When you think of the credit bubble, what comes to mind? 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 products.”

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?

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