lower credit quality, such as more liberal appraisals of property and less rigorous standards in screening loan applications … Among the bank loans made in the years 1920 – 1929, the frequency of default increased with increases in contract maturity and in loan-to-value ratios.
A current of thought today maintains the cause of the Great Depression was the Federal Reserve’ s parsimony towards banks in the early 1930s. Yet, it is difficult to understand how such liquidity would have aided those banks that had risen“ on a continued advance of real estate values,” but“ the rate of absorption halted and the price movement stopped, [ and ] one of the largest categories of bank collateral in the country went stale, and the banks found themselves loaded with frozen assets, which we have been trying ever since to thaw out.”
Commercial building grew to a frenzy in the late 1920s. Cities across the country engaged in skyscraper envy. When the president of the National Association of Building Owners and Managers addressed his membership in 1926, he observed that one-eighth of the national income was spent on building:
Buildings were being put up through the endeavors of bond houses to sell bonds, whether the buildings were needed or not. During 1925, $ 675 million of real estate bonds were sold in this country … an increase of more than 1,000 % in the last five years. [ In fact, later calculations would show that $ 54 million were issued in 1921, $ 752 million in 1925 and $ 833 million in 1928— the peak, before $ 395 million in 1929.] This overproduction is caused by speculative builders, who borrow the full cost of the construction regardless of return. They then sell the buildings at a profit and proceed to erect another somewhere else.
Once in motion, commercial building does not stop on a dime. New York City office space rose 92 % in the back half of the 1920s and by another 56 % after the stock market crash. Two weeks before the stock market crash, the New Yorker described to its readers the feverish levels of speculation and desperation:
[ M ] any contractors of estimable standing are ready to take over the
‘ secondary financing’ of not-too-large operations, meaning they will put up most of the cash necessary to complete the building, over and above what the first mortgage provides. They do this in order to keep their operation from falling apart. This loan for the building, which is really a second mortgage, is discounted at some‘ big, friendly bank,’ so that the contractor’ s money is not tied up after all …
The New Republic critiqued the 1932 skyline:
[ W ] inter evenings were cruelly revealing, for when the sun set before the close of daily business it was all too apparent how many of these towers stood black and untenanted against the stars … With some few exceptions, the newest New York may be described as a 60-story city unoccupied above the 20th floor.
That description may serve as a metaphor regarding the state of municipal finance by 1932. Between 1912 and 1932 local government expenses increased 361 %, state government spending rose 100 % and federal government spending rose 13 %. There had probably been little consideration of access to funding( or the ability to raise taxes) during the good times. By the end of 1931, Chicago and South Carolina could not issue notes or bonds at any rate. By December, municipal bond dealers were no longer willing to hold municipal bond inventories. It was nearly impossible to get price quotes for a wide range of municipal bonds. Arkansas and Detroit defaulted. Employees were paid with scrip.
Dominoes continued to fall. Often, the concession required by potential bond buyers was to cut payrolls and salaries. Between 1930 and 1933, every form of municipal expenditure had been cut with the exception of relief payments.
All manner of deplorable practices became clear when cities begged bondholders and banks for loans. Barrie Wigmore, author of The Crash and its Aftermath, wrote of 1933:
The turmoil over municipal credits begat a long list of criticisms of municipal practices that had been acceptable in previous, less contentious times. The practical power of local governments to alter their commitments to bondholders was fundamental and quite startling, but besides that, critics claimed that municipal accounting practices were lax, employed shifting standards, lacked audits, and hid obligations that had accrued.
All of Wigmore’ s observations ring true today. We know irregular accounting practices are so ingrained they are taken for granted. The Chicago Tribune reported on November 1, 2013:“ General obligation bonds are intended to help governments achieve lasting public works— such as libraries and bridges— that are too costly to pay for all at once. But records show Chicago’ s city leaders exploited a loophole in federal tax law and pushed the boundaries of Internal Revenue Service rules that prohibit using this type of borrowing for day-to-day expenses.”
We already see cities and claimants battling each other in court. This is during a time that is relatively good compared to the municipal precipice between 2009 and 2011. Detroit today might be seen as an outlier, but it may be a forerunner, such as Florida was in the late 1920s. There is a rising docket across the country of bondholders, banks and elected as well as appointed government figures pointing fingers and fighting over an irreconcilably smaller pot than can satisfy the parties. Pension claims, which have been exempted from this study, are the largest promise of all.
We can be certain of surprises ahead. In 1933, tempers flared when the Iowa Supreme Court ruled the City of Dubuque was required to meet its bond commitments. The New York Times headline of the ensuing fracas serves as a warning:“ Iowa Farmers Abduct Judge From Court; Beat Him and Put Rope Around His Neck.”
Frederick J. Sheehan Jr. is the author of Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession( McGraw Hill, 2010). He was Director of Asset Allocation Services at John Hancock Financial Services where he constructed pension plan policies for corporate, municipal and Taft-Hartley pension plans. He currently consults, advising institutions on how to finance their liabilities.
www. MoAF. org | Spring 2016 | FINANCIAL HISTORY 27