The Great Divergence

[kandrathe]

Real-estate tends to be prone to malinvestment. According to David Wheelock (St. Louis Fed) the same reckless bubble in real-estate precipitated the crash in 1929.

I'm glad my policy is always to check, because once again, that article doesn't say what you claim it says. The article examines the effects of a housing bailout program. The only thing it says about housing prices and the cause of the Great Depression is:

Some authors contend that the decline in housing investment in 1928-29 contributed to the onset of the Great Depression, though that view is not widely held today.

That would be coming pretty close to the opposite of your point, although strictly the author is only describing the state of the literature.

"Precipitated" may have been too strong a word. Perhaps, "prefaced" would be more accurate. I would agree that it was probably the contracting in the money supply that caused the stock market crash, AND brought an end to the housing boom.

While yes, he does point out some differences, however he also points out quite a few similarities to the situation we find ourselves in now.

"The rapid increases in building activity,
house prices, and mortgage debt during the 1920s
are characteristics shared with the recent U.S.
housing boom. The 1920s witnessed an increase
in loan-to-value ratios and frequent use of high
interest rate secondary loans, which is also reminiscent
of the recent experience (Doan, 1997, p. 35;
Dovenmuehle, 1965, p. 2). Further, according to
some commentators, lending standards in the
1920s were unusually lax (Saulnier, 1956, p. 10).
Thus, on the eve of the Great Depression, many
homeowners were not well positioned to withstand
the substantial decline in income or house
prices that would occur over the next three years." p.138

So, there are four similar factors; a) rapid increases in building, b) increases in loan to value, c) use of higher interest rate 2nd mortgages, d) lax lending practices.

"The recent distress in the U.S. home mortgage
market has parallels in the experience of
the Great Depression. Like the recent episode,
the increase in mortgage defaults during the
Depression coincided with a sharp decline in
house prices after a period of rapid gains. Also
like the recent experience, mortgage defaults
during the Depression were more prevalent on
mortgages with unconventional terms, such as
short-term, non-amortizing loans. Furthermore,
mortgage underwriting standards appear to have
deteriorated before the downturn of the 1930s,
as they did toward the end of the recent housing
boom. However, unlike the recent experience,
the main cause of mortgage loan distress during
the 1930s was the sharply contracting economy
and falling price level." pp 145-146.

What is different now, is that due to massive influx of cash into the money supply, we are not experiencing deflation, and peoples wages and income are not being reduced along with the falling prices of goods and services. So, people who remain employed, can still make their mortgage payments. And... He wrote that in 2008, before the 2nd wave of foreclosures caused by unemployment. Most people were able to make payments for awhile after losing their jobs, and in many places foreclosure takes about a year from the time the homeowner stops making their payments.

Prices become ludicrous (just as I explained about Google before they had an income strategy).

As I already pointed out, the price for Google at the top of the bubble was less than half the price it currently trades at ten years later. Buying Google then was a sound investment, whatever you believe or believed.

Well, we disagree. If "animal spirits" means anything, it referred to the mood at THAT time. This was the time of Greenspan's "Irrational Exuberance" speech. Most dot com investors were clueless about whether, and how the companies they were investing in could ever make a profit, or the size of their potential markets. Making any money by investing then would have required massive doses of prescience, luck, or both. Of the thousands that began in the 1990's, perhaps a few dozen survived.