Only the Names have been changed

Out here in the foreclosure belt, many blame the securitization of real estate for the boom-bust cycle we are now enduring. Securitization of loans allowed for a huge influx of cash into mortgages and huge group of middle men who profited from the sale of loans--and laughed all the way to the bank even if the loan later went into default.

While securitization was touted as something new and different, a recent article in the New York Times (click here) points out that securitization was first created in the 1920s--and may have played a major role in the financial collapse of 1929 that led to the Great Depression.

Here are some gems from the article:

“Easily obtainable financing via public capital markets corresponded with an urban construction boom,” reported William N. Goetzmann and Frank Newman in a paper just released by the National Bureau of Economic Research, titled “Securitization in the 1920s.”

“Regulation and centralization were glaringly absent,” they add. “Ultimately the size, scope and complexity of the 1920s real estate market undermined its merits, causing a crash not unlike the one underpinning our current financial crisis.”

Yet the lessons of that boom and bust have largely been ignored. Everyone remembers the 1920s and the stock market crash of 1929, but there has been little data collected on what happened to real estate securities or even on how large a market it was. It turns out that real estate securities constituted a major market, and began to falter before stocks did.

“The breakdown in their valuation, through the mechanism of the collateral cycle, may have led to the subsequent stock market crash of 1929-30,” they wrote.

The writer goes on to conclude:

That fact should raise questions about whether the securitization machine should be patched up and back in business to operate without government guarantees.

Perhaps, instead, we should find a way to get banks and other long-term investors, like insurance companies, to make — and keep — most of the real estate loans that are needed in society...

It was, instead, the same old speculative enthusiasm, even if it was wearing fancy new clothes. Investors who had seen real estate prices rise thought that trend could not end. Wall Street sharpies thought they had found a way to make lots of money while not bearing the ultimate risk if the game suddenly ended.

As it turned out, the sharpies were wrong. They too got swept up in the carnage — just as their predecessors had in the 1930s.

Great words to ponder as we look to our leaders to regulate future financial programs.