The housing bubble during the Great Depression was caused by overvaluation of properties and easy access to credit.Sound familiar?
Greater credit availability makes the economy more sensitive to any shocks, according to a recent study by Raghuram Rajan at the University of Chicago and Rodney Ramcharan of the Federal Reserve Board.
In the 1920’s, anyone could get a big loan for a farm or a house. But when the markets tanked and people lost their jobs they found they couldn’t sell their property for the same value they bought it.
Here’s what the study had to say about the effects of easy lending on the economy:
Our evidence suggests that the rise in asset prices and the build-up in associated leverage was so high that bank failures (resulting from farm loan losses) were significantly more in areas with greater ex ante credit availability. Moreover, the areas that had greater credit availability during the commodity price boom had depressed land prices for a number of subsequent decades – probably because farm loan losses resulted in the failure of banks that lent to farmers, and depressed agricultural credit in subsequent decades.
The study’s findings about the cause of the mortgage bubble hit home today, with an estimated 23 per cent of Americans underwater on their mortgages.
Here’s a chart showing the average rate of farm loans in 1920:
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