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09/14/2007

Charles Kindleberger

“I can calculate the motions of the heavenly bodies, but not the
madness of people.”
--Sir Isaac Newton

A few weeks ago in my “Week in Review” column I noted the
thoughts of a private equity / hedge fund type as he toured
California and took in the real estate scene. The fellow quoted
Charles P. Kindleberger, who authored the Wall Street classic
“Manias, Panics, and Crashes: A History of Financial Crises.”

Well, I went back to my own copy to see what Kindleberger
found in his research when it came to property bubbles and while
he admits his interest has never really lied in the field of real
estate, Kindleberger couldn’t help but note the relationship
between bubbles in the sector and those in other objects, such as
stocks.

Kindleberger refers to a 1933 book by Homer Hoyt titled “One
Hundred Years of Land Values in Chicago: The Relationship of
the Growth of Chicago to the Rise in Land Values, 1830-1933.
In it Hoyt “linked the boom in the stock market in 1928-29 to
one in raw land, residential sites, commercial building, and the
like, downtown and in the suburbs, on the rise, but especially in
decline.”

Regarding the upside, Hoyt quotes from a Chicago Tribune
editorial of April 1890.

“In the ruin of all collapsed booms is to be found the work of
men who bought property at prices they knew perfectly well
were fictitious, but who were willing to pay such prices simply
because they knew that some still greater fool could be depended
on to take the property off their hands and leave them with a
profit.”

It turns out that Chicago’s reputation for real estate booms was
such that a bubble in Berlin in 1870, following victory over
France, was called “Chicago on the [river] Spree.” Booms in
Berlin and Vienna around this time were also related to the bull
market on Wall Street. Speculative markets rise together. One
writer in Chicago, 1871, noted that “every other man and every
fourth woman had an investment in house lots.” [Kindleberger]

Charles Kindleberger:

“The spread of euphoria from one market to another is readily
understood. The bandwagon is under way: climb aboard. The
compelling analytical point deals with the downside. When the
stock market collapses, shareholders, especially those on margin,
know they are in trouble, and have to get squared away.
Speculators in real estate initially feel no such compunction.
Their debts are not day-to-day brokers’ loans, but come from
banks on extended terms. They have real assets, not just paper
claims. They can wait out recovery which will come soon, or so
they think.”

As Homer Hoyt wrote in 1933, as a downturn leads to a drying
up of demand for real estate, taxes and interest on loans are still
due. The speculator is “ground down,” as is the bank. “In
Chicago in 1933, 163 out of 200 banks suspended payment.
Real-estate loans, not failed stockbrokers’ accounts, were the
largest single element in the failure of 4,800 banks in the years
from 1930 to 1933.” [Kindleberger]

Kindleberger cites Hoyt’s 1933 work as laying the groundwork
for any analysis of both the Wall Street crash of 1987 as well as
the troubles in the Japanese stock market, January 1990.

“The stock market’s troubles of Oct. 1987 were cleared up
brilliantly as the monetary authorities poured money into the
banking system to forestall trouble from brokers’ loans. Margin
requirements of 50 percent doubtless helped; portfolio insurance
did not. But the agony in real estate was drawn out.
Construction was slowed down to the rate of buildings being
finished, as new starts halted. Vacancy rates in office buildings
rose sharply .

“A classic illustration of the Hoyt insight comes from the
Rockefeller Center Properties, Inc. which had a $1.3 billion
mortgage on Rockefeller Center in midtown Manhattan, after the
complex had been sold to a Mitsubishi entity as an investment.
The mortgage was held in a Real Estate Investment Trust. A
detailed newspaper account notes that in 1987 the trustees sought
to increase the income of the trust by taking out short-term
credits to buy back bonds which were selling at a discount. The
gains were paid out as dividends. In 1989 as the deterioration in
the real estate market progressed, the trustees decided to take out
a letter of credit and pay off the short-term debt .After
prolonged agony, the REIT crashed.”

Then there was Japan. The economy here boomed in the late
1950s and through the 1960s, establishing Japan as a place for
investors of all stripes. The Nikkei stock market index, which
started at 100 in May 1949, was at 10,000 by 1984 and 12,000 in
1986. Then the bubble came and by the end of 1989 the Nikkei
was at a staggering 39,000.

At the same time as stocks were soaring, so was Japanese real
estate. A price index for residential properties in six large cities,
starting at 100 in 1955, reached 4,100 in the mid-1970s, 5,800
around 1980, and then rose to a peak of 20,600 in 1989. As
Kindleberger writes, “The land bubble brought forth remarks
such as the value of land in Tokyo exceeded that of the state of
California, which happens to be larger than all of Japan, or that
the value of Japanese land as a whole was four times that of the
United States.”

Meanwhile, the consumer price index in Japan during this time
rose from 100 in 1983 to just 103.9 in 1989, while wholesale
prices actually fell to 93.6 over the same period.

Deregulation was a major culprit in the twin stock and real estate
bubbles, owing to pressure from foreign governments to loosen
up. Interest rates were also falling; from 5 percent on the
Bank of Japan’s discount rate in 1982 to 2 percent in 1987.
But then while the Federal Reserve in the United States and
Germany’s Bundesbank began inching rates back up in 1987 and
’88, the Bank of Japan waited until December 1989 to change
direction, precipitating a crash in January 1990. “The crash
when it came was abetted by revelations of scandals in which
some major banks made good losses on loans to favored
customers, and hid these actions by imaginative accounting.”

“Real-estate prices leveled off when the Nikkei index dropped,
and later started down but slowly, largely, one gathers, because
the volume of transactions dried up.”

Kindleberger published the edition of his book that I have in my
hands in 1996 and by then, 1,000 commercial and industrial
enterprises in Japan were going bankrupt each month. The
estimate of bad loans on the books of Japanese banks and
financial institutions was $550 billion. In an effort to stem the
tide, the Bank of Japan lowered its discount rate to percent in
September 1995 and would go on to essentially keep the key rate
at zero until just last year. With banks lending out at around 3
percent, this was a surefire way back to profitability. [And
something foreign investors made gobs of money on as well
the yen carry trade.]

It’s interesting to note Kindleberger’s thoughts on central banks
and monetary policy during periods of speculation, in light of the
current debate on this topic.

“Most central bankers choose price stability as the main target of
monetary policy; whether it be wholesale prices, the consumers’
price index or the gross domestic product deflator is not a critical
issue. If, however, the explosion of a bubble in stocks and/or
real estate can affect bank solvency in general, there is a basis for
saying that central bankers should keep an eye on asset prices
too. In one view, asset prices should be incorporated into the
general price level because, in a world of efficient markets, they
hold a forecast of what future prices and consumption will be.
But this assumes that asset prices are determined within a narrow
range by fundamentals, as they often are to be sure, and will not
be affected by herd behavior, leading to a bubble which will
ultimately burst.”

---

Next week, the Edsel.

Brian Trumbore



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-09/14/2007-      
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Wall Street History

09/14/2007

Charles Kindleberger

“I can calculate the motions of the heavenly bodies, but not the
madness of people.”
--Sir Isaac Newton

A few weeks ago in my “Week in Review” column I noted the
thoughts of a private equity / hedge fund type as he toured
California and took in the real estate scene. The fellow quoted
Charles P. Kindleberger, who authored the Wall Street classic
“Manias, Panics, and Crashes: A History of Financial Crises.”

Well, I went back to my own copy to see what Kindleberger
found in his research when it came to property bubbles and while
he admits his interest has never really lied in the field of real
estate, Kindleberger couldn’t help but note the relationship
between bubbles in the sector and those in other objects, such as
stocks.

Kindleberger refers to a 1933 book by Homer Hoyt titled “One
Hundred Years of Land Values in Chicago: The Relationship of
the Growth of Chicago to the Rise in Land Values, 1830-1933.
In it Hoyt “linked the boom in the stock market in 1928-29 to
one in raw land, residential sites, commercial building, and the
like, downtown and in the suburbs, on the rise, but especially in
decline.”

Regarding the upside, Hoyt quotes from a Chicago Tribune
editorial of April 1890.

“In the ruin of all collapsed booms is to be found the work of
men who bought property at prices they knew perfectly well
were fictitious, but who were willing to pay such prices simply
because they knew that some still greater fool could be depended
on to take the property off their hands and leave them with a
profit.”

It turns out that Chicago’s reputation for real estate booms was
such that a bubble in Berlin in 1870, following victory over
France, was called “Chicago on the [river] Spree.” Booms in
Berlin and Vienna around this time were also related to the bull
market on Wall Street. Speculative markets rise together. One
writer in Chicago, 1871, noted that “every other man and every
fourth woman had an investment in house lots.” [Kindleberger]

Charles Kindleberger:

“The spread of euphoria from one market to another is readily
understood. The bandwagon is under way: climb aboard. The
compelling analytical point deals with the downside. When the
stock market collapses, shareholders, especially those on margin,
know they are in trouble, and have to get squared away.
Speculators in real estate initially feel no such compunction.
Their debts are not day-to-day brokers’ loans, but come from
banks on extended terms. They have real assets, not just paper
claims. They can wait out recovery which will come soon, or so
they think.”

As Homer Hoyt wrote in 1933, as a downturn leads to a drying
up of demand for real estate, taxes and interest on loans are still
due. The speculator is “ground down,” as is the bank. “In
Chicago in 1933, 163 out of 200 banks suspended payment.
Real-estate loans, not failed stockbrokers’ accounts, were the
largest single element in the failure of 4,800 banks in the years
from 1930 to 1933.” [Kindleberger]

Kindleberger cites Hoyt’s 1933 work as laying the groundwork
for any analysis of both the Wall Street crash of 1987 as well as
the troubles in the Japanese stock market, January 1990.

“The stock market’s troubles of Oct. 1987 were cleared up
brilliantly as the monetary authorities poured money into the
banking system to forestall trouble from brokers’ loans. Margin
requirements of 50 percent doubtless helped; portfolio insurance
did not. But the agony in real estate was drawn out.
Construction was slowed down to the rate of buildings being
finished, as new starts halted. Vacancy rates in office buildings
rose sharply .

“A classic illustration of the Hoyt insight comes from the
Rockefeller Center Properties, Inc. which had a $1.3 billion
mortgage on Rockefeller Center in midtown Manhattan, after the
complex had been sold to a Mitsubishi entity as an investment.
The mortgage was held in a Real Estate Investment Trust. A
detailed newspaper account notes that in 1987 the trustees sought
to increase the income of the trust by taking out short-term
credits to buy back bonds which were selling at a discount. The
gains were paid out as dividends. In 1989 as the deterioration in
the real estate market progressed, the trustees decided to take out
a letter of credit and pay off the short-term debt .After
prolonged agony, the REIT crashed.”

Then there was Japan. The economy here boomed in the late
1950s and through the 1960s, establishing Japan as a place for
investors of all stripes. The Nikkei stock market index, which
started at 100 in May 1949, was at 10,000 by 1984 and 12,000 in
1986. Then the bubble came and by the end of 1989 the Nikkei
was at a staggering 39,000.

At the same time as stocks were soaring, so was Japanese real
estate. A price index for residential properties in six large cities,
starting at 100 in 1955, reached 4,100 in the mid-1970s, 5,800
around 1980, and then rose to a peak of 20,600 in 1989. As
Kindleberger writes, “The land bubble brought forth remarks
such as the value of land in Tokyo exceeded that of the state of
California, which happens to be larger than all of Japan, or that
the value of Japanese land as a whole was four times that of the
United States.”

Meanwhile, the consumer price index in Japan during this time
rose from 100 in 1983 to just 103.9 in 1989, while wholesale
prices actually fell to 93.6 over the same period.

Deregulation was a major culprit in the twin stock and real estate
bubbles, owing to pressure from foreign governments to loosen
up. Interest rates were also falling; from 5 percent on the
Bank of Japan’s discount rate in 1982 to 2 percent in 1987.
But then while the Federal Reserve in the United States and
Germany’s Bundesbank began inching rates back up in 1987 and
’88, the Bank of Japan waited until December 1989 to change
direction, precipitating a crash in January 1990. “The crash
when it came was abetted by revelations of scandals in which
some major banks made good losses on loans to favored
customers, and hid these actions by imaginative accounting.”

“Real-estate prices leveled off when the Nikkei index dropped,
and later started down but slowly, largely, one gathers, because
the volume of transactions dried up.”

Kindleberger published the edition of his book that I have in my
hands in 1996 and by then, 1,000 commercial and industrial
enterprises in Japan were going bankrupt each month. The
estimate of bad loans on the books of Japanese banks and
financial institutions was $550 billion. In an effort to stem the
tide, the Bank of Japan lowered its discount rate to percent in
September 1995 and would go on to essentially keep the key rate
at zero until just last year. With banks lending out at around 3
percent, this was a surefire way back to profitability. [And
something foreign investors made gobs of money on as well
the yen carry trade.]

It’s interesting to note Kindleberger’s thoughts on central banks
and monetary policy during periods of speculation, in light of the
current debate on this topic.

“Most central bankers choose price stability as the main target of
monetary policy; whether it be wholesale prices, the consumers’
price index or the gross domestic product deflator is not a critical
issue. If, however, the explosion of a bubble in stocks and/or
real estate can affect bank solvency in general, there is a basis for
saying that central bankers should keep an eye on asset prices
too. In one view, asset prices should be incorporated into the
general price level because, in a world of efficient markets, they
hold a forecast of what future prices and consumption will be.
But this assumes that asset prices are determined within a narrow
range by fundamentals, as they often are to be sure, and will not
be affected by herd behavior, leading to a bubble which will
ultimately burst.”

---

Next week, the Edsel.

Brian Trumbore