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 .
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