Real estate securitization was one of the great innovations in finance in the last quarter-century. In an unprecedented way, it allowed vast sums of money to go into the real estate market from people who traditionally did not take part in it.
New York's Waldorf-Astoria was built with the aid of bonds.
But the people making the loans did not need to worry if they would be repaid, and in the end the entire edifice collapsed.
Now, with the securitization market nearly dead, getting that market going again is vital to providing Americans with mortgage loans. Securitization may need to be reformed a little, but it remains critically important to a well-functioning economy.
That is the conventional wisdom now, at least among many bankers and economists.
Most of it is right, except that “unprecedented” part. Although few people now remember it, another wave of private securitizations once altered the real estate landscape, particularly in New York but also in Chicago and some other American cities.
That wave ended pretty much like this one did.
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.
The original wave of securitizations took place in the 1920s, when the United States went on the greatest building boom ever. Many investors saw how rapidly real estate prices were rising and wanted in on the action. The builders and brokers were only too happy to oblige.
To be sure, the securitizations were not as complex as the ones invented in recent years, but they were not all simple either. Most were bonds backed by one commercial building whose construction was being financed, but there were also pools of residential mortgages. Some of the bonds included warrants for partial ownership of the building, and some were convertible into stock.
There was even something similar to the exotic C.D.O.’s, or collateralized debt obligations, that failed so spectacularly. Those securities were not directly backed by real estate, but were instead supported by other securities that had such backing. One 1920s bond was called a “collateral trust” security, with a claim on a building’s profits but not on the building itself.
“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.
If Ben Bernanke had been thinking of that, do you think he might have been more hesitant to say that the subprime mortgage crisis had been “contained” in 2007?
The paper by Professor Goetzmann, the director of the International Center for Finance at Yale University’s School of Management, and Mr. Newman, a former Yale student who is now an analyst for the hedge fund Protégé Partners, appears to be the first to delve into the available data, which Mr. Newman had to dig up.
Professor Goetzmann, who teaches both real estate finance and financial history, said he grew interested in the subject after coming across old real estate bonds and wondering what the story was behind them.
The story, it turns out, is one intrinsic to the New York skyline. From 1929 through 1931, according to data compiled by Mr. Newman, 128 buildings that were 70 or more meters in height, or about 230 feet, were completed in New York City. That was the most ever.
Over the last three years, 2007 through 2009, the figure was 87. That was the highest number in nearly 30 years.
It is notable that the record construction period continued for two years after the Depression had begun, just as cranes dotted the New York skyline last year even as the worst recession since World War II went into its second year. Big buildings take time to plan and to build. Once begun, the best course may be to finish, even if the economy offers little hope for leasing out the space.
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