Comparing the 1920s and 2000s real estate bubbles

The real estate bubble of the 2000s was bigger than the real estate bubble of the 1920s

In many ways, the dual stock market and real estate bubbles of the 1920s were a mirror image of the 2000s market collapse. The 1920s real estate boom peaked in 1925, and the stock market collapsed four years later. In the aughts, the stock market peaked in 2000 and the real estate bubble burst five years later. The 2000s real estate bubble inflated 135%, while the 1920s bubble only inflated 50%. The U.S. real estate bubble bottomed (we think) about six years after the peak. The Great Depression bust ended in 1933—about eight years after. The peak-to-trough decline in the ’20s was 30%, while the decline in the ’00s was 33%. Real estate prices didn’t reach their 1925 levels until 1944—almost 20 years later.

Real Estate BubblesEnlarge Graph

Differences in financing drove the difference

The 30-year fixed-rate mortgage that Americans take as a birthright didn’t exist in the 1920s. Back then, mortgages resembled a typical corporate bond—they had a five-year term, and the borrower paid interest only and then had a balloon payment when they were to refinance. This meant the entire mortgage market had to roll over every five years, which was almost impossible due to the crisis. Mortgages that couldn’t refinance ended up in foreclosure and were dumped onto the market.

Why was the 2000s bubble so much bigger?

The interesting question about the bubble of the 2000s is “Why did it inflate so much more than the ’20s?” There are a couple possibilities.

First, the Federal government took a very active role in encouraging homeownership, starting in the mid-’90s. HUD (the U.S. Department of Housing and Urban Development) directed Fannie Mae and Freddie Mac to increase lending to underserved markets. The government has been subsidizing the residential real estate market since the 1960s between the 30-year fixed-rate mortgage, the mortgage interest deduction, and underpricing guarantee fees on securities. Finding a 30-year fixed-rate mortgage in other countries is difficult. Finally, the Fed eased dramatically in the aftermath of the stock market bubble, and that excess liquidity fed a real estate bubble. Bubbles are psychological phenomena. During the 2000s, people believed that real estate prices couldn’t fall—and aside from the Great Depression, they hadn’t. We would go on to have mini bubbles in places like California and Texas during the 1980s, but we hadn’t experienced a nationwide real estate crash since the 1930s.

Second, Wall Street believed that diversification would bail it out if there were a crash in overheated markets like Phoenix or Las Vegas. Most of these securitizations would have never been made if people assumed the higher correlation rates that we experienced. Given that psychology is a major part of bubbles, fears that we’re creating another bubble in real estate are overblown. Homebuilders—like Toll Brothers (TOL), Lennar (LEN), and KB Home (KBH)—don’t have to worry that they’re sitting on land and homes that are about to collapse. People now know that real estate can fall. We may never experience another residential real estate bubble, but our grandkids might.