The Great Depression and its Impact on Mortgages
Whether you're a potential homeowner or an investor, it's important to understand the history and context on the mortgage market today.
3 Min
You can't talk about the lessons the US learned during the Great Depression without talking about the gold standard.
In a not too distant past, the major world powers used to run their economies according to the gold standard. The gold standard was a monetary system first used by England in 1831. Later on, other powerful countries adopted it, directly linking their currency to the price of gold. To be honest, only countries with vast sums of gold could use the gold standard.
With the gold standard, countries agreed to convert paper money into a fixed amount of gold. Countries that used the gold standard set a fixed price for gold bought and sold at that price. This was then used to determine the value of a country's currency. The point of this was try to make international trade more efficient, since up until then, only heavy gold bullion or coins were used in business.
The gold standard was unofficially introduced to the US in 1834. It was turned into law with the Gold Standard Act of 1900. The United States fixed the price of gold at $20.67 per ounce, where it remained until 1933. That meant that the health of the economy was tied to a fixed, finite resource. When new reserves of gold were found, the economy stabilized; when unprecedented world events happened, like World War I, the gold standard was shaken. It actually had to be suspended during WWI because it couldn’t meet the demand for funds that countries needed to fight the war.
In a demoralizing cycle, European countries and the US had to actively manage the gold standard. They did this by either pausing or resetting the gold standard whenever it showed signs of economic instability. The only way to “reset” the gold standard was to cut back on labor costs—which meant slashing workers’ wages and deflating prices.
Workers paid the price of keeping global trade alive by being humiliated time and again by wage cuts. This would then eat up worker’s buying power and contract the national economy.
The problem with the gold standard was that it was a system that only took into account developed countries. On top of that, it relied on exploiting the working class to maintain its stability. By forcing deflation and inflation again and again, people were disoriented, and they came to expect that markets would always be unreliable, which also prompted people to save more rather than invest.
Because of the gold standard’s volatility, it became increasingly crucial to have a central bank in the US that could help regulate the US economy. This is why the Federal Reserve was established in 1913.
The Federal Reserve is the central bank of the United States. Its purpose is to conduct monetary policy, manage inflation, maximize employment, and stabilize interest rates. However, the transition from the gold standard to fiat money still hadn’t been made, and there were still several rocky years ahead before rates and the US economy stabilized.
In a lot of ways, economic policy during the ‘30s was more emotional than rational. Even after the Federal Reserve was created, the US tried to forcefully keep the gold standard alive, rather than focusing on strengthening US employment.
During the deflationary shock of 1929, Hoover’s Secretary of the Treasury, Andrew Mellon, advised the President to “liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate… purge the rottenness out of this system” because “people will work harder, and live a more moral life”.
However, this unforgiving approach to policy had the opposite effect. At the same time that prices were falling due to deflation, Hoover made sure to keep wages high in order to not eat into the buying power of US citizens. This meant that as wages remained high and prices suspiciously low, an economic bubble was being formed, because the actual health of the economy wasn’t being maintained. The high wages and deflation were a band aid solution that didn’t last very long. Credit was given out to businesses and people with little thought, and when it came back to start repaying loans, nobody had the funds to do it.
In the end, this economic bubble is what caused the Great Depression to stick around for so long. Hoover’s orders to keep wages high conflicted with the necessity to keep prices and wages low in order to maintain the gold standard. Since the gold standard was already ineffective, having two bad policy plans in action at the same time caused national confusion and failure.
Had Hoover actually focused on stabilizing national employment, we would have weathered the Great Depression much better. And if this story sounds familiar—it’s because it is.
In 2008, the US housing industry was devastated by loose lending laws. These flexible laws allowed bond rating agencies to give subprime mortgages AAA ratings. AAA ratings are normally only given to MBSs (bundles of mortgages) that are seen as good investments. The abuse of credit lending made it so that the housing bubble eventually burst in 2008. This caused a high volume of foreclosures and what came to be known as the Great Recession.
Thankfully, in 2008 we were already using fiat money instead of the gold standard. Even so, the 2008 crisis hit the nation hard, and with only the Economic Stimulus Act of 2008 to boost national morale, we took longer to bounce back as a nation. Now, we have the QM rule to qualify home buyers.
What was crucial about the crash of ‘08 was how the US started looking at national debt. Since 2008, we’ve realized that so long as the public’s inflation expectations remain low—rates will stay low. There’s a lot about our economy that is a self-fulfilling prophecy.
When the pandemic stopped the national economy in its tracks for close to two months, national unemployment was at an all time high of 14.8%—a rate not seen since 1948. Thankfully, with several rounds of stimulus checks, student loan pausing, and eviction moratoriums, we’re now in a much better place as a country.
It seems that the economy isn't the only thing bouncing back either. With talk of rebuilding infrastructure throughout the US, houses are starting to be built again at lightning speed. In April 2020, housing completions were at a seasonally adjusted annual rate of 1,191,000. In April 2021 housing completions numbered 1,449,000—a 21.7 percent (±15.8 percent) increase. Single‐family housing completions in April were at a rate of 1,045,000; while the rate for units in buildings with five units or more was 401,000.
Even so, huge changes have affected the labor force and consequently, the housing industry. Between 2 and 3 million women left the workforce to stay with their families. Millennials are also starting to realize that homes are their ticket to catching up on the generational wealth that they’ve been missing out on.
People are now looking for homes that come with land that can double as work offices, gyms, and personal daycare centers besides living quarters.
While there’s going to be a slight pocket of inflation coming up, it won’t last long. Meanwhile, rates are still in the 2s. They’re expected to pick up as 2021 wears on, so if you’re looking to buy a home, your best deal would be to buy during the summer.
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