. Many people that grew up during the
depression seem frugal and downright strict with their budgets and lifestyles. It left a
visual scar on their psyche. How could it not? We look at our current culture and hear
prominent financial gurus telling people to walk away from their home if they have no
equity. Just leave. Don‘t try to fight to keep it. Default and declare bankruptcy if
necessary. My main question is who will pay the eventual bill? If you say the government
then that means you will be paying back for the mass irresponsibility of financial
institutions, imprudent government policy, and the mass greed of many. Unfortunately,
this bubble will affect everyone in some form since all of us need shelter and this credit
bubble was built on the over appraisal of a shingled laden roof over your head.

What do you think of the lawyer‘s letter in relation to our current economic situation?

Lessons From the Great Depression: A Letter from a former
Banking President Discussing the Bubble.
As we hit record lows with the markets, it is clear that we are entering a correction phase.
With the incredible response we had to a personal letter from a lawyer discussing in great
deal, the failures of the previous Great Depression bubble we can see many parallels
emerge to our current potential future. For one, the wanton greed and disregard of
financial prudence. The inability to see beyond the current market and realize that history
has a mischievous way of sneaking up on those who forget her. There is no longer a
debate regarding the once fabled housing bubble. We can all take off our tinfoil hats off
and begin to construct a vision of the future in the midst of a collapsing housing market.
Today I‘ll be posting an article that came out in the Saturday Evening Post in November
of 1932 from a former bank president in New York, three years after the crash,
highlighting the economic situation of a post bubble world. This is an old article so I
retyped the important paragraphs:

“If I draw illustrations from the banking field to indicate the limits to which the
depression reached, it is only because I am writing about banks and not because the
banks are the one glaring example marking the extent of the financial cataclysm. The
railroads, the insurance companies, the building-and-loan societies and mortgage
companies would quite as well depict the situation.”

The collective memories of many Americans believe and associate the Great Depression
igniting from the heart of Wall Street. However, it is clear that many industries built
around financial imprudence also failed during the Great Depression. Think of the many
industries currently facing hard times with the housing decline: insurance companies,
mortgage lenders, hedge funds, the auto industry, home remodeling centers, and many
other housing associated industries. Can it be that for the past decade, we have been using
the home as a center of economic prosperity? Clearly it has helped to a certain extent
with unparalleled amounts of mortgage equity withdrawals. There are estimates from the
FDIC that $5 trillion in wealth has been directly linked to this housing boom. How much
was really lost during the three years following the Crash?:

“The decline in the price of bank stocks was only a minor phase of our debacle. The
quoted value of all stocks listed on the New York Stock Exchange was, on September 1,
1929, $89,668,276,854. By July 1, 1932, the quoted value of all stocks had fallen to

“Stockholders had lost $74,000,000,000. This figure is so large that not many minds can
grasp it. It is $616 for every one of us in America. It is, roughly, three times what we
spent in fighting the World War. The bursting of the South Sea Bubble concerned a single
company. In the bursting of the New York Stock Exchange bubble, the value of all stocks
fell to 17 per cent of their September 1, 1929, price – almost as great a drop as the South
Sea Company stock, with its fall to 13 per cent of its top price. Remember that this
calculation is not a selected example. It is made from the average of all stocks listed on
the Exchange.”

So $74 billion was lost. A massive amount. What would happen if say the $5 trillion in
housing wealth would suddenly disappear? Instead of bank failures we are now facing
hedge fund debacles and everyday it appears that another mortgage outfit is closing shop.
Mortgage resets are hitting the market to the tune of $30 billion a month with our peak
month hitting in October with $50 billion resetting. We will not fall below the $30 billion
monthly mark until September of 2008. Most experts are now predicting a declining
market until 2009 and these are optimistic projections.

“The South Sea Bubble wasn’t so much! We have done pretty well in the way of bubbles
in our own time. All financial history shows no parallel to what we have been going
through. Never before, in this country or anywhere else, has there been such a general
loss in “security” values.”

Bubbles will always occur in profit driven systems because of human nature and bubbles
will bust when they reach a Minsky Moment. In addition, the psychology at a certain
point tips and the market no longer follows previous rules. The system was built on
consistently appreciating real estate and when this ended, it turns out that millions of
people were swimming naked. The only question now is how long will the market
retrench. Unbelievably, those that pumped up the bubble are crying for compassion for
the desolate homeowner now losing his home even though he is laughing all the way to
the bank. Since he is partly responsible for the massive speculation, why doesn‘t he cut a
check from his decade long bubble profits if he feels so bad? Instead, they want the entire
nation to carry the burden of this massive credit orgy. If they truly believe in free market
capitalism, then what is currently happening is the end result; the market is washing out
all the excess from the system. Yet the Fed injecting liquidity amounts to corporate
welfare and is only prolonging the inevitable decline.

“The decline in the quoted value of New York listed stocks is only part of the story. The
total of real-estate mortgages in default, particularly mortgages on city property, is
unexampled. The value of real estate can no longer be accurately appraised, because the
market for real estate has been practically paralyzed.”

We are already seeing this. Many REO properties are simply sitting on the market and
stubborn lenders and sellers are refusing to lower prices. Buyers are refusing to buy or are
unable to get loans. It is a Catch-22 that is accelerating the market on a downward spiral.
People realize that housing is going down and are suddenly reluctant to buy. The MBS
market now seeing the intestines of their portfolios is realizing that some overpricing may
have occurred. I‘m not sure if any of you have seen the new housing syndicate marketing
angle (I caught a glimpse of this on late night infomercial happy television). They are
now pushing, get this, FHA loans! Suddenly, the industry that pumped interest only,
hybrid, reverse mortgage, 2/28 loans, stated income, and every other weird concoction of
loans is coming home to the safest of the safe. But the scary implication here is they are
touting, ―no need to worry here, these are government insured.‖ Guess that means the
American tax payer is going to bail out the housing industry. At least this is what the
housing industry expects.

“The loss of $74,000,000,000 in the value of New York listed stocks is something more
than a mere item of financial data. Implicated in it are ten million cruel heartaches. I am
using “million” as an adjective, and making an understatement. The laborious savings of
an uncounted number of lifetimes have been swept away. Prudent provisions for the
future has been made to contrast unfavorably with the pleasures of spendthrift waste…”

The real pain is in what happens on a micro level. Like the couple earning $130,000 a
year that lost their home to foreclosure and is now facing hard times; these are the real
stories behind the bursting bubble. What is the psychological and financial impact of
those put into 2/28 homes and are now facing foreclosure? There is no financial benefit to
the buyer for jumping into a 2/28 loan aside from squeezing into a home they cannot
afford over the long run. The only one benefiting from this is the mortgage broker who
gets a stronger kick back for putting you into a risky loan and the agent from getting a
commission check after escrow closes. What do they care? The loan is getting an extreme
makeover on Wall Street and they‘ll never see it again. The transparency legislation now
being pushed is 7 years too late. Wall Street has turned off the spigots earlier in the year.
Don‘t worry about the large mortgage outfits, many top CEOs and executives actually
sold out [are in the process of selling out] near the peak.

“Not only did our investments shrivel in the last three years but we even frequently lost
our pocketbooks. Cash in hand, left for safekeeping in a bank, often went the way of our
investments, and worse. Almost $3,000,000,000 of our daily-used cash funds were
sequestered in the doubtful assets of the 4835 insolvent banks. Widespread communities
were left with only the mattress as a safe depository, and with little to put into it. People
became so frightened in regard to the safety of the banks that they locked up in safe-
deposit vaults, or selected elsewhere, more than $1,500,000,000.”

We don‘t have to worry much about losing savings accounts considering Americans now
have a negative savings rate. Try imagining you are now in 2009. What do you think the
sentiment of the American public will be when trials are going on regarding shady
lending practices? Many defunct companies are now getting their legal houses in order
preparing for this. Even with the previous scandals such as Enron, many folks saw this as
something far and away since few even understood what Enron did or what laws they
broke. But everyone will understand the debacle of the housing industry because it hits
every American. It is a simple story of greed and financial negligence. And one thing is
certain, Americans do not like gambling with their homes unless they are winning. Now
that many are losing, they‘ll be out for blood. The Democrats are already taking aim and
claiming it is the mortgage brokers fault for putting us in this mess. Of course there are
other major players including the Fed, hedge funds, buyers/sellers, agents, appraisers, and
flat out greed.

“This is a shameful and humiliating exhibition. It is uniquely bad. Across the border in
Canada, there was not a single bank failure during our period of depression, and one
must go back to 1923 to find even a small one. Nowhere else in the world at any time,
were it a time of war, or of famine, or of disaster, has any other people recorded so many
bank failures in a similar period as did we. We were not experiencing a war, a famine or
any other natural disaster. All the economic tribulations we have undergone in the past
three years have been man-made troubles, and Nature has continued to shower us with
an easy abundance – more, indeed, than we have known how to distribute with economic

We are facing a healthy economy as well. Unemployment is low. Wages are holding
steady. GDP is still growing. Too bad most of this growth is heavily influenced by the
credit bubble. Like the former banking president states, this credit bubble mess is another
―man made problem‖ as well. Where this market will take us is anyone‘s guess but I‘ll
leave you with the final paragraph of the article:

“Human stupidity and cupidity were the taproots of this great financial disaster. Those
are evils which will always best us. There have, however, been revealed faults and
weaknesses in our banking and investment practices that account in part for the extreme
nature of this experience. Isn’t it about time that we began thoughtfully to examine some
of the fundamentals of our banking and investment theories and methods?”

Florida Housing 1920s Redux: History repeating in
Florida and Lessons from the Roaring 20s.
History has a mysterious way of creeping up on those that fail to study it. Somehow, with
all the talking heads going crazy, you would think this housing market has no parallel in
history. When you hear that the national median home price has never gone down there is
always the caveat of ―since the Great Depression.‖ I‘ve written 3 articles about the Great
Depression (letter from a lawyer, letter from a president of a bank, and 3 main reasons
why this bubble is worse) highlighting eerie similarities of this credit bubble to the
Roaring 20s. Keep in mind during the 1920s the nation was engulfed with Coolidge
prosperity and all things business were here to stay. In fact, today we are going to
examine a few paragraphs from an amazing book by Frederick Lewis Allen called Only
Yesterday written in 1931 which examines the decade of the 1920s in great detail. A
reader of this blog recommended this book sometime ago and I‘m glad I had the chance
to read this in depth analysis of the 1920s from an author with an uncanny ability to retell
history. Dispute it all you want but there is a chapter in the book called Home, Sweet
Florida that if one didn‘t see the date, could be published in the Miami Herald dated

Let us compare and contrast the past with our current housing debacle:

“There was nothing languorous about the atmosphere of tropical Miami during that
memorable summer and autumn of 1925. The whole city had become one frenzied real-
estate exchange. There were said to be 2,000 real-estate offices and 25,000 agents
marketing house-lots or acreage. The shirt-sleeved crowds hurrying to and fro under the
widely advertised Florida sun talked of binders and options and water-frontages and
hundred thousand-dollar profits; the city fathers had been forced to pass an ordinance
forbidding the sale of property in the street, or even the showing of a map, to prevent
inordinate traffic congestion. The warm air vibrated with the clatter of riveters, for the
steel skeletons of skyscrapers were rising to give Miami a skyline appropriate to its
metropolitan destiny. Motor-busses roared down Flagler Street, carrying “prospects” on
free trips to watch dredges and steam-shovels converting the outlying mangrove swamps
and the sandbars of the Bay of Biscayne into gorgeous Venetian cities for the American
homemakers and pleasure-seekers of the future. The Dixie Highway was clogged with
automobiles from every part of the country; a traveler caught in a traffic jam counted the
license-plates of eighteen state among the sedans and flivvers waiting in line. Hotels were
overcrowded. People were sleeping wherever they could lay their heads, in station
waiting- rooms or in automobiles. The railroads had been forced to place an embargo on
imperishable freight in order to avert the danger of famine; building materials were now
being imported by water and the harbor bristled with shipping. Fresh vegetables were a
rarity, the public utilities of the city were trying desperately to meet the suddenly
multiplied demand for electricity and gas and telephone service, and there were
recurrent shortages of ice.”

So first we must realize that real estate frenzies have occurred in the past. In addition, the
idea of people waiting to bid on property not currently built occurred during the 1920s in
Florida. And all those high-rise condos waiting to come online in 2008 or 2009? Florida
again seems to be ground zero of the real estate frenzy. Even the out of town investors
going zero down on a mortgage for a property that isn‘t even built is something that
happened long ago. Reminds many people of the multiple license plates in Arizona a few
years ago of people extending their credit to buy a pre-fab construction only to flip it a
few months down the road. Like any boom, this didn‘t happen overnight back then either.
What events led to Florida being the prime location? Let us take a look:

“For this amazing boom, which had gradually been gathering headway for several years
but had not become sensational until 1924, there were a number of causes. Let us list
them categorically.

1. First of all, of course, the climate-Florida’s unanswerable argument.

2. The accessibility of the state to the populous cities of the Northeast-an advantage
which Southern California could not well deny.

3. The automobile, which was rapidly making America into a nation of nomads; teaching
all manner of men and women to explore their country, and enabling even the small
farmer, the summer-boarding-house keeper, and the garage man to pack their families
into flivvers and tour southward from auto-camp to auto-camp for a winter of sunny

4. The abounding confidence engendered by Coolidge Prosperity, which persuaded the
four-thousand-dollar-a-year salesman that in some magical way he too might tomorrow
be able to buy a fine house and all the good things of earth.

5. A paradoxical, widespread, but only half-acknowledged revolt against the very
urbanization and industrialization of the country, the very concentration upon work, the
very routine and smoke and congestion and twentieth- century standardization of living
upon which Coolidge Prosperity was based. These things might bring the American
businessman money, but to spend it he longed to escape from them-into the free sunshine
of the remembered countryside, into the easy-going life and beauty of the European past,
into some never-never land which combined American sport and comfort with Latin
glamour-a Venice equipped with bathtubs and electric iceboxes, a Seville provided with
three eighteen-hole golf courses.

6. The example of Southern California, which had advertised its climate at the top of its
lungs and had prospered by so doing: why, argued the Floridians, couldn’t Florida do
7. And finally, another result of Coolidge Prosperity: not only did John Jones expect that
presently he might be able to afford a house at Boca Raton and a vacation-time of
tarpon-fishing or polo, but he also was fed on stories of bold business enterprise and
sudden wealth until he was ready to believe that the craziest real-estate development
might be the gold-mine which would work this miracle for him.

Crazy real-estate developments? But were they crazy? By 1925 few of them looked so any
longer. The men whose fantastic projects had seemed in 1923 to be evidences of
megalomania were now coining millions: by the pragmatic test they were not madmen
but-as the advertisements put it- inspired dreamers. Coral Gables, Hollywood-by-the-
Sea, Miami Beach, Davis Islands-there they stood: mere patterns on a blue-print no
longer, but actual cities of brick and concrete and stucco; unfinished, to be sure, but
growing with amazing speed, while prospects stood in line to buy and every square foot
within their limits leaped in price.”

Did someone write this yesterday? The book title is still accurate even though 1931 is a
distant memory. The same arguments used in 1925 are being used in the current
marketplace regarding housing. First, the main argument for Florida and Southern
California is the weather. We‘ve dubbed it the sunshine tax. So this argument for
pumping ludicrous mortgages isn‘t something new. Next, we have the argument of
proximity to locations and centers of employment. Another argument used by many
housing pundits pushing these overpriced units. None of these things changed (after all
we still have the sun) and this is nearly 100 years ago. Subdivide and conquer seems to be
the mantra in real estate booms. The author makes a unique point about the primal desire
for families to reunite with a more tranquil life at the cost of working like a maniac to
afford the mortgage on a home in an urban area. A Catch-22 that many families in 2007
are facing. And the marketing and advertising tactics haven‘t changed. Have you seen the
current ads for Florida housing? ―Your home with the tranquility of Venice‖ or ―Come
escape to your own private Paris.‖ What they are implying is that your subdivided cookie
cutter home is somehow similar to condensed apartment style living from Europe. Last
time I checked not many Parisians or Italians had 2 car garages to support monster
Hummers and Expeditions. So this yearning for European style tranquility is highly
misplaced because even Europeans do not live this way. But the underlying implication is
―you too can get away from the stressful congested freeways and 12 hour work days in
the city‖ at least for a few hours in your private palace even though you have to work like
a maniac to afford your exotic-high-flying-zero-down mortgage. But did people get
caught up in the frenzy like this current boom?

“Yes, the public bought. By 1925 they were buying anything, anywhere, so long as it was
in Florida. One had only to announce a new development, be it honest or fraudulent, be it
on the Atlantic Ocean or deep in the wasteland of the interior, to set people scrambling
for house lots. “Manhattan Estates” was advertised as being “not more than three
fourths of a mile from the prosperous and fast-growing city of Nettie”; there was no such
city as Nettie, the name being that of an abandoned turpentine camp, yet people bought.
Investigators of the claims made for “Melbourne Gardens” tried to find the place, found
themselves driving along a trail “through prairie muck land, with a few trees and small
clumps of palmetto,” and were hopelessly mired in the mud three miles short of their
destination. But still the public bought, here and elsewhere, blindly, trustingly-natives of
Florida, visitors to Florida, and good citizens of Ohio and Massachusetts and Wisconsin
who had never been near Florida but made out their checks for lots in what they were
told was to be “another Coral Gables” or was “next to the right of way of the new
railroad” or was to be a “twenty-million-dollar city.” The stories of prodigious profits
made in Florida land were sufficient bait. A lot in the business center of Miami Beach
had sold for $800 in the early days of the development and had resold for $150,000 in
1924. For a strip of land in Palm Beach a New York lawyer had been offered $240,000
some eight or ten years before the boom; in 1923 he finally accepted $800,000 for it; the
next year the strip of land was broken up into building lots and disposed of at an
aggregate price of $1,500,000; and in 1925 there were those who claimed that its value
had risen to $4,000,000. A poor woman who had bought a piece of land near Miami in
1896 for $25 was able to sell it in 1925 for $150,000. Such tales were legion; every
visitor to the Gold Coast could pick them up by the dozen; and many if not most of them
were quite true-though the profits were largely on paper. No wonder the rush for Florida
land justified the current anecdote of a native saying to a visitor, “Want to buy a lot?”
and the visitor at once replying, “Sold.”

Greed has an interesting way of coming back into the mainstream. As the author points
out, even places that were 15, 20, or 30 miles away from the prime locations were selling
like crazy simply because the real estate tornado frenzy brought these places into the fold.
Think of the Real Homes of Genius, the Inland Empire, Arizona, Nevada, and Florida.
One need only look at the current headlines of current Florida housing to find similar
parallels from the above. Why are housing pundits so quick to dismiss history without
taking a critical eye of what happened in the past? Do they somehow think they are above
the narrative of history? Is this time really different? They want you to believe that they
have found the new calculus of housing success. Well as you are seeing, this bust is
playing out exactly like it did almost 100 years ago. To continue with the chapter, it
appears that speculation was rampant just like it was during our boom:

“Speculation was easy-and quick. No long delays while titles were being investigated and
deeds recorded; such tiresome formalities were postponed. The prevalent method of sale
was thus described by Walter C. Hill of the Retail Credit Company of Atlanta in the
Inspection Report issued by his concern: “Lots are bought from blueprints. They look
better that way …. Around Miami, subdivisions, except the very large ones, are often sold
out the first day of sale. Advertisements appear describing the location, extent, special
features, and approximate price of the lots. Reservations are accepted. This requires a
check for 10 per cent of the price of the lot the buyer expects to select. On the first day of
sale, at the promoter’s office in town, the reservations are called out in order, and the
buyer steps up and, from a beautifully drawn blueprint, with lots and dimensions and
prices clearly shown, selects a lot or lots, gets a receipt in the form of a `binder’
describing it, and has the thrill of seeing `Sold’ stamped in the blue-lined square which
represents his lot, a space usually fifty by a hundred feet of Florida soil or swamp. There
are instances where these first-day sales have gone into several millions of dollars. And
the prices! … Inside lots from $8,000 to $20,000. Water-front lots from $15,000 to
$25,000. Seashore lots from $20,000 to $75,000. And these are not in Miami. They are
miles out-ten miles out, fifteen miles out, and thirty miles out.”

Wait. Did they say people needed 10 percent down? We out did the speculative bubble of
the 1920s since we cut out that measly 10 percent down and went zero down and
sometimes people got cash-back at closing! This reminds one of sales even in Orange
County California where new subdivisions sold out the first day. People waited in line for
days to get on a list for the chance to purchase a home at a hyper inflated price. Looking
back people must feel that they were waiting in line to be punched in the face by Mike
Tyson. And what about the metal cranes covering the Florida skyline? Many of these
units won‘t hit the market until 2008 and 2009 at the peak of the bubble decline.
Fascinating how greed can overtake an entire population. And lets be honest, how many
of these people actually had visions of buying a Miami condo to live and raise a family
for an entire generation? I would venture that the percent can be counted on one hand.
What kind of rhetoric was used to pump these new paradise resorts? Let us take a look:

“Steadily, during that feverish summer and autumn of 1925, the hatching of new plans
for vast developments continued. A great many of them, apparently, were intended to be
occupied by what the advertisers of Miami Beach called “America’s wealthiest
sportsmen, devotees of yachting and the other expensive sports,” and the advertisers of
Boca Raton called “the world of international wealth that dominates finance and
industry . . . that sets fashions . . . the world of large affairs, smart society and leisured
ease.” Few of those in the land-rush seemed to question whether there would be enough
devotees of yachting and men and women of leisured ease to go round.

Everywhere vast new hotels, apartment houses, casinos were being projected. At the
height of the fury of building a visitor to West Palm Beach noticed a large vacant lot
almost completely covered with bath- tubs. The tubs had apparently been there some
time; the crates which surrounded them were well weathered. The lot, he was informed,
was to be the site of “One of the most magnificent apartment buildings in the South”-but
the freight embargo had held up the contractor’s building material and only the bathtubs
had arrived! Throughout Florida re- sounded the slogans and hyperboles of boundless
confidence. The advertising columns shrieked with them, those swollen advertising
columns which enabled the Miami Daily News, one day in the summer of 1925, to print
an issue of 504 pages, the largest in newspaper history, and enabled the Miami Herald to
carry a larger volume of advertising in 1925 than any paper anywhere had ever before
carried in a year. Miami was not only “The Wonder City,” it was also “The Fair White
Goddess of Cities,” “The World’s Playground,” and “The City Invincible.” Fort
Lauderdale became “The Tropical Wonderland,” Orlando “The City Beautiful,” and
Sanford “The City Substantial.”

Location, location, location. Speculation, speculation, speculation. I was going through
this weekend‘s LA Times and an inordinate amount of space is given to real estate
advertisements. In fact, most of the ads are housing related. For example, you have your
multiple electronic stores telling you how to fill up every nook in cranny of your place
with 60 inch plasma TVs and state of the art refrigerators that make ice out of thin air. All
for 0 percent financing over 24 months. And then we have all the ads about majestic beds
and sofas that are fit for King Tut himself. Even the King didn‘t have access to American
Express! And then we have the housing ads. I was looking at some condo ads in Florida
and you would think that you are buying the most fantastic, stupendous, amazing,
fabulous, and gorgeous 1,200 square foot piece of land in the entire universe. You may
want to buy stock in Thesaurus publishers with the amount of adjectives these advertising
and marketing agency use for housing. With the benefit of foresight, we know how the
bubble of the 1920s ended but we are still uncertain how this current market will unfold.
As humans, we like hearing things in a narrative form. If A happens then B happens
which obviously leads to C happening. We are terrible at constructing real-time
narratives because we are living the moment and have a hard time stepping back and
examining the landscape from a bird‘s eye view. Call it existential living. For the sake of
forecasting, how did the 1920s Florida housing market end and can we learn anything
from it?

“Perhaps the boom was due for a “healthy breathing-time…

As a matter of fact, it was due for a good deal more than that. It began obviously to
collapse in the spring and summer of 1926. People who held binders and had failed to
get rid of them were defaulting right and left on their payments. One man who had sold
acreage early in 1925 for twelve dollars an acre, and had cursed himself for his stupidity
when it was resold later in the year for seventeen dollars, and then thirty dollars, and
finally sixty dollars an acre, was surprised a year or two afterward to find that the entire
series of subsequent purchases was in default, that he could not recover the money still
due him, and that his only redress was to take his land back again. There were cases in
which the land not only came back to the original owner, but came back burdened with
taxes and assessments which amounted to more than the cash he had received for it; and
furthermore he found his land blighted with a half-completed development.

Just as it began to be clear that a wholesale deflation was inevitable, two hurricanes
showed what a Soothing Tropic Wind could do when it got a running start from the West

No malevolent Providence bent upon the teaching of humility could have struck with a
more precise aim than the second and worst of these Florida hurricanes. It concentrated
upon the exact region where the boom had been noisiest and most hysterical-the region
about Miami. Hitting the Gold Coast early in the morning of September 18, 1926, it piled
the waters of Biscayne Bay into the lovely Venetian developments, deposited a five-
masted steel schooner high in the street at Coral Gables, tossed big steam yachts upon
the avenues of Miami, picked up trees, lumber, pipes, tiles, debris, and even small
automobiles and sent them crashing into the houses, ripped the roofs off thousands of
jerry-built cottages and villas, almost wiped out the town of Moore Haven on Lake
Okeechobee, and left behind it some four hundred dead, sixty-three hundred injured, and
fifty thousand homeless. Valiantly the Floridians insisted that the damage was not
irreparable; so valiantly, in fact, that the head of the American Red Cross, John Barton
Payne, was quoted as charging that the officials of the state had “practically destroyed”
the national Red Cross campaign for relief of the homeless. Mayor Romfh of Miami
declared that he saw no reason “why this city should not entertain her winter visitors the
coming season as comfortably as in past seasons.” But the Soothing Tropic Wind had
had its revenge; it had destroyed the remnants of the Florida boom.

By 1927, according to Homer B. Vanderblue, most of the elaborate real-estate offices on
Flagler Street in Miami were either closed or practically empty; the Davis Islands
project, “bankrupt and unfinished,” had been taken over by a syndicate organized by
Stone & Webster; and many Florida cities, including Miami, were having difficulty
collecting their taxes. By 1928 Henry S. Villard, writing in The Nation, thus described the
approach to Miami by road: “Dead subdivisions line the highway, their pompous names
half-obliterated on crumbling stucco gates. Lonely white-way lights stand guard over
miles of cement side- walks, where grass and palmetto take the place of homes that were
to be …. Whole sections of outlying subdivisions are composed of unoccupied houses,
past which one speeds on broad thoroughfares as if traversing a city in the grip of
death.” In 1928 there were thirty-one bank failures in Florida; in 1929 there were fifty-
seven; in both of these years the liabilities of the failed banks reached greater totals than
were recorded for any other state in the Union. The Mediterranean fruitfly added to the
gravity of the local economic situation in 1929 by ravaging the citrus crop. Bank
clearings for Miami, which had climbed sensationally to over a billion dollars in 1925,
marched sadly downhill again:






And those were the very years when elsewhere in the country prosperity was triumphant!
By the middle of 1930, after the general business depression had set in, no less than
twenty-six Florida cities had gone into default of principal or interest on their bonds, the
heaviest defaults being those of West Palm Beach, Miami, Sanford, and Lake Worth; and
even Miami, which had a minor issue of bonds maturing in August, 1930, confessed its
inability to redeem them and asked the bondholders for an extension.

The cheerful custom of incorporating real-estate developments as “cities” and financing
the construction of all manner of improvements with “tax-free municipal bonds,” as well
as the custom on the part of development corporations of issuing real-estate bonds
secured by new structures located in the boom territory, were showing weaknesses
unimagined by the inspired dreamers of 1925. Most of the millions piled up in paper
profits had melted away, many of the millions sunk in developments had been sunk for
good and all, the vast inverted pyramid of credit had toppled to earth, and the lesson of
the economic falsity of a scheme of land values based upon grandiose plans,
preposterous expectations, and hot air had been taught in a long agony of deflation.

For comfort there were only a few saving facts to cling to. Florida still had her climate,
her natural resources. The people of Florida still had energy and determination, and
having recovered from their debauch of hope, were learning from the relentless
discipline of events. Not all Northerners who had moved to Florida in the days of plenty
had departed in the days of adversity. Far from it: the census of 1930, in fact, gave
Florida an increase in population of over 50 per cent since 1920-a larger increase than
that of any other state except California-and showed that in the same interval Miami had
grown by nearly 400 per cent. Florida still had a future; there was no doubt of that,
sharp as the pains of enforced postponement were. Nor, for that matter, were the people
of Florida alone blameworthy for the insanity of 1925. They, perhaps, had done most of
the shouting, but the hysteria which had centered in their state had been a national
hysteria, enormously increased by the influx of outlanders intent upon making easy

And so the boom ended in a spectacular fashion. The peak hit in 1925 and steadily
declined through the Great Depression. And as the author points out, this was during a
time when the country was supposedly prospering. Doesn‘t this remind you of the current
administration touting our record low unemployment rate and record high home
ownership rate? You would think we are in the apex of financial success with a minor
bump in housing. But markets in Florida and California are hitting massive defaults.
Keep in mind we are only in stage one of this housing bear market. Looking at the past as
a reference, we know that there will be pain in the next few years. Even if Bush and
others are pushing for income relief on debt forgiveness, this means society will carry the
burden. After all, if someone bought a $500,000 home and it was foreclosed and sold for
$450,000 – shouldn‘t the lender and buyer shoulder some responsibility? We will be
heading down this moral hazard road for months.

Even looking at current default rates in Southern California, many people in default have
loans that are 2 years or younger. Now either the lender did a horrible job looking at the
buyer‘s financial situation in which they should be liable, or a buyer speculated either
knowingly or unknowingly. I have empathy for a family that was conned from an FHA
fixed mortgage into a $200,000 subprime mortgage at 10 percent with prepayment
penalties. No reason for this except higher commissions. But a person buying a $500,000
home trying to flip it for $600,000? See why I have an issue raising the caps? Most
people think the money will evaporate like some sort of Vegas magic act. Yet the public
as a whole, even those who didn‘t participate in this speculating frenzy, will be on the
hook if no one directly involved is willing to shoulder the responsibility of gambling
[speculating] in a housing bubble. How about the lender, home owner, and the Wall
Street players shoulder some of the debt forgiveness instead of asking for a government
handout? Why isn‘t anyone going after the MBS market or the hedge funds? After all,
some one did buy these exotic mortgages. So what are some other viable solutions?
Lenders can modify terms on 30 year mortgages and extend the duration or drop rates;
yet this would suppose that buyers actually bought homes to live in for the longterm.
Speculate together, pay together. If you can cut through the green tangled vines of bail
out rhetoric, the bottom line is someone isn‘t happy because the music stopped and they
are left standing with no chair.

Back to the Florida boom and bust, it would be wrong to think that the real estate fever in
the 1920s was only specific to Florida. Other cities had similar booms as well:

“The final phase of the real-estate boom of the nineteen-twenties centered in the cities
themselves. To picture what happened to the American skyline during those years,
compare a 1920 airplane view of almost any large city with one taken in 1930. There is
scarcely a city which does not show a bright new cluster of skyscrapers at its center. The
tower building mania reached its climax in New York-since towers in the metropolis are
a potent advertisement-and particularly in the Grand Central district of New York. Here
the building boom attained immense proportions, coming to its peak of intensity in 1928.
New pinnacles shot into the air forty stories, fifty stories, and more; between 1918 and
1930 the amount of space available for office use in large modern buildings in that
district was multiplied approximately by ten. In a photograph of uptown New York taken
from the neighborhood of the East River early in 1931, the twenty most conspicuous
structures were all products of the Post-war Decade. The tallest two of all, to be sure,
were not completed until after the panic of 1929; by the time the splendid shining tower
of the Empire State Building stood clear of scaffolding there were apple salesmen
shivering on the curbstone below. Yet it was none the less a monument to the abounding
confidence of the days in which it was conceived.

The confidence had been excessive. Skyscrapers had been overproduced. In the spring of
1931 it was reliably stated that some 17 per cent of the space in the big office buildings of
the Grand Central district, and some 40 per cent of that in the big office buildings of the
Plaza district farther uptown, were not bringing in a return; owners of new skyscrapers
were inveigling business concerns into occupying vacant floors by offering them space
rent-free for a period or by assuming their leases in other buildings; and financiers were
shaking their heads over the precarious condition of many realty investments in New
York. The metropolis, too, had a future, but speculative enthusiasm had carried it upward
a little too fast.”

Compare this to the current metal cranes that stand up like a Brontosaur head in the
middle of many metro cities. You see them in San Diego, Miami, and Orange County.
Take a plane over Arizona and Nevada and you‘ll see a jigsaw of subdivided land and
spectacular urban sprawl. Are we growing this fast? Looking at population statistics it
doesn‘t seem that the building is in proportion to our growing demand for housing; we
may have overbuilt a tad bit. Considering that many baby-boomers are looking to
downsize, many homes should be coming online in the next 5 to 10 years simply because
of the natural occurrence in the shift of demographics. Many will downsize and retire to
less urban areas, thus creating more inventory.

A question many are wondering is ―will there be another bubble after this one?‖
Considering we went from a technology bubble to a housing bubble, I think we‘ve had
enough for two decades. The cost of owning a home in certain areas, as many families are
realizing, comes at too high of a cost. A society can only prosper so long via debt
spending. So what happened after the boom in Florida?

“After the Florida hurricane, real-estate speculation lost most of its interest for the
ordinary man and woman. Few of them were much concerned, except as householders or
as spectators, with the building of suburban developments or of forty-story experiments
in modernist architecture. Yet the national speculative fever which had turned their eyes
and their cash to the Florida Gold Coast in 1925 was not chilled; it was merely checked.
Florida house-lots were a bad bet? Very well, then, said a public still enthralled by the
radiant possibilities of Coolidge Prosperity: what else was there to bet on? Before long a
new wave of popular speculation was accumulating momentum. Not in real-estate this
time; in something quite different. The focus of speculative infection shifted from Flagler
Street, Miami, to Broad and Wall Streets, New York. The Big Bull Market was getting
under way.”

Maybe we will finally see the decade long obsession with real estate go away. However
after the boom in the 1920s, people decided to go back and gamble on US Steel, General
Electric, General Motors, Woolworth, and Radio. Keep in mind that the economy didn‘t
shift gears over night. From the peak in September of 1929 it took approximately 3 years
to hit bottom in 1932. Will we have another Great Depression? Probably not since there
are many other factors in our current economy that are vastly different. However, a
recession and a deep one at that, is almost a foregone conclusion.

I highly recommend that you read Only Yesterday by Frederick Lewis Allen because it‘ll
give you a fascinating and enlightening view of the 1920s and how an important defining
time for America still impacts us today. We will always have booms and busts, otherwise
known by a nicer name, the business cycle.

The Menace of Mortgage Debts: Lessons from the Great
Depression Series: Part IV: Where do we go After the
Housing Crash?
As we approach Super Duper Tuesday, a day that is historical in magnitude, we need to
reflect on how we got into the current housing mess. It would be easy to say that the
mortgage problems simply arrived over night but they have been building up for a
decade. This housing crisis is unprecedented; that is until we look at the mortgage mess
from the Great Depression. On Saturday, I was digging through journals written during
the Great Depression and found an article written by Arthur Holden for Harpers in 1932,
four years into the Great Depression. This will be the fourth part in our Great Depression

1. Personal Story by a Lawyer from a Previous Asset Bubble. Can we Learn from the
Past and How will the Housing Decline Impact You?

*A story from a lawyers perspective highlighting the societal impacts of foreclosures.
Many things are eerily similar to what we are currently entering into.

2. Lessons From the Great Depression: A Letter from a former Banking President
Discussing the Bubble.

*With the current corruption on Wall Street and shady rogue traders, you have to wonder
when are good bankers going to step up to the plate?

3. Florida Housing 1920s Redux: History repeating in Florida and Lessons from the
Roaring 20s.

*Think we can learn from history? Florida already went through what they are currently
going through in the 1920s. Read for insight into future trends.

If you are interested in gaining insight into how nationwide real estate crashes unwind, I
suggest you read all three articles carefully. With this article, I decided to type up
important parts (which was a large part of the article) and if you are looking for
perspective, I suggest you read it in its entirety. I will comment throughout the article to
offer perspective and insight into today‘s current mortgage problems.
The Menace of Mortgage Debts

“As the great depression advances into the fourth year it becomes increasingly apparent
that the mortgage crisis involves something more than the “little fellow” struggling to
keep his home. It is not only the function of “shelter” that is involved. The mortgage
structure is a part of the whole economic scheme, into which is woven the intricate
system of social inter-dependability which allows us to live and carry on. When the
customary flow of credit is seriously interrupted at any one point many diverse processes
are also interrupted upon which we depend for both the comforts and the necessities of
life. Since the War the civilized world has experienced the greatest economic upheaval of
which we possess a recorded history. The mortgage crisis is perhaps the final phase of
this world-wide dislocation of our credit system.”

You could take the above paragraph out of any business section of today‘s business
journals. We are suffering much like the credit problems of the 1930s. Housing even 76
years ago had a major impact on the overall health of the US economy. This housing
mess is much beyond ―subprime‖ since housing is a staple of the American economy and
we are seeing even prime loans coming under strain.

“To understand what has happened it is necessary to look at the problem in perspective.
In the first place all facts are relative. We cannot understand the menace of the mortgage
situation unless we consider the cost of carrying our present mortgage burden in relation
to our changed national income. In 1929 the national income for the United States was
85 billions of dollars. By the year 1932 this figure had fallen to 36 billions. The most
conservative figure for mortgages that I can find shows that in the year 1929 the
combined total of urban and rural mortgages in the United States amounted to at least 46
billions of dollars. It is difficult to determine how much this figure has changed between
1929 and 1932. The first effect of the calling of outstanding loans was to increased the
amount of money borrowed against real estate. It is safe to say, however, that any
general increase in the total of mortgage loans has since been erased by the calling in of
outstanding mortgages and the constant demand for the reduction of principal. I,
therefore, assume that the total present mortgage indebtedness is about 43 billions of
We already know that wage growth has been stagnant throughout the past decade.
However, during the Great Depression national income fell by an astounding figure while
mortgage debt remained rather stable. What this did is increased the overall burden of
debt servicing with less income. Sounds familiar? We are already given an idea of why it
is important to quickly adjust mortgages to current market prices to alleviate some of the
burden or we will quickly fall into a similar fate.

“The reduction of the national income has had a drastic effect upon the rents which it has
been possible to pay. In other words, the yield of real property has suffered a sharp
decline. The best estimates that I am able to gather indicate that this decline amounts to
as much as 35 per cent. Yet the fixed mortgage charges have declined hardly at all.”

We are already having predictions of this kind. Merrill Lynch went so far as predicting a
30 percent decline in national real estate. Of course to mention the Great Depression or
any historical knowledge is blasphemy in today‘s world of 24 hour pseudo-business cable
stations. Yet we are already mentioning similar price declines in the magnitude of the
1930s. In fact, this bubble is much larger than any in history including the Great

“But the prosperity of the nation depends upon its ability to make economic use of
what is capable of producing; that is, it must either consume what it produces or sell it
abroad. If because of fixed contracts, real estate levies too large a tool on the national
income, the amount of income available for the consumption of commodities contracts
also. As a result we have industrial stagnation, followed eventually by hunger and

Production cannot be generally resumed until credits are liberated to restore the
purchasing power of the people. Credits cannot be liberated for the purchase of
commodities, in appreciable quantity, so long as current funds are being drained off for
the liquidation of capital obligations. Increased lending for refinancing purposes will
only make matters worse, because on the one hand it draws off additional funds which
might otherwise have gone into compensating producers, while at the same time it
reestablishes debt burdens which we acknowledge we are unable to carry. “

This is a major rub for our current economy. At least during the Great Depression, we
had a larger agricultural and industrial base. The amazing thing of today‘s modern
economy is that we essentially had an economy that was built on trading, building,
financing, and flipping real estate. Our manufacturing base is nearly obsolete due to off-
shoring. The center of our economic machine was trading houses to one another in the
pyramid climb to larger and bigger homes. How we went on this long is simply amazing.

“Bankers are not free agents. They are frequently compelled by law to resort to
foreclosure proceedings in the interest of the beneficiaries of trust funds in cases where it
is apparent that foreclosure will not only cause further misadjustments but perhaps
ultimately bring a burden instead of a benefit to the mortgagee. So long as they exercise
a diligence in following the prescribed legal procedure, trustees are held harmless in the
eyes of the law, quite irrespective of the social consequences their actions.”

You can simply replace trustees here we hedge funds. With the Hope Now Alliance and
all these ill advised ―help plans‖ they haven‘t done much since the problem isn‘t just sub-
prime borrowers but the ―little fellow‖ who has good credit but is finding it ever more
difficult to service their debt. Now with unemployment rising and so many people
dependent on a perpetually increasing housing market, we are seeing our economy
severely contract.

“For example, two friends purchased adjoining identical houses in 1926 for $30,000. A
certain bank placed a $15,000 mortgage on each. In 1929 the first owner paid off
$10,000 on his mortgage. The second owner, when asked to do likewise, requested a
reappraisal of his property. When a value of $40,000 was placed upon it he was able to
induce the bank to lend him an additional $2,000, which he explained he needed in his
business. In 1932 when both mortgages again fell due the bank needed liquid capital and,
therefore, asked for full payments. Neither owner was able to meet this call. A
reappraisal indicated that the value of the houses had fallen to $16,000 each. On one, the
bank held a mortgage for $5,000, on the other for $17,000. What did the bank do? It
commenced foreclosure proceedings on the strong mortgage fro $5,000 and allowed the
weaker to stand. Why? It could readily transform the smaller mortgage into an asset on
its books, whereas the larger mortgage would inevitably show a loss if the property were
taken over.”

You mean people were doing cash out refinancing back in the 1930s? Many mortgage
brokers thought they were at the vanguard of mortgage financing but that game has been
done, and nothing is new under this housing sun. I think you know how that game ended
and there is nothing to stop history from repeating itself.

“It is often forgotten that real estate is a capital asset, not a commodity. Loans which
are secured by capital assets are very different in their nature from loans which are
secured by commodities.

Real estate for example is not consumed, it is used. Never in one year are the capital
requirements of the nation bought and paid for. When a loan is made against capital the
lender in a sense purchases an interest in the property, limited by the conditions of the
contract. In the case of real estate he purchases a share in the property secured by a

How many times have we read on housing or economic blogs that housing is not a
commodity? I‘m surprised that somehow rules that applied seventy years ago were no
longer applicable in the financial engineering models of today. A house still has four
walls and a roof. Quickly we are realizing that these ―outdated models‖ do have some
fundamentals behind them.
“When dollars being to rise in value, that is to say when prices in general being to fall,
fixed obligations such as bonds and mortgages and other forms of notes offer an
opportunity for a quick profit. This is a phenomenon that has long been common
knowledge among shrewd investors. If, however, the fall in prices continues to the point
where general earning capacity is inadequate to meet fixed obligations, then these
special advantages begin to break down.”

Bernanke has all but abandoned this point and remember that he is a student of the Great
Depression. In his mind‘s eye he feels that the Fed didn‘t do enough quick enough to stop
the Great Depression. His 125 basis point cut shouldn‘t come as a shock to those of you
who have read his research. Expect more rate cuts as he is now able to put his hypothesis
to the true test in reality. This is not a trial run. The article goes on to offer 3 suggestions
for fixing the current mortgage mess:

“Three ways have been suggested to take us out of our dilemma. These are:

1. Inflation of the currency in the hope of raising prices to such a basis that the nominal
income in dollars will be adequate to meet fixed contract obligations, which at present
seem insurmountable. There are grave technical complications which tend to offset what
the uninformed consider easy advantages of inflation. For real estate these complications
would be ruinous.

2. The laissez-faire method: to let contract which cannot be executed go by default. To
real estate this means widespread foreclosure with properties passing into the hands of
the prior mortgagee, or, where unsatisfied tax liens exist, into the hands of local
governmental units. As has already been pointed out, such as method produces chaotic
uncertainties and dislocations.

3. The third method offers the substitution of new machinery for the adjustment of
contracts which cannot be carried out in their original terms. In brief, this means the
establishment of legal sanctions to permit the waiving of accepted foreclosure
proceedings in the public interest, on condition that all parties to the contract enter into
new agreements which are equitable in the light of changed conditions.”

Number 1 is all but abandoned and the Fed has taken the dollar to the gallows. Number 2
isn‘t happening either since we have the prospect of higher caps, massive drops in rates,
and government programs such as FHASecure and the Hope Now Alliance. And the
intervention hasn‘t stopped yet. The third method offered the best solution in the 1930s
and offers the best solution today. The only difference today is people are intentionally
foreclosing and the pride of homeownership isn‘t a ubiquitous phenomenon. This doesn‘t
change the fact that for those who still want to live in their home, laws should be allowed
for cram-downs and mortgage restructuring. Good luck getting this passed with second
lien holders standing to lose their entire principal. We are in for years of legal wrangling.
This was addressed in the 1930s as well:
“Although legally there is nothing between strict adherence to the contract and the
pleasure of the mortgagee, our great insurance companies, finding that they cannot
enforce either the letter of the contract or the letter of the law, have commenced the
granting of mortgage moratoriums. The situation is developing so rapidly that it is
impossible to tell how far adjustments will have gone by the time this paper appears. As I
write, bills have been offered in several State Legislatures providing for moratoriums on
mortgage indebtedness and even on local taxation. A bill has already passed the House
of Representatives in the Congress which is designed to permit a debtor to apply to the
courts for the appointment of a custodian looking to “a composition or an extension of
time to pay his debts.” After acceptance by a majority in number of creditors, including a
majority in amount of secured claims, the court may confirm this composition.

What the nation as a whole needs is the recognition of the principle that debt claims
cannot exact a higher rate of interest than the product of labor will yield. Our debt
obligations, like our tax obligations, are consuming far too large a share of the nation
income to-day.”

What is unfolding today seems to be an end to a super-cycle. A once in a lifetime credit
bubble that permeates the entire economy. What we have here ironically is at the helm of
the Fed, someone who studied deeply the Great Depression and is facing a very similar
circumstance to that of 80 years ago. His hypothesis is that monetary policy could have
stopped or at least mitigated some of the pain of the Great Depression. We are now
seeing the theory go into practice. So far it is not working and if anything, the law of
unintended consequences is showing that banks and Wall Street are benefiting more than
the little fellow. You have to wonder if he is thinking, ―maybe my thesis is wrong‖ but
knowing how unwillingly many people in power are able to admit their mistakes, don‘t
bet on it.

Business Devours its Young: Lessons from the Great
Depression: Part V: Destroying the Working Class.
The deflation versus inflation debate is a hotly debated one. If we are to look at the
Consumer Price Index as our guide to inflation, we can see that yes by this measure
inflation is increasing. Yet if we are to look at wages and housing prices, deflation is
occurring. What gives? Well the narrow definition of inflation is an increase in the
money supply. Looking at momentary measures we do not have inflation. But looking at
the current news cycle and what is going on, we are approaching Great Depression like
scenarios. In this two-piece article, we will first discuss the current assault on today‘s
market with job declines and wage decreases followed by a disturbing article posted in
1933 examining the new business climate that emerged during the Great Depression.
General Motors is offering buyouts to many longtime workers to replace them with new
younger workers for half the hourly wage. The state of California is putting hiring and
income freezes and laying off workers. Do these things sound inflationary? Take a look
at the GM plan:

“DEARBORN, Mich. (AP) - About a quarter of General Motors Corp.’s hourly work
force represented by the United Auto Workers could leave the company under a new
round of buyout and early retirement offers, the UAW president said Thursday.

President Ron Gettelfinger estimated that 15,000 to 20,000 GM workers could take the
packages, but said they all must be replaced under terms of the UAW contract deal
reached with the company last year.

GM is offering buyout or early retirement packages to all 74,000 of its UAW-represented

Most of the replacement workers, he said, will do non-assembly jobs and be paid at a
lower wage scale, which is about half the $28 per hour that average hourly workers
now make.

GM has about 46,000 hourly workers eligible for retirement incentives, but Gettelfinger
said that economic uncertainty could hold down the number of workers leaving.

Many of those who have taken a previous buyout have found that it didn’t meet their
expectations, Gettelfinger said, while others have found leaving very beneficial.

“I just think that it’s dependent on each person’s situation,” he said. “If you just look at
the economy overall, everybody’s concerned about right now whether we’re headed into
a recession. You’ve got the subprime issues. You’ve got tight money markets out there. So
a lot of things have changed in people’s lives.”
The actual package looks to be about $100,000:

“Chrysler is trying to cut up to 21,000 of its 45,000 U.S. manufacturing jobs, giving
workers on temporary or indefinite layoff up to $100,000 to sever ties with the company.”

After taxes this $100,000 comes out to be about $60,000. Now as you know, the
economy of Michigan isn‘t doing so well and a family can blow through $60,000 in one
year. If you have many more years to work and have a mortgage, you are stuck since
some homes have been on the market for as long as two years. The state of California
isn‘t doing so well either as the Los Angeles Times is reporting:

“The Long Beach school board voted to close an elementary school this week. The Rialto
Unified School District, in what is believed to be the first such action in the state this
year, sent notices to 305 employees including teachers, informing them that they may not
have a job next fall. The San Francisco school district may take city “rainy day” money
to help balance its budget.

School districts across California have begun trimming services and preparing to lay off
teachers in response to Gov. Arnold Schwarzenegger’s proposed budget, which could cut
about $4.8 billion in education funding this year and next year. Educators say it’s the
worst financial crisis they can remember.”

What this means is more unemployment, a smaller tax base, and less consumer spending.
What really amazes me is the general disregard for manufacturing. We have allowed our
entire manufacturing base to be off-shored and many try to show blue collar workers in a
negative light as milking the system. My father was a blue collar worker and I can attest
as I‘m sure many of you can, that blue collar labor is not an easy lifestyle and many do
earn each and every penny. My amazement is in how society has no problem with a
mortgage broker pushing papers and making $100,000 with a GED while a GM worker
assembling cars all day with overtime making $100,000 is somewhat living on the gravy
train. How can we as a nation have lost perspective on the value of actual work? Did we
somehow think that flipping homes was going to prove to be the highlight of our
economic prowess? The banking and real estate industries are fighting with all their
might for every single kind of bailout imaginable. Now in an incredible sense of irony, a
group of banks are rumored to offer a bailout to the monoline insurers:

“Ambac Financial Group Inc., the bond insurer facing a crippling credit-rating
downgrade, may get $3 billion in new capital as part of a rescue agreement with banks,
according to a person with knowledge of the discussions.

An announcement may come early next week, said the person, who declined to be named
because no details have been set. The New York-based company rose 16 percent in New
York Stock Exchange trading yesterday after CNBC Television said Ambac and its banks
were preparing a deal.
A rescue that enabled Ambac to retain its AAA rating for the municipal and asset-backed
securities guarantees would help banks and municipal debt investors avoid losses on
securities it insures. Banks stood to lose as much as $70 billion if the top- rated bond
insurers, which include MBIA Inc. and FGIC Corp., lose their credit ratings,
Oppenheimer & Co. analysts estimated.”

The market desperate for good news reversed a triple digit loss in the last hour to end
higher by 90+ points. Think about how insane the above proposition is. This is like you
getting into a car accident, calling your insurance company, and having them tell you that
you need to loan them some money in order for them to help you out. It is absurd and I
don‘t see how the above gets going without splitting the company up and allowing muni-
bonds to work on their own. What this means is that they still will collapse because
absurd CDO involvement and subprime Wonderland investing. In a sign that even the
muni side may have problems, we have our first city in California looking at a potential

“As Vallejo gains the dubious distinction as one of California’s few municipalities to
consider bankruptcy, the city’s fiscal plight is gaining widespread, even national

City bankruptcy attorney Marc Levinson, Orrick, Herrington & Sutcliffe, said many cities
face dire financial conditions, and are watching Vallejo closely.

If the city does file for bankruptcy, Levinson said Vallejo could be a first to seek
protection due to revenues being unable to keep up with expenses.

“This would be one of the first where there’s a systemic problem - where there’s no
revenues to cover the expenses,” Levinson said.

“That’s why people are following this. It could be a first,” Levinson said. “There’s
simply not enough money to go around.”

City and union negotiators have been involved in marathon talks, which are expected to
continue over the weekend. Mayor Osby Davis said Friday afternoon that the two sides
have “an agreement to agree,” but provided no specifics. (See related story on A1.)

The city is grappling with a $6 million shortfall in its $91 million general fund. Though
Vallejo started the fiscal year in the black, expenses have outpaced revenues by $10
million and every penny of the $4 million in reserves.”

Not enough money to go around is correct. Apparently cities are taking a note from our
federal government spending more than they earn.

Lessons from the Great Depression
With all this news, I came across another ominous article from Harper‘s Magazine called
―Business Devours its Young‖ talking about the new business psychology that permeated
the market in 1933. This article offers a minor glimpse to where we are heading and
given our massive overspending for a decade, there is simply no way of avoiding a
correction. This issue of Lessons from the Great Depression is Part V in our ongoing

1. Personal Story by a Lawyer from a Previous Asset Bubble. Can we Learn from
the Past and How will the Housing Decline Impact You?

*A story from a lawyers perspective highlighting the societal impacts of foreclosures.
Many things are eerily similar to what we are currently entering into.

2. Lessons From the Great Depression: A Letter from a former Banking President
Discussing the Bubble.

*With the current corruption on Wall Street and shady rogue traders, you have to wonder
when are good bankers going to step up to the plate?

3. Florida Housing 1920s Redux: History repeating in Florida and Lessons from the
Roaring 20s.

4. The Menace of Mortgage Debts: Lessons from the Great Depression Series: Part
IV: Where do we go After the Housing Crash?

*Looking four years into the future from the infamous 1929 stock market crash.
Mortgage bailout plans look very similar to things we did nearly a century ago.

Business Devours Its Young

“As I was walking up the street from my office the other evening, young Norcross fell into
step with me. Norcross is a minor executive in the local office of a large manufacturing
concern. From my causal acquaintance with him I had considered him generally good-
natured; but tonight he was clearly in a black mood.

“I’m sore,” he burst out, almost before I had time to greet him. “I’m good and sore. I’ve
just had my third salary cut in three years.”

Thereupon, as if under an overpowering compulsion to unburden himself to the first
sympathetic listener, Norcross poured forth his story. He had been engaged by his
company in 1924, at a salary which seemed to him very low, but which he was willing to
accept in view of the company’s assurance that it was merely provisional and that if he
did satisfactory work he would be “in line for an early raise.” He did satisfactory work;
the proof of this, he told me, lay in the fact that his duties and responsibilities were
steadily and rapidly enlarged. The promised increase in salary, however, was long
deferred; there were always reasons, it seemed, why a change in the budget of his
department was “impracticable at the moment.” He was given a small raise in 1927 and
another in 1929, but by no means what he had been led to expect. Meanwhile he had
slaved hard, working till six or seven night after night and taking work home with him; he
had not simply done the duties which were set for him, but had genuinely devoted himself
to the company’s interests. Again and again he and the other employees had been told
that if they redoubled their efforts “they all would prosper”; and always he had felt that
a substantially larger salary was just over the top of the next hill. “They said there was a
promising future for me there, and I was simple enough to believe them.”

Then came the depression and three big salary cuts - though the company was still
managing to pay its dividends. “Now I’m getting twelve per cent less than when I started
in 1924,” exploded Norcross, “though I’m doing nearly twice as much work as I did
then, and I know I’m worth three times as much. And at that,” he added savagely, “I
suppose I’m luck to be there at all - they’ve thrown three whole departments out the
window in the past eighteen months.

“Don’ misunderstand me. It’s not being hard up that gripes me, though I’ve had to
borrow to pay my insurance premium this month, and that’s no fun. What really hurts is
realizing that I’ve been played for a sucker, right from the start. That stuff about loyalty
to the company was just so much applesauce - and I swallowed it. I kept on swallowing it
even when my raise was held off with lame excuses. I guess you would have, too, if you’d
heard old Thompson talk in our pep-meetings. Now I see it all for what it was - a skin
game. I’ve been gypped. It’s perfectly clear to me now what the policy of pretty nearly
every company is: Hire them cheap, keep them in line with soft talk, tell them they’re
partners in a great enterprise, and then when the enterprise needs a little cash and you
have them at your mercy, forget all the partnership stuff and soak them. Of course
Thompson has me by the short hair now, because he knows I don’t dare get out, jobs
being as scarce as they are this winter. But what wouldn’t I give to wade right into his
oak-paneled office and tell him what I think of him! Believe me, it would singe the hair off
his head.”

Couple of things here. What we are seeing with GM is only one example of the above
company tightening and protection of dividends at the sake of workers. There is a great
divide in this country. From the top 5 percent and the other 95 percent. I remember a pep-
talk in our real estate office and how a running tally was kept on a white erase board.
Everyone thought the office had loyalty to them and now, as they are cutting back many
now find themselves finding other work. In fact, this is a great gig for those receiving
monthly membership dues. Many broker offices hire agents and don‘t pay them a nickel
since they run completely on commission. They split the profit with you. All those signs
―of prices always go up!‖ and ―sell them fast!‖ can make someone leave quickly if they
don‘t believe the hype. Where are all those touting real estate as the place to make
millions overnight? They are fad sellers and how many of those were out there touting
the housing market and now are hidden in the shadows? No apologies for creating the
new assembly line of the century; a fleet of brokers, agents, Wall Street banks, and
builders that invested this entire belief that housing was somehow the way to eternal
wealth. Now we‘ve sold out our manufacturing base and even our gambling in houses is
coming to an end and we are faced with the reality that we need to retool our economy or
face having foreign nations buy up our banks and most important national interests. The
article continues:

“Even during the boom years there were many storms upon the seas of business, and men
and women who had tied up their hopes with corporations which employed them were
constantly being betrayed by harsh circumstances. But not until the depression was there
a wholesale breakdown of the structure of faith. During the past three years the number
of Norcrosses and Smiths has multiplied many times.

Since 1929 they - and executives too - have had to face, however unwillingly, a hard fact:
that as business is now generally organized, when earnings fall off the employees are the
first to suffer. The president of the Gadget Manufacturing Corporation sees that the
estimated earnings of his company for the month are sixty thousand dollars less than in
the corresponding month of the last year; and whatever he may think about the personal
fortunes of Norcross and Smith, his cold business sense tells him that, according to the
principles now accepted in the business world, his first duty is tot protect the return on
the company’s bonded indebtedness and its position with the banks, his second duty is to
protect its preferred dividends, his third duty is to protect its common dividends, and not
until all these duties have been discharged may the men and women in the office or the
factory be taken into consideration. Unless he is a particularly conscientious executive,
he is activated also by a natural selfish motive: the motive to “make a good showing”
and thus maintain his own reputation as a canny business manager. If he shows his
directors a statement of declining earnings, they may begin to wonder if he is awake to
the emergency. They will want to see the missing sixty thousand dollars made up.”

We need only look at the current CEOs and titans of industry and their severance
packages to see how well we compensate people that push financial products that have
financially crippled our economy and have diverted resources from more productive
measures. What are these measures? Well I‘m certain we can find something more useful
then selling each other houses ad infinitum. Yet the above shows that massive disconnect
from Wall Street to Main Street. Even now with the current bailout talks, they are not
looking out for homeowners in middle America who have lost their jobs and are falling
behind on modest mortgages but want to bailout the religion of housing greed with those
who took out jumbo mortgages on the pretense that housing always goes up. There is no
money to be made on helping someone that is behind on a $90,000 mortgage. But
someone with a $1 million mortgage? The current housing oversight arm OFHEO has
such a small and pittance budget that of course they are setup to fail. Now these hands-off
banks want corporate welfare from the government in bailing out their stupid decade long
investments. Then we call up Washington. For all those that think somehow government
regulation at its most basic level is socialism, these red herrings were thrown out in the
1930s as well:

“I have heard it predicted that this embitterment will drive disappointed employees into
the ranks of the communist and socialists; that they will resolve that “the capitalists must
be kicked off the back of labor,” and off the backs, as well, of the lesser executives and
other office workers. So far there is no sign of such a change, and there seems to be little
immediate prospect of it. An observant employer whose company was forced to put
through three drastic economy measures in 1931 - cutting salaries and twice dropping
considerable bodies of employees - told me that each of these measures visibly hurt the
morale of the office for a week or ten days, but that after an interval the staff appeared to
work with as keen an eye for the company’s advantage as before. “The capacity for
loyalty and for hope is so strong in most of us,” this employer told me, “that it will
survive almost any number of shocks. I’ll wager that even your friend Smith, if he gets a
new job and business picks up, will pretty soon forget everything he said about refusing
to have his leg pulled; he’ll be putting his back into his work as if the success of the
company were the most important thing in life to him.”

The important consideration is that we will manage with the credit crunch. The problem
we are facing is one of conspicuous consumption. Many Americans being addicted to
credit for their lifetimes have a fear of cutting down because an unknown world awaits
them. We have survived embattled times. In fact, after the Great Depression the greatest
generation emerged. Will this greatest generation step up and usher in a path for the
younger generations to have a chance for the future or will they only look out for
themselves? This question will come up in the next few years and we may start seeing the
tinge of generational warfare taking seed. Unless younger workers perceive a fair shake
in the future they will resent what is going on. How can it be that a young professional
couple cannot afford a home when only a few decades ago one blue collar wage earner
was able to buy a modest home? How can it be that younger professionals pay a higher
percentage into Social Security and are being told it will not be there for them when they
retire? The buck is now stopping and we have hard choices to make. No longer can we
push aside these issues simply because they are third rails in politics. These issues will
force many hard decisions. Let us now look at the final portion of the article:

“The moral argument is as strong as the economic. Let us consider the man who is being
paid a $5,000 salary by his employers as representing a human investment of $100,000
earning a five per cent return. Balance this man, his hopes and fears, his family, his
responsibilities, his children’s education, his position in the community, against a
common-stock investment in the company of $100,000, likewise earning a five per cent
return. Suppose we have to decide which of these investments shall be penalized by
reducing its return from five per cent to four, or to zero. Can there be any doubt that the
investment in flesh and blood should be allowed to remain intact, that the social damage
done by penalizing it is likely to be far greater than that done by penalizing the paper
holding in common stock? Which investment is likely to be of paramount importance,
financially, or spiritually, to the holder? Remember that it is the general practice among
owners of common stock to diversify their holdings, and that usually they have other
resources than their common stock, whereas in a majority of cases the employee’s whole
career and all it represents to him are involved in his job, and the loss of it may
immediately bring him and his wife and children to grips with poverty. I believe that in
ninety-nine cases out of a hundred any fair-minded person who knew personally both the
holder of common stock and the employee whose fate hung in the balance, and was able
tot foresee just what the effect of an adverse decision would be upon each of them, would
vote to let the stock-holder carry the immediate loss.”

Crash! The Housing Market Free Fall and Client #10
Contagion. Lessons From the Great Depression: Part VI.

Last week was one of the most volatile stock market weeks in many years. The market
went off its medication and was up and down like a pogo stick. When volatility is this
high, you are either going to see a break through upward or a severe correction to the
downside. Given that market psychology is radically shifting and the wealth effect has
much more of an impact on behavior, the consumer is becoming tapped out even though
Wall Street is having a hard time understanding why consumers no longer want to
continue on the human sized hamster wheel. If you want to see the eradicate waves in the
market last week we need only look at the daily numbers for the DOW:

Monday: Market down 153 points -

Tuesday: Market up 416 points (largest one day increase in 5 years) +

Wednesday: Market down 38 points -

Thursday: Market up 49 points +

Friday: Market down 194 points -

For the week, the market is up 57 points. All that and the market barely moves up 57
points. But this doesn‘t highlight the entire story. For the week, the Fed on Tuesday
announced that it would be exchanging mortgage-backed securities for Treasurys and
extending terms that would allow payback in 28 days instead of overnight. The market of
course rallied on this since it was viewed as a full on bailout but the rally didn‘t even last
one day. Soon, the news again of write downs was hitting the market. The market had a
few days that would have been severely negative if it weren‘t for the Federal Reserve
bailout plan version 5.0. But on Friday everything came crashing down with the news
that Bear Stearns was being bailed out by JP Morgan/Chase and the Federal Reserve. The
significance of this event is that nothing of this kind had ever been taken on by the
Federal Reserve since the Great Depression. Suddenly we are making lots of comparisons
with the Great Depression.

Early Friday, the CPI came out flat and defied any sense of logic for 95 percent of the
Oh really? I guess folks from the BLS don‘t shop, use gas, need healthcare, and go to
school. But aside from that, inflation was 0 percent. Since March 4th, crude has gone from
$98 a barrel to $110 a barrel, an increase of 12 percent in 10 days! An ounce of gold went
from $958 on March 4th to $1,004 an ounce, an increase of 4.8 percent in 10 days.
Meanwhile, the US Dollar Index went from 73.947 to the current 71.93, a drop of 2.7
percent. At the minimum with the dollar declining, the average American family lost
purchasing power. Yet the absurd notion of hedonics simply does not reflect the majority
of families consumption behavior. I discussed this thoroughly in a past article examining
a hypothetical budget for a family (The Invisible Mortgage Hand) and it caused a stir
with readers. The premise of the article was that credit was being used as a bridge for the
lack of wage growth and also, the increase in consumer prices. Now that credit is in
shambles and risk is increasing, lenders are being more stringent about their lending
standards. Now you‘ll have to fog two mirrors for a loan.

Lessons from the Great Depression - Crash!

Today I think it is appropriate to look at the actual crash of 1929 and how it unfolded.
The importance of this post will examine the multiple interventions that entered into the
market trying to prop it up while the market steadily unfolded for four years before
bottoming out. When we look at a number such as 1929-1933, we seem to
compartmentalize that these four years somehow went quicker than our future four years
of say 2008-2012.

Try to imagine for a moment, how 2012 will look. Does this seem like tomorrow? Does
this seem like a quick turn of a chapter? Of course not. So when we examine the crash of
1929, we realize that the market declined both abruptly and quickly at times but took
years. It wasn‘t for lack of intervention or from motivation. There were those perma-bulls
back then that couldn‘t foresee a world without new credit devices that emerged during
the early part of the century. This is part VI in a series which I think is incredibly
important. We have been here and keep in mind Ben Bernanke is a student of the Great
Depression and believes that one of the primary causes of the Great Depression was lack
of vigorous intervention by the Fed at that time. He will now be able to put his theory
into practice.

Lessons from the Great Depression Series:
1. Personal Story by a Lawyer from a Previous Asset Bubble. Can we Learn from
the Past and How will the Housing Decline Impact You?

2. Lessons From the Great Depression: A Letter from a former Banking President
Discussing the Bubble.

3. Florida Housing 1920s Redux: History repeating in Florida and Lessons from the
Roaring 20s.

4. The Menace of Mortgage Debts: Lessons from the Great Depression Series: Part
IV: Where do we go After the Housing Crash?

5. Business Devours its Young: Lessons from the Great Depression: Part V:
Destroying the Working Class.

With each subsequent rate cut, the market is losing more and more faith with the Federal
Reserve. I think the Federal Reserve realizes that there is only so much more room before
they hit a zero percent interest bottom. The bullets are running out and soon, a new
weapon will be needed.


I am a big fan of Frederick Lewis Allen who has written extensively on the historical,
social, and economic circumstances of the early half of the century. For those of you who
want to see where we are heading we need to have a wider scope than just the last few
decades. It doesn‘t seem that people much care about history yet are willfully accepting
to repeat it. This is a chapter titled Crash! that gives an amazing account of the days and
time surrounding the crash of 1929:

―Early in September the stock market broke. It quickly recovered however, indeed, on
September 19th the averages as compiled by the New York Times reached an even higher
level than that of September 3rd. Once more it slipped, farther and faster, until by
October 4th the prices of a good many stocks had coasted to what seemed first-class
bargain levels. Steel, for example, after having touched 261 3/4 a few weeks earlier,
had dropped as low as 204; American Can, at the closing on October 4th, was nearly
twenty Points below its high for the year; General Electric was over fifty points below -
its high; Radio had gone down from 114 3/4 to 82 1/2.

A bad break, to be sure, but there had been other bad breaks, and the speculators
who escaped unscathed proceeded to take advantage of the lessons they had learned
in June and December of 1928 and March and May of 1929: when there was a break
it was a good time to buy. In the face of all this tremendous liquidation, brokers‘ loans as
compiled by the Federal Reserve Bank of New York mounted to a new high record on
October 2nd, reaching $6,804,000,000 — a sure sign that margin buyers were not
deserting the market but coming into it in numbers at least undiminished. (part of the
increase in the loan figure was probably due to the piling up of unsold securities in
dealers, hands, as the spawning of investment trusts and the issue of new common stock
by every manner of business concern continued unabated.) History, it seemed, was about
to repeat itself, and those who picked up Anaconda at 109 3/4 or American Telephone at
281 would count themselves wise investors. And sure enough, prices once more began to
climb. They had already turned upward before that Sunday in early October when
Ramsay MacDonald sat on a log with Herbert Hoover at the Rapidan camp and talked
over the prospects for naval limitation and peace.

Something was wrong, however. The decline began once more. The wiseacres of Wall
Street, looking about for causes, fixed upon the collapse of the Hatry financial group in
England (which had led to much forced telling among foreign investors and
speculators), and upon the bold refusal of the Massachusetts Department of Public
Utilities to allow the Edison Company of Boston to split up its stock. They pointed,
too, to the fact that the steel industry was undoubtedly slipping, and to the accumulation
of ―undigested‖ securities. But there was little real alarm until the week of October 21st.
The consensus of opinion, in the meantime, was merely that the equinoctial storm of
September had not quite blown over. The market was readjusting itself into a ―more
secure technical position.‖

It is clear from anyone that has studied the Great Depression, that not one event collapsed
the market. It was like a tipping point that finally capitulated the market downward.
Interestingly enough, a financial group had collapsed in England and also, a public utility
company was allowed to split up its stock (doesn‘t it seem familiar that these two parallel
with Bear Stearns being bailed out and also, the proposed splitting up of the monolines?).
Either way, the market in early 1929 had already had a few incidents where the market
declined only to be propped back up by massive speculation. The speculation was so
spectacular that even at the last minute, investors were still pushing stocks up. And of
course, it almost seemed unfathomable that the market would collapse. Even the prophets
of Wall Street couldn‘t envision such a scenario:

―In view of what was about to happen, it is enlightening to recall how things looked at
this juncture to the financial prophets, those gentlemen whose wizardly reputations were
based upon their supposed ability to examine a set of graphs brought to them by a
statistician and discover, from the relation of curve to curve and index to index, whether
things were going to get better or worse. Their opinions differed, of course; there never
has been a moment when the best financial opinion was unanimous. In examining these
opinions, and the outgivings of eminent bankers, it must furthermore be acknowledged
that a bullish statement cannot always be taken at its face value: few men like to assume
the responsibility of spreading alarm by making dire predictions, nor is a banker with
unsold securities on his hands likely to say anything which will make it more difficult to
dispose of them, unquiet as his private mind may be. Finally, one must admit that
prophecy is at best the most hazardous of occupations. Nevertheless, the general state of
financial opinion in October, 1929, makes an instructive contrast with that in February
and March, 1928, when, as we have seen, the skies had not appeared any too bright.
Some forecasters, to be sure, were so unconventional as to counsel caution. Roger
W. Babson, an investment adviser who had not always been highly regarded in the
inner circles of Wall Street, especially since he had for a long time been warning his
clients of future trouble, predicted early in September a decline of sixty or eighty
points in the averages. On October 7th the Standard Trade and Securities Service of the
Standard Statistics Company advised its clients to pursue an ―ultraconservative policy,‖
and ventured this prediction: ―We remain of the opinion that, over the next few months,
the trend of common-stock prices will be toward lower levels.‖ Poor‘s Weekly Business
and Investment Letter spoke its mind on the ―great common-stock delusion‖ and
predicted ―further liquidation in stocks.‖ Among the big bankers, Paul M. Warburg had
shown months before this that he was alive to the dangers of the situation. These
commentators — along with others such as the editor of the Commercial and Financial
Chronicle and the financial editor of the New York Times –would appear to deserve the
1929 gold medals for foresight.‖

It is often sited that no one really foresaw the crash of 1929 but there were a handful of
people that were echoing a warning cry. But how many people listened? Even the
predictions were slightly modest from the bears yet they were still not given the time of
day. But of course you had your perpetual housing bulls:

“Professor Irving Fisher, however, was more optimistic. In he newspapers of
October 17th he was reported as telling the Purchasing Agents Association that
stock prices had reached “what looks like a permanently high plateau.” He expected
to see the stock market, within a few months, “a good deal higher than it is today.‖
On the very eve of the panic of October 24th he was further quoted as expecting a
recovery in prices. Only two days before the panic. the Boston News Bureau quoted R.
W. McNeel, director of McNeel‘s Financial Service, as suspecting “that some pretty
intelligent people are now buying stocks. ―Unless we are to have a panic-which no one
seriously believes-stocks have hit bottom,‖ said Mr. McNeel. As for Charles E. Mitchell,
chairman of the great National City Bank of New York, he continuously and
enthusiastically, radiated sunshine. Early in October Mr. Mitchell was positive that,
despite the stock-market break, ―The industrial situation of the United States is absolutely
sound and our credit situation is in no way critical. . . . The interest given by the public
to brokers‘ loans is always exaggerated,‖ he added. ―Altogether too much attention is
paid to it.‖ A few days later Mr. Mitchell spoke again: ―Although in some cases
speculation has gone too far in the United States, the markets generally are now in a
healthy condition. The last six weeks have one an immense amount of good by shaking
down prices. ….. The market values have a sound basis in the general prosperity of our
country.‖ Finally, on October 22nd, two days before the panic, he arrived in the United
States from a short trip to Europe with these reassuring words: ―I know of nothing
fundamentally wrong with the stock market or with the underlying business and credit
structure. . . . The public is suffering from ‗brokers‘ loanitis.‖

In these types of situations, be careful who you listen to. The CEO of Bear Stearns as
early as 2 days before his company was bailed out by the Federal Reserve had this to say:
―New Chief Executive Alan Schwartz appeared on CNBC Wednesday to allay fears that
the firm faces a liquidity crisis, a perception heightened by the Federal Reserve‘s decision
on Tuesday to loan up to $200 billion in Treasury bonds to primary dealers, a move that
would allow Bear to swap some of its mortgage-backed securities for more secure debt.

―Our balance sheet has not weakened at all,” said Schwartz, noting that Bear‘s $17
billion cash position was the same as it had been in November. On Monday, the company
posted a similar message on its web site: ―The company stated that there is absolutely no
truth to the rumors of liquidity problems that circulated today in the market.‖

So much for not having a weak balance sheet. In 2 days Bear Stearns lost 40 percent of
its market value. In these times, even those perceived as experts have a motivation to
keep the pretense up that all is well. Clearly as CEO, one is to expect that you would have
a better sense of your company‘s situation. I still think we have yet to see the break point
where the market trends fully lower. During 1929 the moment came in late October:

―The next day was Thursday, October 24th.

On that momentous day stocks opened moderately steady in price, but in enormous
volume. Kennecott appeared on the tape in a block of 20,000 shares,General Motors in
another, of the same amount. Almost at once the ticker tape began to lag behind the
trading on the floor. The pressure of selling orders was disconcertingly heavy. Prices
were going down….. Presently they were going down with some rapidity….Before the
first hour of trading was over, it was already apparent that they were going down with an
altogether unprecedented and amazing violence. In brokers‘ offices all over the Country,
tape-watchers looked at one another in astonishment and perplexity. Where on earth was
this torrent of selling orders coming from?

The exact answer to this question will probably never be known. But it seems
probable that the principal cause of the break in prices during that first hour on
October 24th was not fear. Nor was it short selling. It was forced selling. it was the
dumping on the market of hundreds of thousands of shares of stock held in the name of
miserable traders whose margins were exhausted or about to be exhausted. The gigantic
edifice of prices was honeycombed with speculative credit and was now breaking under
its own weight.

Fear, however, did not long delay its coming. As the price structure crumbled there was a
sudden stampede to get out from under. By eleven o‘clock traders on the floor of the
Stock Exchange were in a wild scramble to ―sell at the market.‖ Long before the lagging
ticker could tell what was happening, word had gone out by telephone and telegraph that
the bottom was dropping out of things, and the selling orders redoubled in volume. The
leading, stocks were going down two, three, and even five points between sales. Down,
down, down…. Where were the bargain-hunters who were supposed to come to the
rescue at times like this? Where were the investment trusts, which were expected to
provide a cushion for the market by making new purchases at low prices? Where were
the big operators who had declared that they were still bullish? ere were the powerful
bankers who were supposed to be able at any moment to support prices? There seemed to
be no support whatever. Down, down, down. The roar of voices which rose from the
floor of the Exchange had become a roar of panic.

United States Steel had opened at 205 1/2. It crashed through 200 and presently was at
193 1/2. General Electric, which only a few weeks before had been selling above 400,
had opened this morning at 315 — now it had slid to 283. Things were even worse with
Radio: opening at 68 3/4, it bad gone dismally down through the sixties and the fifties
and forties to the abysmal price of 44 1/2. And as for Montgomery Ward, vehicle of the
hopes of thousands who saw the chain store as the harbinger of the new economic era, it
had dropped headlong from 83 to 50. In the space of two short hours, dozens of stocks
lost ground which it had required many months of the bull market to gain.

Even this sudden decline in values might not have been utterly terrifying if people could
have known precisely what was happening at any moment. It is the unknown which
causes real panic.‖

Amazingly, it seems like the fire that lit the fuse was forced selling in October 1929. The
current catalyst of this market is the forced liquidation of many companies and margin
calls are now starting to creep back into the lexicon of the market. Without credit, the
system cannot function just like a Ponzi Scheme cannot go on without new players. Once
the buyers (credit) dries up, the gig is up. It wouldn‘t be a problem if companies were
adequately capitalized but they are leveraged to the hilt and really have no viability
without access to credit. That is their mistake. Just like many states unable to save during
the good times for an inevitable downturn in the future. Those that claim we will not have
a recession need their heads examined. Even after the ―crash‖ the market had a few short
rallies until it finally capitulated:

―The New York Times averages for fifty leading stocks had been almost cut in half,
failing from a high of 311.90 in September to a low of 164.43 on November 13th; and
the Times averages for twenty-five leading industrials had fared still worse, diving from
469.49 to 220.95.

The Big Bull Market was dead. Billions of dollars‘ worth of profits-and paper profits-had
disappeared. The grocer, the window-cleaner, and the seamstress had lost their capital. In
every town there were families which had suddenly dropped ‗from showy affluence into
debt. Investors who had dreamed of retiring to live on their fortunes now found
themselves back once more at the very beginning of the long road to riches. Day by day
the newspapers printed the grim reports of suicides.

Coolidge-Hoover Prosperity was not yet dead, but it was dying. Under the impact of the
shock of panic, a multitude of ills which hitherto had passed unnoticed or had been offset
by stock-market optimism began to beset the body economic, as poisons seep through the
human system when a vital organ has ceased to function normally. Although the
liquidation of nearly three billion dollars of brokers‘ loans contracted credit, and the
Reserve Banks lowered the rediscount rate, and the way in which the larger banks and
corporations of the country had survived the emergency without a single failure of large
proportions offered real encouragement, nevertheless the poisons were there;
overproduction of capital; overambitious (expansion of business concerns;
overproduction of commodities under the stimulus of installment buying and buying with
stock-market profits; the maintenance of an artificial price level for many commodities,
the depressed condition of European trade. No matter how many soothsayers of high
finance proclaimed that all was well, no matter how earnestly the President set to
work to repair the damage with soft words and White House conferences, a major
depression was inevitably under way.

Nor was that all. Prosperity is more than an economic condition; it is a state of
mind. The Big Bull Market had been more than the climax of a business cycle; it had
been the climax of a cycle in American mass thinking and mass emotion. There was
hardly a man or woman in the country whose attitude toward life had not been affected
by it in some degree and was not now affected by the sudden and brutal shattering of
hope. .With the Big Bull Market zone and prosperity going, Americans were soon to find
themselves living in an altered world which called for new adjustments. new ideas, new
habits of thought, and a new order of values. The psychological climate was changing;
the ever-shifting currents of American life were turning into new channels.

The Post-war Decade had corne to its close. An era had ended.‖

It is only a matter of time before the current era of easy credit ends. The question of when
it happens does remain.

Winston Smith and the Bailouts in Oceania: Lessons
from the Great Depression Part VII.

Let us layout something from the beginning. Bailouts are already occurring. The
mainstream media for the most part still seems to be echoing a sentiment that bailouts
haven‘t occured. The bailouts have already occurred in the past tense. Bear Stearns being
injected and propped up via a proxy JP Morgan/Chase was a bailout. Of course, the
public was told and fed a line that if Bear wasn‘t propped up the entire edifice of Western
Civilization would come careening into the sea. The fact that the Fed is now exchanging
Treasurys for zombified mortgage backed securities is an absolute bailout. Have we
already forgotten the Hope Now Alliance or the FHA Secure programs?

Keep in mind the current administration has perfected the ministry of truth language. In
August of 2007, President Bush had this to say about bailing out homeowners:

―Obviously anybody who loses their home is somebody with whom we must show an
enormous empathy,‖ Bush said. Asked whether he would champion a government
bailout, Bush responded: ―If you mean direct grants to homeowners, the answer would be
`No, I don‘t support that.‘‖

Today we get the following:

―WASHINGTON (AP) — The Bush administration announced new steps Wednesday to
help more homeowners head off foreclosure, clashing with lawmakers in both parties
who want the government to step in with a broader housing rescue.

Scrambling to counter Democratic calls for a large federal housing aid package, the
administration said it would use an existing Federal Housing Administration program to
enable more low- and moderate-income homeowners to refinance into government-
insured mortgages with monthly payments they can afford.‖

Former Goldman Sachs CEO and current US Treasury Secretary Henry Paulson who has
been jawboning lassiez faire government, was in secret talks to prop up and bailout Bear
Stearns and their whacked out Monte Carlo casino portfolio of counterparty derivatives
on the back of the Federal Reserve which has become the de facto loan shark of all
investment banks on Wall Street. A sort of flea market and money laundering scheme
where you bring in crappy loans and walk out with cash. You would think that the Fed
has mastered the Midas touch and is able to turn raw mortgage sewage into pristine bars
of gold.

We are dealing with the ministry of truth here and somehow some of the media is buying
it. The narrative is now beginning to take shape. That is, Democrats are looking to bailout
the mom and pop homeowners while Republicans are taking a hands off approach letting
the free market do its thing. This isn‘t true. Take a look at everything that has occurred
and look at who is running the country. They may be saying no bailout but the actions are
showing that they are more than willing to bailout investment banks and Wall Street
while letting the American public swallow the bill and in the process, get nothing in
return. If anything, it seems that the Democrats are catching onto this and the line in the
sand is being drawn. After all, the current administration is more than keen to veto
anything coming from the Democrats.

The Democratic side of the argument is pushing for a $300 to $400 billion package to
shore up the FHA to buy more toxic waste. It seems that the Republicans have the
Federal Reserve and the Democrats are looking to have the FHA:

―Democrats are pushing a plan that would offer government insurance for between $300
billion and $400 billion in refinanced mortgages, potentially allowing more than one
million homeowners to move into less costly loans. So far, their proposal hasn‘t secured
any high-level Republican support.

In a scaled-back version of the Democrats‘ plan, Federal Housing Administration
commissioner Brian Montgomery said Wednesday that his agency would start providing
government insurance for some U.S. homeowners who owe more on their mortgages than
their homes are worth. The plan would allow borrowers to qualify for government-
insured loans if lenders agreed to write down part of the principal, giving borrowers
some equity in the homes.‖

Clearly, lenders do not like this deal since they‘ll be forced to write down bad loans and
take the losses. Why go for this when we can passively wait while Henry Paulson works
out some other bazooka ideas with the Fed and investment banks can simply unload their
horrific mortgages with the Fed in the great mortgage swap meet? After all, why go for
85 percent or less of the face value of the note when the Fed is willing to give you 100
percent par value for the wink-wink ―AAA‖ rated mortgages, investment firms can shore
up a bit more capital, and grease the wheels once again? At this point in the game we are
going to get some form of major bailout. We already have. The issue we can focus on
now is how do we structure policy to punish those that gambled and inflamed the fires of
mortgage and credit (aka debt) fraud and set in place regulation and enforcement that
will prevent this from happening again in the future. And for those of you that say,
―personal responsibility falls on the borrowers‖ you should read this article by Gretchen
Morgenson over at the New York Times. She has done, in my opinion an excellent job in
covering the credit and mortgage debacle. I know some industry insiders have knocked
her for some of the nuisances of mortgage finance but overall she‘s worth a read:

―WE‘VE all heard a great deal in recent months about the greedy borrowers who caused
the subprime mortgage calamity. Hordes of them duped unsuspecting lenders, don‘t you
know, by falsifying their incomes on loan documents. Now those loans are in default and
the rapacious borrowers have moved on with their riches.
People who make these claims, with a straight face no less, overlook a crucial fact.
Almost all mortgage applicants had to sign a document allowing lenders to verify their
incomes with the Internal Revenue Service. At least 90 percent of borrowers had to sign,
seal and deliver this form, known as a 4506T, industry experts say. This includes the so-
called stated income mortgages, affectionately known as ―liar loans.‖

So while borrowers may have misrepresented their incomes, either on their own or at the
urging of their mortgage brokers, lenders had the tools to identify these fibs before
making the loans. All they had to do was ask the I.R.S. The fact that in most cases they
apparently didn‘t do so puts the lie to the idea that cagey borrowers duped unsuspecting
lenders to secure on loans that are now - surprise! - failing.‖

And how many people actually spent the ridiculously expensive amount of $20 to verify
tax income? How about low single digits:

―My estimate was between 3 and 5 percent of all the loans that were funded in 2006 were
executed with a 4506,‖ Mr. Summers said. ―They just turned a blind eye, saying,
‗Everything is going to be fine.‖

I mean why wait one day for income verification? Heck, most lenders knew from day one
that buyers didn‘t have the income yet continued funding the loan since it wasn‘t their
money, it was other people‘s money (OPM). The lender passed the loan to Wall Street,
who cut it up and passed it to foreign investors, who naively thought that AAA rated did
not mean loading up your portfolio with Real Homes of Genius. It wasn‘t like foreign
investors were going to take a trip on the 105 and hit North Long Beach to take a look at
what they just bought. Would you be angry at a bank if someone walked in and said,
―I‘m Prince Albert in a Can and you should give me $200,000 on my word and I am
going to use this money to purchase an English muffin cart‖ and the bank proceeded to
write a loan in exchange for this promise? Of course you‘d be furious and the blame
would be largely on the bank since it is their institutional role to manage their own risk.
And if it was their own money, they wouldn‘t let this happen. The problem occurred
because lenders and brokers rarely had their skin in the game.

If lenders are so hungry to lend here is a great idea that puts their money where their
mouth is. Start a pool of all like minded folks that think there is really no problem (there
is a lot in this group), place your own cash in this fund to dish out mortgages, and start
making some loans. If you really believe what you are saying, then you should have no
problem handing out your own money to those buyers. Why does my gut tell me that in
this case, you‘ll be running a 4506 at a larger rate than 3 to 5 percent.

The Great Unfolding Happening Once Again

In our Lessons from the Great Depression series, we try to take an educative look at what
occurred in the past and try to avoid similar pitfalls. Clearly, we are not learning anything
since we are essentially repeating many things from a bygone era. This is part seven in
the series:
Lessons from the Great Depression Series:

1. Personal Story by a Lawyer from a Previous Asset Bubble. Can we Learn from
the Past and How will the Housing Decline Impact You?

2. Lessons From the Great Depression: A Letter from a former Banking President
Discussing the Bubble.

3. Florida Housing 1920s Redux: History repeating in Florida and Lessons from the
Roaring 20s.

4. The Menace of Mortgage Debts: Lessons from the Great Depression Series: Part
IV: Where do we go After the Housing Crash?

5. Business Devours its Young: Lessons from the Great Depression: Part V:
Destroying the Working Class.

6. Crash! The Housing Market Free Fall and Client #10 Contagion.

This is going to be a rather long post but I think it warrants a full reading. These excerpts
were written in 1935 during the Great Depression. They give us a look at an overall
perspective of what happened both politically and economically to exasperate the current
situation. The parallels are uncanny and of course, we are in different times, yet it doesn‘t
mean that many rules do not apply in the current environment. The text is from Lords of
Creation (a 450 page tome but worth every page) by Frederick Lewis Allen. I know
many of you may have a hard time finding this rare old gem of a book. It is worth
transcribing parts from this book in their entirety because they offer an excellent case
study of how the crisis unfolded and I‘m not sure if many of you will have a chance to
read this superb book:

The Vicious Spiral

―Let us try to analyze what was happening in those dolorous years of 1930 and 1931 and

The analysis cannot be simple, clear cut, dogmatic; for the sequence of cause and effect
in our world of endlessly involved mutual relationships is exceedingly complex.

We must remember, in the first place, the continued existence of various distortions in the
American economy which had made the recovery and prosperity of the country during
the nineteen-twenties an astonishing achievement against odds. We must remember how
curiously our foreign trade was balanced - that the only way in which we had been able to
permit Europe to buy our goods was by lending her huge amounts of capital, and that
obviously this could not keep up indefinitely. We must remember that the farmers who
grew our staple crops had never fully recovered from the distress into which the collapse
of their overseas markets had plunged them shortly after the war; and that as soon as
industry languished, the country as a whole was likely to feel the dragging weight of a
comparatively impoverished farming population‖

I think it is worth mentioning that at this time, we were a creditor nation. War torn
Europe rebuilding after the first World War had caused great amounts of debt which was
owed to the United States. We are no longer a creditor nation so this parallel is different
and clearly not a better position to be in. Let us continue:

―Nor must we overlook the fact that the economic breakdown of the early nineteen-
thirties was not simply an American phenomenon, but was world-wide. Europe in
particular, staggering under a terrific burden of debts incurred during the war, and
hampered by trade barriers built up by bitter national rivalries, had never enjoyed any
such boom in the nineteen-twenties as had the United States, and was now drifting into a
fresh economic crisis. This was bound to prolong and intensify the American crisis.

But it is doubtful if an of these factors - or all of them together - quite explain a
breakdown as cumulative and appalling as that which actually took place. Let us look for
other clues.

One of these clues is the increase in efficency which was being brought about by
improved methods of manufacture and of business, and especially by the machine - above
all by the power-driven machine. As we have already noted (in Chapter VIII) machines
were constantly replacing men. A given number of people were becoming able to
produce and distribute more and more goods. There is no need to present specific
illustrations of this fact; the Technocrats of 1932 deluged the country with them. But it
may not be amiss to remark that the tendency toward technological unemployment about
which the Technocrats talked so furiously was not confined to industry; consider, for
example how the output of American farms had been increased by the use of huge
reapers and combines and also by the spread of knowledge about better farming methods;
or consider how machinery and improved organization had likewise speeded up work in
business offices. That the machine was an instrument for the production of plenty is
undeniable - but that its increasing use was attended by economic strain is also
undeniable. During the seven fat years the men whom it had thrown out of work had
lost his job in the textile mill became an apartment-house janitor, the man who had
been fired from the automobile factory ran a filling station, and so on. But the strain
was there - and it was just barely met.”

It is worth noting that the weak recession of 2001 from the technology bubble bursting
was propped up by a subsequent bubble in housing. Many that lost jobs in the field were
able to retool and jump into the real estate industry either as brokers, agents, financiers,
or ancillary support to a booming market. The barrier to entry was non-existent and the
pay nearly matched up if not superseded the pay from the high-tech jobs. Those that lost
jobs in manufacturing were able to jump into the construction field to boost up the home
builders and the insatiable demand for housing. We had our own 7 fat years.
―To meet it, the American economy had to expand. There had to be constant growth -
new factories, new construction, new industries, new occupations, new expenditures. The
moment this expansion stopped for any reason, the American economy would begin, so
to speak, to die at the roots - to suffer from and increasing technological unemployment.
Prosperity had to go ahead very fast to stay in the same place.

For years past, this expansion had been achieved with the aid of a huge inflation of
credit, and in particular with the aid of the speculative boom in real estate and then
of the boom in the stock market. It was as if a huge bellows were blowing upon the
industrial system of the country, making the fires burn brightly. Meanwhile, however,
this expansion had had other effects - and they, too, are clues to what happened when the
bellows ceased to blow.

For one thing, it had helped to bring about an immense increase in the internal debt
of the country. One needs only to glance at the tabulations in Evans Clark‘s study of The
Internal Debts of the United States to realize what a change had been brought about by
the ―investment consciousness‖ of the American people, plus the urgent salesmanship
of the dispensers of securities and of life-insurance policies, plus the new financial
gadgets of the time, plus the reckless optimism of the boom years. During these years,
to quote Mr. Clark‘s book, we had “piled up our debts almost three times as fast as
our wealth and income increased.” While our wealth was growing only by an estimated
20 per cent, and our income by an estimated 29 per cent, the total amount of our long-
term debt had been growing by an estimated 68 per cent - from 76 billion dollars to 126
billion dollars. A large increase? Yes, and it and come on top of another large increase
during the war years. If we compare the long-term debt of the United States in 1929 with
that in 1913-14, we find the increase in fifteen or sixteen years to have been no less than
232 per cent!‖

People forget that a large part of the speculative boom of the 1920s was tied to real estate.
It is ingrained in the cultural psyche that the stock market and Wall Street set off the
Great Depression decade but the 7 fat years were built on a very weak house of cards.
During this time we also saw that while income was rising, the amount of debt was
growing even quicker. Does this sound familiar?

―Part of this huge accretion was due to the same factor which had placed such a heavy
burden on indebtedness upon Europe - the war. The Federal Government‘s debt was 1154
per cent larger in 1929 than in 1913-14. But the states and the smaller governmental untis
had also increased their obligations - by 248 per cent. And business, too, had succeeded
in cumbering itself with fixed claims of unprecedented magnitude. The debt of the
railroads had not increased by very much, if only because they had been notoriously
over-bonded in 1913-13; here the gain amounted to a mere 26 per cent. But meanwhile
the total debt of pulbic utilities had grown by 181 per cent; the debt of financial concerns
(including especially investment trusts and insurance companies) by 389 per cent;
and a series of real-estate booms had lifted the total amount of urban mortgages by
no less than 436 per cent.
Now it is obvious that no man can say with certainty how large a burden of debt an
economic system can carry. No man can say with assurance that this vastly enlarged debt
was enough to break the American system. For one thing, one man‘s debt is another
man‘s wealth. Yet here was at least a potential source of strain: a rigid structure of claims
- many of them imprudent - in an otherwise highly flexible economy.‖

Again we realize that during this time, the pushers here weren‘t brokers with mortgage
products although this was high as well during this time, but pushers of stock and
insurance policies. Debt was simply growing in so many areas that the amount was back
breaking to the public.

“But it did not go on. President Hoover prevented it from going on by calling for the
formation of the Reconstruction Finance Corporation to bring first aid to harassed
banks and corporations and to stop the epidemic of bankruptcies. Thus another
traditional cure for a business depression was withheld. Rightly or wrongly, the
property interests of the country felt that the financial system could not stand such
strong medicine. The debt structure - now supported by government intervention -
remained almost intact. Many long-term debts - especially mortgages - were in
default, but new ones had taken their place. The cold figures show what was
happening: according to the computations of Dr. Simon Kuznets for the National Bureau
of Economic Research, the amount of money paid out in interest in the year 1932 was
only 3.3 per cent less than in 1929 - though meanwhile salaries had dropped 40 per cent,
dividends had dropped 56.6 per cent, and wages had dropped 60 per cent.‖

Interesting to note that WaMu cut its dividend from 15 cents to 1 cent, a drop of 93
percent. Also, the idea of the government buying up mortgages to prevent collapse did
not keep the Great Depression from coming. Why go down this road again? We already
know how it ended back then.

―It was a bitter time in which to be President of the United States. No presidential
reputation can withstand an economic depression; even those people who are most
insistent that the government should keep its hands off business will blame the
government when business goes wrong. It was particularly bitter time for a President who
had proclaimed in his speech of acceptance that ―given a chance to go forward with the
policies of the last eight years, we shall soon, with the help of God, be in sight of the day
when poverty will be banished from this nation.‖ Hoover had gone forward with the
Coolidge policies; Andrew Mellon, the idol of the conservative business world, was still
Secretary of the Treasury; and yet disaster was descending upon the nation with
cumulative force.

By the autumn of 1930, the Hoover recovery moves of late 1929 and early 1930 were
clearly failing. The cut in the income tax was accentuating a mounting governmental
deficit. The public works program had not gone far - the deficit stood in its way. The
President‘s insistence that wages must not be reduced was being widely disregarded, and
even where the wage rate still stood firm, the amount of money paid out in wages was
becoming smaller and smaller as factories went on part time or shut down entirely. The
Federal Farm Board’s effort to sustain the price of wheat was a dismal failure,
involving the government in huge losses. And as for the campaign of synthetic
optimism, by the autumn of 1930 it was already becoming a sour jest, and by the
end of 1931 a compilation of the cheerful prophecies made by Hoover and his aides
and by the leaders of business and finance, published under the scornful tile of Oh
Yeah? Was greeted everywhere with derisive laughter.”

If anything, this site and many other sources have chronicled the absolute absurd and
unjustified optimism of the current decade. Random quotes. Pollyanna predictions
justified on whim. Clearly there is a more modern form of cynicism to the current
captains of industry who run firms into the ground much to the chagrin of investors and
jump out of their corner office in golden parachutes. We also know from history, that
cutting taxes and running massive deficits always ends badly! Yet during this
administration we have run incredible deficits while cutting taxes as if economic law has
been suspended. Of course these things end badly. We also know that trying to put in any
price supports is absolutely insane. That is why the increasing of mortgage caps sets an
almost reverse price ceiling which makes no sense since prices are now naturally
adjusting to market forces. Price supports are absolute failures. The fact that the Fed
stepped in and offered $2 for Bear Stearns was $2 too much. JP Morgan/Chase went up
to $10 to placate investor outcries. Either way, if the forces were allowed to take place
Bear Stearns would have gone down and exposed cracks that are still in the system. All
we‘ve done is offered a temporary price support via public intervention and allowed key
players to get out with some money instead of none.

―It was during this panic of the autumn of 1931 that Hoover decided that the American
debt structure must not be permitted to fall to pieces. He called a group of financiers to
Washington to form a pool of credit for the rescue of distressed capital; and presently he
asked Congress to take over the task by setting up the Reconstruction Finance

The situation which thus arose contained, perhaps, a certain element of ironic
humor. Now financial magnates who still cried out for “less government in
business” and inveighed against “the dole” could go, hat in hand, to Washington
and get the government to put itself into business by giving a dole of credit to their
banks or railroads. The apostle of rugged individualism had taken the longest step
in American history toward state socialism - though it was state socialism of a very
special sort.”

Sort of like the $15 billion home builders are asking for in retroactive tax breaks. Or
giving tax incentives for buyers to jump into the shark tank of homes. Again, Wall Street
is demonstrating that when times are good, the government should stay as far away as it
can but when things get tough, they have no problem running to mommy for an extra $20
to make it through the week. At least that vapid hypocrisy isn‘t something new. They
were doing it over 75 years ago.

Sheep Back to the Slaughter: Lessons from the Great
Depression Part VIII: All the Change and Bear Market
How quickly people forget the lessons from the past. Last week was a complete bear
market rally. We had a few companies such as Google and Honeywell announce solid
earnings but the banking sector is still in the shambles. Here is a quick tip for any
amateur investors, when a company announces massive layoffs this typically is good for
the stock but bad for the economy. It is becoming rather apparent that what is good for
Wall Street is only going to exacerbate the common condition of the middle class of
America. If stealth inflation wasn‘t enough they now have to deal with watching a class
of speculators make money on mal-investment in financially engineered products that do
nothing for the well being of our country. Citigroup Inc. announced a $5.11 billion
quarterly loss and future job cuts of 9,000 but rallied 7.49 percent during the week:

―NEW YORK (Reuters) - Citigroup Inc posted a $5.11 billion quarterly loss on Friday
and said it will cut another 9,000 jobs after suffering billions of dollars of write-downs
tied to mortgages, other debt and a slumping economy.
The loss was larger than expected and reflected more than $16 billion of write-downs
and credit-related costs at the largest U.S. bank.

Investors nevertheless took comfort that the bank and its new chief executive, Vikram
Pandit, are taking steps to get past credit problems, drive down expenses, and restore
luster to a stock down by about half over the last year.‖

This wasn‘t the only good for Wall Street bad for employee announcements. Merrill
Lynch posted its 3rd consecutive quarterly loss and announced plans to cut 2,900 workers.
This was good enough news to make the stock rally 8.4 percent for the week:

―NEW YORK (Reuters) - Merrill Lynch & Co posted its third straight quarterly loss on
Thursday and said it planned to cut 2,900 more jobs after recording more than $6.5
billion in write-downs on subprime mortgages and other risky assets.

The $2 billion loss was worse than Wall Street analysts‘ gloomy expectations, but
Merrill Lynch‘s shares rose 4 percent amid hopes the world‘s largest brokerage was
closer to seeing improvement.

―My sense is, they tried to clean the bad stuff off the shelves, and they hope it‘s mostly in
the trash,‖ said Michael Holland, founder of Holland & Co, which oversees more than $4
billion of assets.‖
Bwahaha! The rally was built on hope and this coming from folks that are knocking the
idea of many Americans being hopeful about their country. If we let these yahoos on
Wall Street run our country we‘d see a 1,000 point rally on the same day they announce
1,000,000 job cuts. There was very little to be excited about during the week. The DOW,
S&P 500, and NASDAQ were all up 4.2+ percent on the week. This apparently was good
enough for people to jump back into the market once again to get another expensive
lesson. Heck, these firms are cutting jobs and posting major losses and you are jumping
back in? Did they not see the horrific housing numbers for California? Do you really
think we are at the bottom? Take a look at these articles:

Housing in Graphics and California $16 Billion in the Hole: The Genesis of the
California Housing Market.

Lords of Housing: Believing in the $22.5 Trillion Housing Market.

Double Bubble: California Compared to the United States. Vacancy Rates up
Homeownership Down.

Digging into Countrywide: When Half Your Loans are in California and Florida.

We are nowhere near a bottom. Most logical and objective folks are now saying we are
going to have a recession. It will not be as light as the one in 2001. Let us take a look at
some historical monthly employment job losses/gains for reference here:

The so-called mild recession of 2001 saw 15 straight months of job losses with 9 months
straight of job losses between 100,000 and 325,000. Take a look at where we are
currently. We are nowhere near the ―mild‖ numbers of the previous recession and this
one is expected to be worse. Now do you see why those large numbers at Citigroup and
Merrill are more ominous than a fake bear market rally?

In today‘s article we are going to try and sneak a peak at the future. In our Lessons from
the Great Depression series we are trying to educate ourselves from the past to avoid
costly mistakes in the future. Today‘s article will examine the transition from the Hoover
administration to the Roosevelt administration. Here is a list of previous articles:

1. Personal Story by a Lawyer from a Previous Asset Bubble. Can we Learn from
the Past and How will the Housing Decline Impact You?

2. Lessons From the Great Depression: A Letter from a former Banking President
Discussing the Bubble.

3. Florida Housing 1920s Redux: History repeating in Florida and Lessons from the
Roaring 20s.

4. The Menace of Mortgage Debts: Lessons from the Great Depression Series: Part
IV: Where do we go After the Housing Crash?

5. Business Devours its Young: Lessons from the Great Depression: Part V:
Destroying the Working Class.

6. Crash! The Housing Market Free Fall and Client #10 Contagion.

7. Winston Smith and the Bailouts in Oceania: Lessons from the Great Depression
Part VII.

The country is quickly realizing how screwed up Wall Street is. I love how Charlie
Gibson with his asinine questions tried to peg the Democratic candidates about the
raising of capital gains taxes. Let us actually look at the numbers:

―The percentage of Americans who owned stocks, either directly or through a mutual
fund, fell by 3.3 percentage points to 48.6 percent in 2004, down from 51.9 percent in

Stock ownership rates were highest in 2004 among families with higher incomes and
families aged 55 to 64. Overall median stock holdings fell to $24,300 in 2004, down
from $36,700 in 2001.

With baby boomers turning 60 this year and nearing retirement, the survey found that the
percentage of families with some type of tax-deferred retirement account, such as a 401k,
fell by 2.5 percentage points to 49.7 percent of all families.

However, those who had retirement accounts saw their holdings increase. The median for
holdings in retirement accounts rose by 13.9 percent to $35,200.‖

Of course Charlie Gibson in his liberal elite silo of friends and influence keeps forgetting
that he asks questions that normally pertain to only 10 percent of the United States
―…So the rules in Washington — the tax code has been written on behalf of the well
connected. Our trade laws have — same thing has happened. And part of how we‘re
going to be able to deliver on middle-class tax relief is to change how business is done in
Washington. And that‘s been a central focus of our campaign.

―MR. GIBSON: Senator Obama, you both have now just taken this pledge on people
under $250,000 and 200-and-what, 250,000.

SENATOR OBAMA: Well, it depends on how you calculate it. But it would be between
200 and 250,000.

MR. GIBSON: All right.

You have however said you would favor an increase in the capital gains tax. As a matter
of fact, you said on CNBC, and I quote, ―I certainly would not go above what existed
under Bill Clinton, which was 28 percent.‖

It‘s now 15 percent. That‘s almost a doubling if you went to 28 percent. But actually Bill
Clinton in 1997 signed legislation that dropped the capital gains tax to 20 percent.‖

Did we not just look at the median stock holdings for most Americans? Let us say you
kicked royal butt on that $24,300 stock holdings and gained 10 percent over the year. So
now you decide to cash out and sell all your $26,730 of stock holdings. You are taxed on
the gains of course and you made $2,430. The difference between 15 percent and 28
percent is a whopping $315! People are paying that in one month by:

1. Lost earning power and stagnant wages

2. U.S. Dollar going south to Cabo in Baja California

3. Higher fuel costs

4. Higher food costs

Yet the media again fails to look at the damn facts. In fact, most Americans have their
wealth stored in the equity in their home. That is why the housing bubble bursting is so
painful and why it is so utterly frustrating to hear the economically devoid media from
digging deeper into the data. During the debate housing came up for about one minute!
Yelling no more taxes is a pathetic rally cry that no longer holds water. Folks are wising
up that inflation is a shadow tax that penalizes main street U.S.A and caters to those on
Wall Street. Think this is only happening in Rust Belt states and not ―elite‖ coastal
regions. Well California is quickly catching up as it usually does:

L.A. Times - ―SACRAMENTO — California‘s unemployment rate hit 6.2% in March,
the highest level in almost four years, spurred by a continuing downturn in construction
and financial activities.
The Employment Development Department reported Friday that 1.13 million people
were out of work last month, marking the state‘s weakest economic performance since
July 2004, when the jobless rate also stood at 6.2%.

Levy noted that California’s unemployment rate is the third-highest in the country,
trailing Michigan with 7.2% and Alaska with 6.7%. California is doing worse than
Pennsylvania and Ohio, Levy said, two Rust Belt states that have figured prominently in
the presidential primary elections because of their manufacturing job losses.‖

That‘s right folks, the only two states with higher unemployment rates are Michigan and
Alaska. No wonder why I had the urge to cling to my gun last month. Absolute media
distortion and again they are focusing on the minutia while Rome is burning. Hey look!
American Idol!

Today‘s article is going to examine what happened after Hoover left office and the
economy was in absolute shambles. It is important to note that there is a once in a
lifetime bubble bursting here. The magnitude of the financial stupidty will cascade down
and only increase the unemployment numbers. Even only looking at the previous mild
recession we are miles away from facing the impact of the full economic onslaught that
we will unavoidably go through. That will happen. The only question is what are we
going to do after the fall to prevent this from happening to future generations? That is if
people have sufficient desire to leave a world equally or better for the future.

This is a chapter from Lords of Creation examining the transition of the new

―If the stroke of chance which closed the banks on Inauguration Day was bitterly tragic
for Herbert Hoover, it was also staggering for Franklin Roosevelt. The country over
which he was to govern was prostrate. The financial machinery had stopped. Most
financial institutions were teetering on the edge of insolvency. Business was slumping
fast to the low levels reached during the panicky spring of 1932. The farm population and
the industrial population were in dire straits; unemployment and destitution were
widespread. And who could be sure that the demoralization of the national economy had
not only just begun?

Furthermore, Roosevelt‘s plans, formulated at leisure, had not contemplated the meeting
of any such extraordinary crisis as the collapse of the whole banking system; at the very
outset of his administration he must improvise. He and his cabinet officers were now to
their jobs, to their staffs, even to each other. At a moment of the gravest danger the
command of the Ship of State was being turned over to a group of passengers none of
whom had ever been on the bridge before.
Yet in another respect the stroke of chance favored the new President. It gave him, for the
moment at least, an almost united country. The closing of the banks had thrown rich and
poor, employer and employee, banker and depositor, Republican and Democrat, into a
common predicament; and this predicament was so sudden and unprecedented that
divergent opinions as to the way out had not had time to crystallize. There was even, for
millions of Americans, a curious thrill in the completeness of the breakdown after so
many months and years of foreboding: a feeling of Now it has happened: now for action.
When Franklin Roosevelt stepped forward on the platform before the Capitol and began
his Inaugural Address, not only the throng below him but a vastly greater throng of
listeners at millions of radios were ready to listen hopefully, to follow eagerly, to
welcome a New Deal.‖
Ironically, one economic thing that currently holds all Americans together is
housing. This infatuation has put the vast population in the same condition. You
either own and see your equity evaporating or rent and are seeing your dollar get
weaker and weaker. Why do you think the economy is now without a doubt the
number one issue?

―He did not disappoint those first hopes. Whether or not events make men, certainly
Franklin Roosevelt who assumed the Presidency on that eventful day seemed a wholly
different man from the all-things-to-all-men candidate of 1932.

His Inaugural - delivered in a ringing voice - was clear, strong, confident; and citizens
innumerable who had longed for action in the days when Hoover seemed to be doing
nothing were thrilled as by the note of the fife when the new President pledged himself to
ask Congress, if the need arose, for ―broad executive power to wage a war against the
emergency, as great as the power that would be given to me if we were in fact invaded by
a foreign foe.‖

His promise of action was immediately made good. He met the banking crisis boldly and
with a wholly contagious confidence. He at once called Congress to meet in emergency
session. He at once issued - with a few changes - the national bank-holiday proclamation
which had been prepared for Hoover‘s use a few days before. His smiling little
Secretary of the Treasury, William H. Woodin, plunged into arduous preparations
for the reopening of the banks - providing for a possible expansion of the currency
based on the sound assets of the banks, and arranging to consider the condition of
every bank and to decide which institutions could be opened, which must be placed
under the direction of governmental “conservators,” and which must remain closed.
When Congress assembled, Roosevelt asked it for virtually dictatorial power over
transactions in credit, currency, gold, and silver. This power was granted him the very
day he asked for it. Nine days after the Inauguration the first banks were ready to be
opened. And on the evening before the opening, Roosevelt sat before a radio microphone
in the White House and talked to the American people as one would talk to a group of
friendly neighbors, explaining with admirable clarity and persuasiveness just what he had
been doing and what he expected them to do. The address was a triumph of democratic
statesmanship. The banks were opened without panic, and stayed open.

To be sure, not all the banks were permitted to resume business. At least a fifth of the
deposits of the country were still tied up, and the purchasing power of the country was
correspondingly reduced. But Franklin Roosevelt had done his first great task brilliantly -
and he still had the whole nation with him.
Even the men of Wall Street, shaken by the experiences of the past few weeks and by the
obvious anger and distrust of the general public, had little choice but to go along with the
new President who moved through the crisis with so sure a step, and who so obviously
held their future fortunes in his hands. They were the more disposed to go along with him
when he asked Congress - before the banks were opened - for authority to cut Federal
expenses to the bone (yes, even to cut the veterans‘ allowances) in order to maintain the
national credit. Even when Roosevelt, in April, issued an executive order prohibiting the
export of gold, and Woodin formally admitted that the United States was off the gold
standard (as in reality it had been ever since March 4) the financiers did not seem unduly
dismayed; J.P. Morgan himself smilingly faced a group of reporters at 23 Wall Street and
gave his approval to the move.‖

Clearly, with the current administration they can give 2 cents (which is probably
going to be the value of the dollar once they leave office) how things will play out on
the world stage. The U.S. Treasury and Federal Reserve currently is only willing to
jawbone about a strong dollar yet is willing to bailout both overtly (Bear Stearns)
and covertly (the Fed discount swap meet) those on Wall Street. In the mean time
most Americans deal with the fallout of absolute incredible fiscal mismanagement.
This president may leave office with the U.S. $10 trillion in the hole, nearly twice of
what he came into office with:
―The country wanted action? Roosevelt gave it action. Throughout the spring of 1933 he
showered recommendations and drafts of bills upon an astonished Congress which
followed his requests as if in a trance. Bills to bring about financial reforms, bills to
stimulate business in one way or another, bills to set up new governmental agencies:
Congress passed them all - some of them before the members had even had a chance to
read them, much less to ponder over them. There was every reason for the men of the Hill
not to balk but to follow blindly. The Democratic majority was huge, the patronage was
still undistributed; the country was in the mood for headlong change and was enchanted
with Roosevelt; telegrams and letters urging Senators and Representatives to ―support the
President‖ were flooding in from all over the country.
The executive departments were in a fury of activity. Conferences were going on at all
hours, bills were being drafted and revised and redrafted at breakneck speed, and in the
mammoth new government buildings the lights burned late; the very atmosphere of the
once placid city of Washington was electric with excitement. Officials and advisers
representing the widest divergence of views were being pressed, helter-skelter, into the
planning of the recovery program - hard-boiled business men, hard-boiled politicians,
deserving Democrats, professors of economics, labor leaders, socialists, sentimental
theorists of every hue. What would come of their furious labors was far from clear;
but the country liked action, liked its smiling President, and liked to feel once more
the sense of hope.

And it liked most of all the fact that a really definite improvement in the condition
of the country was taking place.

As we look back upon the events of that spring of 1933, it is clear that to a
considerable extent the improvement was due to the expectation of inflation. It did
not really begin until after the Administration formally forsook the gold standard in April.
It was given a distinct fillip by the action of Congress, in May, in giving the President
permission to bring about inflation in any one of four ways. The fall of the dollar in
foreign exchange was providing a temporary stimulus to exports; the prospect of higher
prices (coupled with the prospect of governmental regulation through the N.R.A) was
causing business men all over the country to stock up with goods.‖

This time is different however. First, according to government data inflation is
largely controlled. The Fed would love nothing more to inflate away our debt, allow
the dollar to tank to increase exports, and let everyone “feel” wealthier. Too bad
they are running out of ammunition and since Ben Bernanke is a master student of
the Great Depression, he’s probably trying to go down this road. Of course, more
evidence is looking like we are going to have our own lost decade like Japan’s with a
zero interest policy and propping up zombified banks longer than we should. This
will annihilate productivity and will allocate Federal resources from more prudent
usage such as fixing infrastructure and recapturing new industry to our country.
This at least has a long-term benefit. Playing hide the credit default swaps from the
public does nothing except keeps us from facing the truth.

―Nevertheless there was a new feeling in the air. Investors who in 1932 had rushed to sell
because they thought there might be inflation now rushed to buy for the same reason. The
rise in the price of wheat and other crops was restoring a measure of hope to the men and
women of the farm belt. The wheels of industry were actually beginning to turn faster,
the unemployed were actually beginning to be put back to work.

The rally had its disquieting features, and perhaps the most disquieting was the terrific
outburst of speculation which accompanied it. Despite the public distrust of Wall
Street, despite the widespread belief that prosperity on the 1929 pattern was false
and dangerous, despite the grim experiences of 1930 and 1931 and 1932, the shorn
lambs swarmed into the brokerage houses once more in incredible numbers. Where
some of them got the money to speculate with was a mystery. More than a few of
them, indeed, were shabbily clad; one had the feeling, as one watched the customers in a
broker‘s office, hanging over the chattering ticker or following with eager eyes the
moving figures on the trans-lux screen, that perhaps some among them were desperately
staking their last savings on the turn of the Wall Street wheel. The behavior of the market
as it skyrocketed upward gave plenty of indication that even if the bankers were
somewhat humbled by recent events, the pool managers on the Exchange were not. Some
of the manipulative operations in which the alcohol stocks (which were supposed to be
about to profit by the coming repeal of the Eighteenth Amendment) were pushed up to
extravagant prices - and into the hands of the suckers - were as outrageous as the worst
pool exploits of 1929.

As for volume of trading on the Stock Exchange, the amazing fact was that during the
two successive months of June and July 1933, this was greater than it had been in any
month of 1929 except the panic month of October. On no less than nineteen days during
1933 the daily volume of trading was more than six million shares - a strange
phenomenon when one considers that there never had been even a single four-million
share day until the bull-market frenzy of 1928. Speculation in the commodity markets
was similarly feverish and unashamed.

It is true, of course, that the Administration, by dangling the idea of inflation before the
public, was partly to blame for this debauch. Nevertheless the exaggerated form which
the speculative campaign took was an ominous sign. The national economy seemed like
an engine with a loose part: speed it up just a little, and it began to wrack itself to pieces.‖

People just had to get back into the game again. This recent rally is nothing more
than this kind of rally. There is no fundamentals to justify what is going on. All
long-term indicators point to at least one to two years of strong to severe
corrections. We are in massive debt (see above) unemployment will only keep
increasing (see above) and the public is worried about capital gains taxes which the
majority pay very little on anyways? Again we are talking distraction and avoiding
the truth. That is, wages have been stagnant for a decade, we’ve lost our
manufacturing base, and we’ve become a country built on trading paper and houses
to one another in a game of financial musical chairs.

―Yet elsewhere the prospect was heartening. Even if the United States was not going
back to work so fast as it was going back to speculation, the gain in economic activity in
the brief interval since March was remarkable. By July the index of industrial production
had regained about half the ground it had lost since 1929; and while the rise in
employment and in payrolls was decidedly less spectacular, it was sharp.

There had taken place, too, another significant change. No one could fail to realize that
the economic initiative was now in the hands of Franklin Roosevelt. At scores of points
in the economic system of the country the government - with public opinion still
overwhelmingly behind it - was intervening or promising to intervene. The economic
capital of America had moved from Wall Street to Washington.‖

A Bubble That Broke the World: Lessons from the Great
Depression Part IX. When Credit is Debt.

We are swimming in a world of debt. Somewhere in the past decade debt lost the
negative connotation of being a four letter word. In fact, the language of so many things
has changed and the ultimate ramifications now have sweet language to soften the utter
destructiveness of the underlying instrument. Junk bonds are now looked at as high yield
bonds. I don‘t like junk but I sure love the sound of high yield! The most profound
change has been the idea that credit has now supplanted the concept of debt. When we
talk about the worldwide credit crisis what we are really talking about is the global debt
problem. When you think of credit the underlying meaning is positive. You received
credit for completing the assignment. Hey Joe, I give you great credit for working so hard
on the project. We credit you sir for the excellent job here! It would be extremely
different if credit cards were title debt cards. Or what if we called them, ―instant
layaway‖ cards instead of calling them platinum premium member cards.

The psychology of this housing bubble is absolutely fascinating and disturbing. When
you really boil it down, you have to wonder what people were thinking. There were folks
who are reluctant to place a $100 bet in Vegas yet they were able to purchase an
overpriced home and many are now sitting on $100,000 or more of negative equity.
Many would like to think they weren‘t speculating because it was real estate but there
was no fundamental reason for home prices to reach the level that they did. The irony of
this all is that we still keep hearing that this is a credit crisis. The fact is that Americans
were unable to keep this economy going without massive amounts of debt. Debt that
fueled spending and accounted for a large percentage of our GDP.

In reality it was a large Ponzi scheme and in the end like all Ponzi schemes they come
crashing down on their own weight. Today in our lessons from the Great Depression
series we are going to look at a book written in 1932 called a Bubble that Broke the
World by Garet Garrett. It is a fascinating look at the social reasons why bubbles form
and ultimately collapse. It is worth a full read but we‘ll go through some important
passages here and parallel them to our current situation. This lesson is part IX in our
continuing series:

1. Personal Story by a Lawyer from a Previous Asset Bubble. Can we Learn from
the Past and How will the Housing Decline Impact You?

2. Lessons From the Great Depression: A Letter from a former Banking President
Discussing the Bubble.

3. Florida Housing 1920s Redux: History repeating in Florida and Lessons from the
Roaring 20s.
4. The Menace of Mortgage Debts: Lessons from the Great Depression Series: Part
IV: Where do we go After the Housing Crash?

5. Business Devours its Young: Lessons from the Great Depression: Part V:
Destroying the Working Class.

6. Crash! The Housing Market Free Fall and Client #10 Contagion.

7. Winston Smith and the Bailouts in Oceania: Lessons from the Great Depression
Part VII.

8. Sheep Back to the Slaughter: Lessons from the Great Depression Part VIII: All
the Change and Bear Market Rallies.

A Bubble That Broke the World

―Mass delusions are not rare. They salt the human story. The hallucinatory types are well
known; so also is the sudden variation called mania, generally localized, like the tulip
mania in Holland many years ago or the common-stock mania of a recent time in Wall
Street. But a delusion affecting the mentality of the entire world at one time was hitherto
unknown. All our experience with it is original.

This is a delusion about credit. And whereas from the nature of credit it is to be expected
that a certain line will divide the view between creditor and debtor, the irrational fact in
this case is that for more than ten years debtors and creditors together have pursued the
same deceptions. In many ways, as will appear, the folly of the lender has exceeded the
extravagance of the borrower.‖

I think it is important to note that in this current bubble it does take two to tango.
Many borrowers bought in many cases as speculators even though they thought
they were making a prudent decision. It can be said that this is no more logical than
buying a luxury car and expecting more than what you paid for it 5 years later.
Ultimately when you go to sell the market will dictate the price. But not everyone
participated in this mania. Look at these sobering numbers and I’ve tried to word it
to change your perspective on what is going on.

According to the U.S. Census Bureau, 31.8 percent of all U.S. owner-occupied homes
have no mortgage. 32 percent of the country rents. The vast majority of those
remaining with mortgages have been financially responsible. Why should it now be
the responsibility of those who managed their finances prudently to bailout the few
who speculated — including irresponsible lenders who made loans to people who
had no chance of ever paying it back?

Let us continue with the article:
―The general shape of this universal delusion may be indicated by three of its familiar

First, the idea that the panacea for debt is credit. Debt in the present order of magnitude
began with the World War. Without credit, the war could not have continued above four
months; with benefit of credit it went more than four years. Victory followed the credit.
The price was appalling debt. In Europe the war debt was both internal and external. The
American war debt was internal only. This was the one country that borrowed
nothing; not only did it borrow nothing, but parallel to its own war exertions it loaned to
its European associates more than ten billions of dollars. This the European governments
owed to the United States Treasury, besides what they owed to one another and to their
own people. Europe‘s attack upon her debt, both internal and external, was a resort to
credit. She called upon this country for immense sums of private credit-sums which
before the war had been unimaginable-saying that unless American credit provided her
with the ways and means to begin moving her burden of debt she would be unable to
move it at all.

Result: The burden of Europe‘s private debt to this country now is greater than the
burden of her war debt; and the war debt, with arrears of interest, is greater than it was
the day the peace was signed. And it is not Europe alone. Debt was the economic terror
of the world when the war ended. How to pay it was the colossal problem. Yet you will
find hardly a nation, hardly any subdivision of a nation, state, city, town or region that
has not multiplied its debt since the war. The aggregate of this increase is prodigious, and
a very high proportion of it represents recourse to credit to avoid payment of debt.‖

How the tables have turned. We are now a largely debtor nation. We owe money to
China, Japan, Europe, and many other foreign players. We are no longer a lender
but the world’s greatest borrower. We are now a debtor in this game. In fact, each
day we have to borrow large sums of money to keep consuming at current levels.
Our trade deficits show this unnerving fact clearer than anything else. Simply
looking at cargo coming into our large ports in San Pedro and Long Beach we see
that 3 cargo containers come in with produced goods and we send out 1 container;
many times when we export items it is raw materials. This imbalance is harming us.
And of course, if we are to learn from Europe during the early part of the 1900s is
that war debt drags an economy down into the dumps.

“Second, a social and political doctrine, now widely accepted, beginning with the
premise that people are entitled to certain betterments of life. If they cannot
immediately afford them, that is, if out of their own resources these betterments
cannot be provided, nevertheless people are entitled to them, and credit must
provide them. And lest it should sound unreasonable, the conclusion is annexed that if
the standard of living be raised by credit, as of course it may be for a while, then people
will be better creditors, better customers, better to live with and able at last to pay their
debts willingly.
Result: Probably one half of all government, national and civic, in the area of western
civilization is either bankrupt or in acute distress from having over-borrowed according
to this doctrine. It has ruined the credit of countries that had no war debts to begin with,
countries that were enormously enriched by the war trade, and countries that were created
new out of the war. Now as credit fails and the standards of living tend to fall from the
planes on which credit for a while sustained them, there is political dismay. You will hear
that government itself is in jeopardy. How shall government avert social chaos, how shall
it survive, without benefit of credit? How shall people live as they have learned to live,

and as they are entitled to live, without benefit of credit? Shall they be told to go back?
They will not go back. They will rise first. Thus rhetoric, indicating the emotional

position. It does not say that what people are threatening to rise against is the payment of
debt for credit devoured. When they have been living on credit beyond their means the
debt overtakes them. If they tax themselves to pay it, that means going back a little.

If they repudiate their debt, that is the end of their credit. In this dilemma the ideal
solution, so recommended even to the creditor, is more credit, more debt.‖

Was this written yesterday? Talk about repeating history again. This psychological
notion that one is entitled to a better life regardless of your savings is not new. In
fact, it seems that the mentality then is the same as today; if you can’t afford the
artifacts of middle class life with your own saved money then it is probably the fault
of lack of credit. Forget that it means you probably can’t afford it. And the solution
offered at the time? More debt! I can hear Bernanke saying, “more credit for
liquidity” and we are back at square one. Remember that Ben Bernanke is a student
of the Great Depression so none of this is lost on him. Yet somehow he thinks the
problem wasn’t too much debt but not enough “credit” quick enough. Well he just
saw how impotent the Fed was with their rate cuts. He bought a bit of breathing
room but we are still nowhere out of the woods. If we keep thinking that the only
problem is the need for more debt we are going to spiral downward into a debtor’s
hell. In many cases we may already be at this point.

“Third, the argument that prosperity is a product of credit, whereas from the beginning of
economic thought it had been supposed that prosperity was from the increase

and exchange of wealth, and credit was its product. This inverted way of thinking was
fundamental. It rationalized the delusion as a whole. Its most astonishing

imaginary success was in the field of international finance, where it became unorthodox
to doubt that by use of credit in progressive magnitudes to inflate international trade the

problem of international debt was solved. All debtor nations were going to meet their
foreign obligations from a favorable balance of trade. A nation’s favorable balance in
foreign trade is from selling more than it buys. Was it possible for nations to sell to
one another more than they bought from one another, so that every one should have a
favorable trade balance? Certainly. But how? By selling on credit. By lending one
another the credit to buy one another‘s goods. All nations would not be able to lend
equally, of course.

Each should lend according to its means. In that case this country would be the principal
lender. And it was. As American credit was loaned to European nations in amounts rising
to more than a billion a year, in the general name of expanding our foreign trade, the
question was sometimes asked: ―Where is the profit in trade for the sake of which you
must lend your customers the money to buy your goods ?‖

The answer was: ―But unless we lend them the money to buy our goods they cannot
buy them at all. Then what should we do with our surplus?‖ As it appeared that
European nations were using enormous sums of American credit to increase the power
of their industrial equipment parallel to our own, all with intent to produce a great
surplus of competitive goods to be sold in foreign trade, another question was sometimes
asked: ―Are we not lending American credit to increase Europe‘s exportable surplus of
things similar to those of which we have ourselves an increasing surplus to sell? Is it not
true that with American credit we are assisting our competitors to advance themselves
against American goods in the markets of the world?‖

Welcome to our new world. Guess where these foreign nations are putting their
money? Does the idea of sovereign wealth funds ring a bell? Not only are they
placing it back into their own countries building stronger internal economies but
they are also buying the best businesses in the United States for cheap. This is all
well in good if you look at it from a strictly economical stand point but what about
countries like Russia or Venezuela that clearly do not have the same political
ideologies as we do here. In fact, in some cases they are against the values of the
country that is sending loads of money to them. Therein lies the problem. The
solution would be simple in say the case of Venezuela in that we stop buying oil from
them. But do you think the American people would go for that and see prices sky
rocket? Of course not. They jumped to arms about a $30 tax break for the summer
so you really have got to be kidding when it comes to mass psychology. If we are
unwilling to reshape our economy and see the interconnectedness of the problem
debt brings on we are going to wake up and see that America is up for sale to the
world, pennies on the dollar. In fact, this may already be unavoidable and you need
only look at the dollar for this to resonate.

―The answer was: ―Of course that is so. You must remember that these nations you speak
of as competitors are to be regarded also as debtors. They owe us a great deal of money.
Unless we lend them the credit to increase their power of surplus production for export
they will never be able to pay us their debt.‖

Lingering doubts, if any, concerning the place at which a creditor nation might expect to
come out, were resolved by an eminent German mind with its racial gift to subdue by
logic all the difficult implication of a grand delusion. That was Doctor Schacht, formerly
head of the German Reichsbank. He was speaking in this country. For creditor nations,
principally this one, he reserved the business of lending credit through an international

bank to the backward people of the world for the purpose of moving them to buy
American radios and German dyes. By this argument for endless world prosperity as a

product of unlimited credit bestowed upon foreign trade, we loaned billions of American
credit to our debtors, to our competitors, to our customers, with some beginning toward
the backward people; we loaned credit to competitors who loaned it to their customers;
we loaned credit to Germany who loaned credit to Russia for the purpose of enabling
Russia to buy German things, including German chemicals. For several years there was
ecstasy in the foreign trade. All the statistical curves representing world prosperity rose
like serpents rampant.

Result: Much more debt. A world-wide collapse of foreign trade, by far the worst since
the beginning of the modern epoch. Utter prostration of the statistical serpents. Credit
representing many hundreds of millions of labor days locked up in idle industrial
equipment both here and in Europe. It is idle because people cannot afford to buy its
product at prices which will enable industry to pay interest on its debt. One country
might forget its debt, set its equipment free, and flood the markets of the world with
cheap goods, and by this offense kill off a lot of competition. But of course this thought
occurs to all of them, and so all, with one impulse, raise very high tariff barriers against
one another‘s goods, to keep them out. These tariff barriers may be regarded as

reactions. They do probably portend a reorganization of foreign trade wherein the
exchange of competitive goods will tend to fall as the exchange of goods unlike and
noncompetitive tends to rise. Yet you will be almost persuaded that tariff barriers as such
were the ruin of foreign trade, not credit inflation, not the absurdity

of attempting by credit to create a total of international exports greater than the sum of
international imports, so that every country should have a favorable balance out of which
to pay its debts, but only this stupid way of people all wanting to sell without buying.‖

Our trade imbalance is a danger to our country’s long-term prosperity and has
global implications beyond economics. It is certain if we continue on this path there
will be a worldwide meltdown. There has been no desire from any political party to
reign in the manic spending of the American people. Somehow they thought that for
a decade of trading paper back to one another, flipping houses, and taking money
out of homes to add upgrades was the idea of a healthy economy. What we ended up
doing is simply rearranging the deck chairs on the Titanic while the world built up
stronger production capacity and has siphoned off a competitive advantage in many
areas. Spending more than you make impacts the world more than you think. It is
time to get serious about this and make it a national priority to get our books in
order. Former Federal Reserve Chairman Paul Volcker knew this and jacked up
the Fed Funds Rate into the double-digits to reign in inflation. People did not like
this but in the end it made us more productive in the 80s and 90s. Who will be the
next person to reign in spending before this bubble breaks the world?


When you look at the current unemployment rate of 5 percent, you would think that our
economy would be humming along. Yet the way that they calculate the official
unemployment rate is such a joke, you are almost left guessing how many people are
really out of work. Are you looking for work and simply can‘t find a job and gave up?
Consider yourself not counted in the numbers. Are you working part-time although you
want full-time employment? Guess what? You are not counted either! It is patently
absurd and frustrating to see what kind of gimmicks the government uses to massage the
unemployment data.

Mish over at Global Economic Trend analysis on a monthly basis has to dig into the data
to point out the stupidity of the unemployment numbers:

It is such an utter disturbance that people are quoting 5 percent as the unemployment rate
when 9.2 percent of our population is either underemployed, working part-time, or flat
out given up and not working. Also, what about all the people in finance, construction,
lending, or any fields associated to the credit bubble that are now receiving a lot less
simply because they are commissioned based or depend on their being easy credit? These
people are still hanging on by a thread with a massively reduced income yet they are still
counted as fully employed. That is the issue with our current unemployment rate. So if
our current rate is closer to 10 percent, wouldn‘t that change the perception of our current

This is part X in our continuing Great Depression series:
1. Personal Story by a Lawyer from a Previous Asset Bubble. Can we Learn from
the Past and How will the Housing Decline Impact You?

2. Lessons From the Great Depression: A Letter from a former Banking President
Discussing the Bubble.

3. Florida Housing 1920s Redux: History repeating in Florida and Lessons from the
Roaring 20s.

4. The Menace of Mortgage Debts: Lessons from the Great Depression Series: Part
IV: Where do we go After the Housing Crash?

5. Business Devours its Young: Lessons from the Great Depression: Part V:
Destroying the Working Class.

6. Crash! The Housing Market Free Fall and Client #10 Contagion.

7. Winston Smith and the Bailouts in Oceania: Lessons from the Great Depression
Part VII.

8. Sheep Back to the Slaughter: Lessons from the Great Depression Part VIII: All
the Change and Bear

Market Rallies.

9. A Bubble That Broke the World

It may help to take a look at the unemployment rate during the Great Depression:

*Soucre: Gold Ocean
―The Great Depression began in 1929 when the entire world suffered an enormous drop
in output and an unprecedented rise in unemployment. World economic output continued
to decline until 1932 when it clinked bottom at 50% of its 1929 level. Unemployment
soared, in the United States it peaked at 24.9% in 1933. It remained above 20% for two
more years, reluctantly declining to 14.3% by 1937. It then leapt back to 19% before its
long-term decline. Since most households had only one income earner the equivalent
modern unemployment rates would likely be much higher. Real economic output (real
GDP) fell by 29% from 1929 to 1933 and the US stock market lost 89.5% of its value.‖

The chart above is disturbing. Yet you also need to remember that the job losses came
fast and furious during this time. If you were unemployed, you were unemployed. In
today‘s market, anyone can get a minimum wage job with our so-called service industry
yet struggle along as a walking zombie. What happens when you go from a $100,000 a
year real estate career to earning $9 an hour in a service sector job? If you dig into the
previous jobs report from the BLS you‘ll notice that the larger increase of jobs is in
service oriented jobs that pay less than the other important sectors such as finance and
manufacturing. Either way, the sham of the current job report is that it covers up the true
reality of the situation.

You may also be shocked to hear that California now has the nation‘s third-highest
unemployment rate only behind Michigan and Alaska:

―(LA Times) Although April‘s unemployment rate was unchanged from March, it
represented a full percentage point increase above April 2007. Almost 200,000 more
people were out of work than last year, giving the state the third-highest unemployment
rate in the nation, behind Michigan and Alaska.

California lost 800 nonfarm jobs in April from the previous month. But seasonally
adjusted numbers for the month were up slightly — 0.2% — over a year earlier,
according to the Employment Development Department.‖

The Great Depression also hit hard throughout the country on farmland that was
mortgaged and many local banks going into default. But we had a backup plan then.
We were a lender as a nation! Now we are a massive debtor. We also witnessed deflation
during the Great Depression which we are already seeing asset deflation with real estate:

―Another unusual aspect of the Great Depression was deflation. Prices fell 25%, 30%,
30%, and 40% in the UK, Germany, the US, and France respectively from 1929 to 1933.
These were the four largest economies in the world at that time.

To put the severity of the depression in modern perspective, consider the following. Real
US GDP went down 4.4% in the five years that it declined since 1959, all added
together! Unemployment has never exceeded 9.7% and we have not had one year of
deflation. Maybe you‘re thinking, ―what‘s wrong with a little price deflation?‖
Depending on how much and how unexpected, deflation can be a devastating economic
event. Imagine wages falling by 30% and the value of debts simultaneously increasing by
that much.

In the great depression it would have been nice if the suffering had been so evenly
distributed. Instead the deflation caused bankruptcies, which in turn led to, more
bankruptcies! Millions of people and companies were wiped out completely. The lack of
adequate social programs left people of all social strata depending on relatives and
friends for charity. Spending became paralyzed with fear as the downturn was so
unexpected, so severe, and the bad news just kept coming for years.

Many did not realize how severe the downturn was until 1932 or 1933 when the economy
had technically hit bottom and even begun to chug forward. People‘s resources were
depleted by then and so were many of their friends‘. So the human misery caused by the
Depression really started in the mid-1930s.‖

The problem inherent in today‘s market is as follows:

First - Unemployment is understated by underemployment and shadow workers (those
that have given up looking for work). It also does not reflect the loss of income in once
high paying jobs.

Second - The FDIC although providing protection to depositors has created a sort of
moral hazard. If you look on sites like Bankrate, you‘ll notice that the highest savings
rates normally come from the most capital impaired institutions. Many on the list will
probably go bankrupt in 1 or 2 years. Now why would anyone invest their money in these
institutions if they knew that their money wasn‘t protected? If it weren‘t for the FDIC,
these lenders would be bankrupt and rightfully so; they have horrible and flawed business
models and should be allowed to fail. Instead, they offer you a nice yield on a 6 month

Third - Underemployment is just as bad as unemployment. In terms of economic data
and spin, it is probably worse since it gives many a false sense of security. We are not at
a 5 percent unemployment rate. It is simply an absurd number and even the fact that the
CPI told us last month that energy prices dropped, I think that even the lay person now
gets that there is something rotten in Denmark. If you look at the report, how can you
consider someone working part-time but wanting full-time employment as part of the
official unemployment number? The current number that should be quoted is the 9.2
percent number. As we‘ve gone along, we‘ve managed to allow the Ministry of Truth to
massage out every kink out of the most important statistics of our economy.

Forth - Banks are being propped up on a crutch. There will be more bank failures. Think
this is just hyperbole? Then why is the FDIC bringing out folks from retirement who
lived through the S & L collapse to gear up for the next phase of the debt crisis?

―(MarketWatch) He‘d built a new home by a lake in Texas, bought a boat and was
working on his golf game. While taking on some part-time work, Holloway also traveled
for months across the U.S. with his wife, from Seattle to Washington D.C., catching up
with old friends and family.

That life of leisure abruptly changed about six weeks ago when Holloway got a phone
call from his former employer, the Federal Deposit Insurance Corp., or FDIC, which
regulates U.S. banks and insures deposits.

Holloway, a 30-year FDIC veteran, had worked extensively with failed lenders in
Houston during the savings and loan crisis in the late 1980s and early 1990s, when
thousands of thrifts collapsed.

Earlier this year, the FDIC began trying to lure roughly 25 retirees like Holloway back to
prepare for an increase in bank failures. It‘s also hiring about 75 new staff.

Holloway quickly went back to work. ANB Financial N.A., a bank in Bentonville, Ark.
with $2.1 billion in assets and $1.8 billion in customer deposits, was failing and an expert
like Holloway was needed to value the assets and find a stronger institution to take them

No problem folks! Any comparison to the Great Depression is doom and gloom. Listen. I
know that folks like to make light of this but the problem of complacency and mind
numbing control from drones on the media is that people are now content to be under
slavery to debt. Do you really own that car? Try missing a payment. Do you really own
that $700,000 McMansion? Try missing your mortgage payment. The false guise of
security is that consumer inflation is non-existent (hello $4 gas!), that unemployment is at
5 percent (you mean I can kick back at home and watch Montel and not be considered
unemployed?), and finally assuming that things from the past cannot occur again.

Simply from looking at the data it looks like we are going to have our own lost decade
like Japan. The data has gotten so out of whack, that you have rely on other measures like
income to triangulated your assumptions. If we are simply to look at the CPI and
employment numbers from the government we‘d assume the economy is perfect like a
bowl of warm porridge.

I‘m not the only one that is waking up to this insanity:

―(Harper‘s Magazine) If Washington‘s harping on weapons of mass destruction was
essential to buoy public support for the invasion of Iraq, the use of deceptive statistics has
played its own vital role in convincing many Americans that the U.S. economy is
stronger, fairer, more productive, more dominant, and richer with opportunity than it
actually is.

The corruption has tainted the very measures that most shape public perception of
the economy-the monthly Consumer Price Index (CPI), which serves as the chief
bellwether of inflation; the quarterly Gross Domestic Product (GDP), which tracks
the U.S. economy’s overall growth; and the monthly unemployment figure, which
for the general public is perhaps the most vivid indicator of economic health or
infirmity. Not only do governments, businesses, and individuals use these yardsticks in
their decision-making but minor revisions in the data can mean major changes in
household circumstances-inflation measurements help determine interest rates, federal
interest payments on the national debt, and cost-of-living increases for wages, pensions,
and Social Security benefits. And, of course, our statistics have political consequences
too. An administration is helped when it can mouth banalities about price levels being
―anchored‖ as food and energy costs begin to soar.‖

So the most relied upon measures for the health of the economy are completed screwed
up. Like the entire ownership society myth that was pushed (and by the way
homeownership is now back to 2002 levels, pre-dating the ownership society speech in
2003). The problem that is going on is we have a silent destruction of our treasured U.S.
Dollar and our productive base is being dismantled piece by piece. People were placated
since they felt somehow that pushing papers around and flipping houses was somehow
going to keep us competitive with nations that are pumping out engineers and scientist on
an incredible basis. Time to rethink our numbers and demand the truth be reflected but it
would appear that most folks simply want access to a credit card, a television, and a
burger in the hand. Time to get real and focus on improving the balance sheet of our

Bipolar Housing: Lessons from the Great Depression:
Part XI. Understanding the Impact of Asset Deflation and
Consumer Inflation.

Middle class Americans are quickly finding out the difference between wants and needs.
During an era of financial decadence, many are now finding it difficult to adjust
psychologically to the new realities that confront us. There are many examples that we
can use to cite this shift in consumer psychology. First, you don‘t need to own a home but
you do need shelter. This can be met by leasing a place. You don‘t need a gas guzzling
tank to drive around perfectly paved freeways. There are much more accessible and fuel-
efficient ways of getting around. You can hold off on buying that massive plasma screen
television. Maybe a 40″ regular flat screen will do. This is our new reality.

I still get the sense from many people that this will only be a temporary bump in the road
to more consumption. This couldn‘t be anything further from the truth. What we are now
facing is here to stay simply because years and years of financial irresponsibility are now
crashing down upon us like a ton of bricks. This was predictable and a consequence of
spending beyond our means. The political jockeying is now going forward to once again
cement this idea of a new paradigm. Some want to continue to drill for more oil as if
saying, ―vote for me and you can continue frolicking in your F-150s and Hummers as if
the world hadn‘t changed!‖ It is absurd and economically speaking, drilling off shore
would only decrease prices by chump change measured in cents but apparently, this is
logic that jives with a large portion of our population. This is probably the same segment
of the population that thought lower interest rates on housing and easier lending standards
were excellent ideas.

In May, the Economist pointed out in a rather quick and to the point article that the
nominal nationwide drop in housing prices of 14.1% is the worst drop ever. Even more
painful than the drop in 1932 when home prices fell nominally by 10.5%. In this article I
am going to demonstrate that the 14.1% drop is even worse because of inflation while the
10.5% drop in 1932 was reflecting an actual deflationary climate of the time. This is part
XI of our Great Depression series:

1. Personal Story by a Lawyer from a Previous Asset Bubble. Can we Learn from
the Past and How will the Housing Decline Impact You?

2. Lessons From the Great Depression: A Letter from a former Banking President
Discussing the Bubble.

3. Florida Housing 1920s Redux: History repeating in Florida and Lessons from the
Roaring 20s.
4. The Menace of Mortgage Debts: Lessons from the Great Depression Series: Part
IV: Where do we go After the Housing Crash?

5. Business Devours its Young: Lessons from the Great Depression: Part V:
Destroying the Working Class.

6. Crash! The Housing Market Free Fall and Client #10 Contagion.

7. Winston Smith and the Bailouts in Oceania: Lessons from the Great Depression
Part VII.

8. Sheep Back to the Slaughter: Lessons from the Great Depression Part VIII: All
the Change and Bear

Market Rallies.

9. A Bubble That Broke the World

10. The Sham of our Current Unemployment Numbers

Bipolar Housing - Keeping the Mania in Maniac

First, we should take a look at inflation numbers from the Great Depression and compare
those to our current economic climate. The major phenomenon that occurred during the
Great Depression is that of deflation. An overall decline in prices was prevalent. Wages
and asset prices across the board were declining. Take a look at the graph:
Since that time, we have never seen a sustained deflationary period. We‘ve always had
inflation since then but the major boogeyman that no one really wants to confront is that
of deflation. In fact, knowing that Ben Bernanke is a major student of the Great
Depression I‘m sure we‘ll fire up the printing presses before we fall into a deflationary
spiral. Unfortunately, he may have no control over this. Let us now take a look at the
broader historical range of inflation:

As you can see from this graph, inflation numbers at least measured on a year over year
percent change basis are radically increasing even after all the hedonic adjustment
mumbo jumbo that the BLS does to the data. Yet during the past decade we have a few
things going on:

-Wages stagnant

-Housing Boom/Bust

-Massive growth in credit (to make up for lack of wage growth)

-Increasing fuel prices

-Dollar is no longer backed by gold (since 1970s)

-Major part of our economy based on consumption

-Major part of our economy based on consuming real estate

And now, we are seeing the consequences of an irresponsible Federal Reserve policy that
brought us negative rates and thus fueled the specter of future consumer inflation that we
are now all facing. Now the needs are more expensive (fuel, food, education, healthcare)
while the wants (SUVs, HDTVs, McMansions) are seeing incredible price deflation. If
you think deflation isn‘t possible, let us read an excerpt from an article published in 1932
in Harper‘s Magazine:

―As the great depression advances into the fourth year it becomes increasingly apparent
that the mortgage crisis involves something more than the “little fellow” struggling to
keep his home. It is not only the function of ―shelter‖ that is involved. The mortgage
structure is a part of the whole economic scheme, into which is woven the intricate
system of social inter-dependability which allows us to live and carry on. When the
customary flow of credit is seriously interrupted at any one point many diverse processes
are also interrupted upon which we depend for both the comforts and the necessities of
life. Since the War the civilized world has experienced the greatest economic upheaval of
which we possess a recorded history. The mortgage crisis is perhaps the final phase of
this world-wide dislocation of our credit system.‖

Welcome to history redux. Unless you consider Ed McMahon and Jose Canseco as ―little
fellows‖ we now know that this housing bust is impacting everyone. Many are now
realizing that prices do go down especially when you have a government complacent in
allowing our currency to fall through the floor like a rock. Take a look at this US Dollar
index chart:

The U.S. Dollar has lost over 20 percent of its value over the past 2 years. This is simply
irresponsible and the policies of the government are partially to blame for this. But given
that in the Great Depression prices were falling across all areas, the 10.5% decline was
more like an 8 percent decline once we factor in the overall CPI numbers. Given that the
CPI over the past year is around 4 percent, we can say that homes in real terms are off by
18 to 19 percent nationally. Let us read a bit more from the Harper‘s article:

―…In 1929 the national income for the United States was 85 billions of dollars. By the
year 1932 this figure had fallen to 36 billions. The most conservative figure for
mortgages that I can find shows that in the year 1929 the combined total of urban and
rural mortgages in the United States amounted to at least 46 billions of dollars. It is
difficult to determine how much this figure has changed between 1929 and 1932. The
first effect of the calling of outstanding loans was to increase the amount of money
borrowed against real estate. It is safe to say, however, that any general increase in
the total of mortgage loans has since been erased by the calling in of outstanding
mortgages and the constant demand for the reduction of principal. I, therefore,
assume that the total present mortgage indebtedness is about 43 billions of dollars.

The reduction of the national income has had a drastic effect upon the rents which it
has been possible to pay. In other words, the yield of real property has suffered a sharp
decline. The best estimates that I am able to gather indicate that this decline amounts to
as much as 35 per cent. Yet the fixed mortgage charges have declined hardly at all.‖

We are in a similar state of affairs. The rise in unemployment and stagnant wages given
inflation, are actually a yearly drop in real income. You feel it simply by the rise in all
cost of living items. Also, the calling in of these now defunct mortgages are forcing
further writedowns thus reducing the balance sheet of many businesses. That is why the
$500 billion in option ARMs that are gearing up to reset is such a nail in the coffin for
our economy and surely by that time, even the most ardent deniers of the recession will
come around.

These are the mind games the government is playing with people. They realize that the
connotation of ―tax‖ makes it politically a hot potato so they rather encourage policies
that gouge Americans through the hidden tax of inflation. After all, most Americans
would quickly answer that inflation is the rise in the price of goods failing to ask the next
question, ―is central banking policy actually causing these price rises?‖ Of course it is.
Yet the Federal Reserve is now stuck. They never saw an oil boom that would come on
so quickly forcing their hand to either halt cutting rates or even start raising rates. Which
of course would be like kicking the housing market while it is down. But what choice do
they have? Either that or face a dollar that falls further and consumer inflation that will
continue to grow. They have brought this on in large part and now will be impotent in
fixing the mess.

And if you think that the current logic is modern, just take a look at the 1932 article
―For example, two friends purchased adjoining identical houses in 1926 for $30,000. A
certain bank placed a $15,000 mortgage on each. In 1929 the first owner paid off $10,000
on his mortgage. The second owner, when asked to do likewise, requested a reappraisal
of his property. When a value of $40,000 was placed upon it he was able to induce the
bank to lend him an additional $2,000, which he explained he needed in his business.
In 1932 when both mortgages again fell due the bank needed liquid capital and,
therefore, asked for full payments. Neither owner was able to meet this call. A
reappraisal indicated that the value of the houses had fallen to $16,000 each. On one, the
bank held a mortgage for $5,000, on the other for $17,000. What did the bank do? It
commenced foreclosure proceedings on the strong mortgage for $5,000 and allowed the
weaker to stand. Why? It could readily transform the smaller mortgage into an asset on its
books, whereas the larger mortgage would inevitably show a loss if the property were
taken over.‖

Why do you think REOs are flooding lenders to the point where they simply do not know
what to do? In fact, the frustration that is emerging is many short-sales are simply not
going through because some lien holders are blocking the deal since there is no incentive
for them to stay. If you think about it, the junior lien holder ―should take one for the
team‖ but how likely is that? So in the end, it becomes a lose-lose proposition and that is
why we will continue to see massive asset deflation in housing. At the same time you can
expect consumer inflation to continue upward.

The few things that can offset this are not present. A strong, sustainable, and robust
employment market would push wages higher but is this really what is going on? So rule
that one out. You can also have a market where prices are stabilizing but this is not in the
cards either. What you can do is eliminate debt and figure out the difference between an
economic want and need. Take a look at the article from 1932 one more time:

―When dollars begin to rise in value, that is to say when prices in general begin to fall,
fixed obligations such as bonds and mortgages and other forms of notes offer an
opportunity for a quick profit. This is a phenomenon that has long been common
knowledge among shrewd investors. If, however, the fall in prices continues to the point
where general earning capacity is inadequate to meet fixed obligations, then these special
advantages begin to break down.‖

That is why debt is absolutely destructive in a down market. Nothing exemplifies this
more than being in a negative equity position on a home. As your home falls in value, the
mortgage does not move. In fact, if you have a toxic option ARM your balance may even
increase! It would be one thing if mortgages were pegged to yearly price values and
adjusted accordingly but that of course isn‘t how the system works. These option ARM
mortgages functioned essentially like call options. If your home went up in price during
your intro period, good for you. All you needed to do was sell the place and pocket the
difference. Now that prices are declining, you simply let the option expire worthless
(walkaway) and take the hit on your credit. It is a small price to pay for massive gains
and that is why many played this game. But make no mistake about it, this was
speculation on its purist form and will ensure continued asset deflation. We can learn by
examining the past but many choose to ignore it.

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