NCPA - National Center for Policy Analysis

Securitization In The 1920s

August 23, 2010

The financial innovations that propelled the boom and collapse of the commercial real estate securities market in the last decade parallel those of that same market in the 1920s, says the National Bureau of Economic Research (NBER). 

Issuance of commercial mortgage-backed securities financed the construction of most of the U.S. skyscrapers in the 1920s, and led to overbuilding and then widespread vacancies.  The price declines in the mortgage-backed securities market in the late 1920s preceded the crash of the equity markets and the start of the Great Depression.  Analyzing the events of the earlier crisis can provide insights to regulators and financial institutions struggling with solutions to the current one, say NBER researchers William Goetzmann and Frank Newman.  

For example, the researchers observe that by nearly every measure, real estate securities were as toxic in the 1930s as they are now: 

  • Widespread economic optimism after World War I fueled demand for office space, boosting average commercial rents 168 percent nationally from a pre-war base through 1924.
  • That kicked off a speculative commercial real estate construction boom not matched until the mid-2000s.
  • New York and Chicago were the primary focus of the real estate run up; more office buildings taller than 70 meters were constructed in New York between 1922 and 1931 than in any other ten-year period before or since.
  • Real estate bond issuance, which accounted for nearly 23 percent of all corporate debt issued in 1925, fell to just 0.14 percent of the debt market by 1934 and some days no bonds traded.
  • The real estate bond market soon vanished, as did many of the bond houses that created them, among them many of the most trusted names on Wall Street; that was followed by public outrage over institutional corruption.  

Ultimately, the size, scope and complexity of the 1920s real estate market undermined its merits, causing a crash not unlike the one underpinning the nation's current financial crisis, due in part to a commercial construction boom matched only in the mid-2000s. 

The researchers conclude that publicly-issued real estate securities affected real construction activity in the 1920s and that the breakdown in their valuation, through the mechanism of the collateral cycle, may have led to the subsequent stock market crash of 1929-1930. 

Source: Frank Byrt, "Securitization in the 1920s," NEBR Digest, May 2010; based upon: William Goetzmann and Frank Newman, "Securitization in the 1920s," National Bureau of Economic Research, Working Paper No. 15650, January 2010. 

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