WI: Chicago Plan Implemented

[Ian_W]

I never said that it would.

Considering the mortgage market was the core of the banking crisis of the 1930s, then a plan that doesn't solve the problems of the banking market is no plan at all.

I mean, you *could* just restructure the whole bank sector, demonetise gold and officially target inflation to 15% for the hell of it, but I'd expect you'd do these things with a prior hope of solving actual problems.

 

[kernals12]

Considering the mortgage market was the core of the banking crisis of the 1930s, then a plan that doesn't solve the problems of the banking market is no plan at all.

I mean, you *could* just restructure the whole bank sector, demonetise gold and officially target inflation to 15% for the hell of it, but I'd expect you'd do these things with a prior hope of solving actual problems.

All the changes that were made to the mortgage industry IOTL in the 1930s could be done along with the Chicago Plan. There's nothing about it that stops the creation of Fannie Mae.

 

[kernals12]

Usually the deeper the decline, the more rapid the recovery. CapU is so low after a deep depression that you tend to have strong recoveries. You don't have to invest in new equipment, you merely have to rehire people to utilize the old equipment once the recovery happens.

Another thing: the stimulus provided by the New Deal wasn't very big. Budget deficits never were higher than 5% of GDP even when unemployment hit 25% (for comparison, in 2009, the deficit hit 10% of GDP, when unemployment was only 10%). This was still a pre-Keynesian era.

 

[Johnrankins]

Another thing: the stimulus provided by the New Deal wasn't very big. Budget deficits never were higher than 5% of GDP even when unemployment hit 25% (for comparison, in 2009, the deficit hit 10% of GDP, when unemployment was only 10%). This was still a pre-Keynesian era. View attachment 460426

The biggest problem for the New Deal is that FDR kept changing his mind on what it meant. He said something like (I am paraphrasing) "If something doesn't work we will try something", good in theory but in practice, it scares off investment as businesses aren't sure what the hell you want and imposes costs on them. First, you impose costs by insisting they do things one way and a few months later they had to spend money to do something else.

FDR needed a more consistent policy. Businesses need stability and they certainly don't want to spend money on regulations that are going to change in a few months when they have to spend money all over again.

 

[Ian_W]

The biggest problem for the New Deal is that FDR kept changing his mind on what it meant. He said something like (I am paraphrasing) "If something doesn't work we will try something", good in theory but in practice, it scares off investment as businesses aren't sure what the hell you want and imposes costs on them. First, you impose costs by insisting they do things one way and a few months later they had to spend money to do something else.

FDR needed a more consistent policy. Businesses need stability and they certainly don't want to spend money on regulations that are going to change in a few months when they have to spend money all over again.

Nahh, FDR's problem is the social constraints he is working under, that can be summed up as 'America is a capitalist country'.

Capital whines a lot about regulation and so on, but it doesn't stop them investing. What stops them investing is no prospect of making profit to selling to customers.

Once the War Stimulus happened, funded by borrowed money, then you got full recovery.

The principle problem with the Chicago Plan is you're imposing structural change in the middle of a crisis. The FDIC, by allowing privatising profits but socialising losses, was just more achievable.

 

[kernals12]

Nahh, FDR's problem is the social constraints he is working under, that can be summed up as 'America is a capitalist country'.

Capital whines a lot about regulation and so on, but it doesn't stop them investing. What stops them investing is no prospect of making profit to selling to customers.

Once the War Stimulus happened, funded by borrowed money, then you got full recovery.

The principle problem with the Chicago Plan is you're imposing structural change in the middle of a crisis. The FDIC, by allowing privatising profits but socialising losses, was just more achievable.

So all the regulations that were imposed (seperation of lending and investment, ban on interest earning checking accounts) weren't structural changes?

 

[marathag]

Also, mortgages were not very common pre 1930. People either rented or bought their homes with cash.

Eh? Maybe for homes in the East, but mortgages for property were common after the Civil War

Google NGRAM shows a big spike for phrase 'Home Mortgage' after 1890 and another in the 1920s

I have this from here


But to handle the influx of tens of thousands of homesteaders, a few small landjobbers and mortgage companies would not be sufficient. To gain investor confidence and attain sufficient capital, western farmers would need a larger, more standardized group of intermediaries.
Into this void entered a new industry of mortgage banks. One such bank was the Iowa Loan and Trust, founded on a “cold winter night in ‘72,” as described by its company history.

Organized by John Owens, a retired businessman, the gathering brought together some of Des Moines most prominent citizens; these included Samuel Merrill, a civil war hero and two-term governor of Iowa; Tom Jewett, later founder of the Jewett Typewriter Company, which earned the highest prize at the Chicago World Fair in 1893; and Corydon Fuller, a respected banker and close personal friend of President James Garfield. Owens told the men: “Iowa has a future... what it need most [is] some eastern money and some organized effort to keep the money coming this way to finance the growth of the young town and state.” Their biographical details were critical -- to sell large quantities of mortgages in the East and get this eastern money wouldrequire a degree of trust never before placed in western banks or western farm mortgages.

Already suspicious of the plains states and their development, the nascent farm mortgage industry proved a compelling target for the skeptical eastern elite. The general sentiment was expressed by one Wall Street financier: “if there is one thing in this country for which I have a greater distrust than any other, it is western real estate... I have seen for myself, how excitable and unsteady are the judgements of western men.” The “financier” captures a dual-wariness: this was not just a question of unproven agricultural lands; it was a question of trustworthiness and whether the “west,” which most of these men had never visited, could be entrusted with their money. In this vein, the New York Times hammered away at the industry for almost two decades in both their news and opinion sections. A letter to the editor in August, 1876 blared, “there is probably no legitimate business carried on between the two oceans so loosely and which such an utter disregard of the ordinary precautions taken by businessmen as the lending of Eastern money in the West. A news article a year later described the industry as, “an organized system of perjury and fraud... and the visible operators being men of straw.” The suspicion extended even into the literary realm: Mark Twain, James Fenimore Cooper, and Charles Dickens all satirized the industry. The validity of these concerns will be returned to later. For the moment, however, it is important to realize that there was a strain of deep suspicion both of western farmers and their bankers among the investing establishment, one that would persist as the farm mortgage ran its course.

Why, then, did investors defy the pundits and invest in these securities? The investing landscape certainly contributed. In the fixed income arena, two of the most popular options -- treasury bonds and railroad bonds -- lost much of their appeal throughout the 1870s and 1880s. Treasury bond yields were driven down by a combination of fiscal policy, and by the demands of the growing National Bank network, which required treasury bonds to back its currency issuances. In the late 1860s, twenty-year treasury yields had averaged between 5-6%.
Throughout the 1870s, prices rose and yields fell below 4%. For investors seeking long-term, risk-free debt, the situation would not improve for decades, as yields averaged between 3-3.5%
in the 1880s and 1890s.

New England municipal bonds, another popular investment, offered little attraction -- their risk premiums over treasuries were virtually zero, and even became negative at times due to the previously mentioned structural necessity of purchasing treasury bonds. In other words, an investor could at times expect a lowerreturn on New England municipal bonds than on United States Treasury bonds. Railroad bonds had been a popular option for higher yielding securities, offering a roughly .5-1% risk premium over treasuries.
But after years of speculative growth, railroad securities (and their underlying businesses) had collapsed in 1873, leaving 20% of the industry’s bonds in default rising to 30% by 1876.
While investors were compensated with a higher risk premium for holding railroad bonds during this period, the situation diminished both the supply of and demand for these bonds. As tends to happen in a low-yield environment, investors were susceptible to chasing higher returns at higher risk profiles.

Into this void entered companies like the Iowa Loan and Trust, J.B. Watkins Company, Kansas Loan and Trust, and National Loan and Trust. Although the investing environment was favorable, it still took considerable effort to convince eastern investors of the virtues of western farms. Jabez Bunting “J.B.” Watkins, a young midwestern lawyer and founder of his eponymous mortgage company, went to great lengths to attract investors. After taking out advertisements in twenty-five newspapers and periodicals, he invited investors to visit his office in Lawrence, Kansas at his own expense. Watkins spent considerable time trying to assuage the concerns of these investors, whose knowledge of the West was limited at best. Many associated Kansas and the surrounding states with drought and locusts. Through both reassurances and a growing record of success (Watkins’ loans largely survived the great locust plague of 1874), Watkins slowly managed to convince investors that loans to Kansas farmers could be safe.
Despite Watkins’ efforts, the biggest selling point was never going to be safety -- the returns of farm mortgages compared to the standard menu of investments available were unparalleled. Although usury laws had been established in many of the Great Plains states in the 1850s, the interest rate caps were the highest in the nation: usually 11 or 12%. Unfortunately, little information survives about the returns investors received on farm mortgages in the 1870s.

Especially in the early years of the industry, however, mortgage companies seem to have avoided this cap in many cases, possibly through a structure that involved upfront fees in addition to standard interest payments -- even after eastern agents, loan agents in the West, and the Watkins took a slice of the interest, investors received as high as 10% returns on money entrusted to J.B. Watkins. In states without a cap, returns could have been much higher: in states like the Dakotas, interest rates of 18% were not uncommon. By 1880 rates had fallen considerably -- the average farmer paid 12.7% in the Dakotas, 10% in Kansas, 8.6 % in Iowa -- and investors could have likely expected returns roughly 2-3% below those figures

In the 1880s, this process would be formalized through the mortgage backed debentures, bonds that combined hundreds of mortgages to provide a safer income stream. Even as competition intensified in the 1880s and interest rates in the West fell, these debentures yielded between 5-7% (with most offering 6%) in a period when treasury bonds offered half that return. These debentures will be discussed in further detail. It is important to realize for now that for the entire existence of the farm mortgage industry, barring foreclosure, the potential
returns of farm mortgages dwarfed those of safer eastern bonds.

At first gradually, and then in droves, investors began to embrace this new investment. In most writing about the farm mortgage industry, the end “investor” is described in only the most ambiguous terms. Who these investors actually were remains a source of uncertainty and debate.
In critical eastern papers, the average investor was invariably a small-time saver living in the Northeast. After the failure of the Kansas Farmers’ Loan and Trust Company in 1889, New England Farmerdescribed the loss of “the means of living of several hundred investors scattered throughout New England, who, by advice of savings bank officials, who were considered shrewd businessmen had invested their money in these mortgages.” The New York Times, described the end buyers of these mortgages as “multitudes of small Eastern investors,” or as “the

mortgagee, living in New Haven, Newark, or Rochester. These claims were not wrong, but after predicting the imminent failure of the industry for two decades, the image of small retirees being duped into investing their hard-earned savings with shifty western companies fit well into the newspapers’ chosen narrative.

Retail investors, however, were far from the only investors involved in the western farm mortgage industry. Scholars agree that the biggest investors were likely insurance companies, banks, and possibly investment companies in the East. How big is unclear. Most state laws allowed life insurance companies to invest only in local mortgages, if at all. Two states, Connecticut and Wisconsin were the exceptions, and their five major insurance companies became major investors in western farm mortgages. While some of these insurers set up their
own networks of loan agents, most relied on the farm mortgage banks as intermediaries. While it is unclear how much of their business was done through the banks, by any metric they were major investors in farm mortgages: already by 1876, the four companies from Connecticut held $46 million worth of the securities. By comparison, fourteen years later (by which time the population of the region had roughly doubled and per capita mortgage indebtedness had increased substantially) farm mortgage banks had $251 million in loans outstanding. Savings banks were also investors in western mortgages, as both distributors (passing the investments along to their small retail depositors) and as end holders themselves, and some were forced to shut down after taking losses on farm mortgages in the 1890s. As for investment companies, an Iowa newspaper reported that a dozen of them held western farm mortgages in 1883, with one said to hold $20 million alone. The involvement of “smart money,” or capital invested by professionals, does not in itself validate the existence and safety of the western farm mortgage.


The role these institutional investors played does, however, undermine the theory that western farm mortgages were an obviously bad investment (as coverage from the New York Times suggested), much less a scam directed towards unwitting retail investors.

What has been presented so far is the core of the western farm mortgage industry. Long before there was any thought of disastrous droughts, overvaluation, mortgage backed debentures, or guarantees there was a simple business model: facing increasingly poor investment options, eastern investors, both institutional and individual, sought out alternative options. At the same time, the West needed capital to help thousands of prospective farmers take advantage of the Homestead Act and build their livelihoods. Mortgage banks sprang up to connect these two parties with a simple business model of originating loans and selling them to investors. Stripped of its complications, the western farm mortgage industry was a reasonable way of moving capital
west and developing the Great Plains.

And how many had these farm mortgages?
I
In 1891, the Iowa Bureau of Labor Statistics collected surveys from farmers in its annual report for the first and only time. After six years of low crop prices combined with a pair of droughts, their frustration was profound. The farmers blamed traders in Chicago, they blamed the weather, and they blamed the most recent settlers. But for many, the blame was directed at their creditors: “I have worked on a farm in southern Iowa fifty-two years, have owned and managed my farm to the best of my ability; and while I have made a living, I have not made one dollar where the money loaner has made ten on the same amount invested.”
Across Kansas, Iowa, Nebraska and their neighboring states, about 50% of farms had a mortgage, and their
indebtedness was rising every year. Although the farmers in the survey were hanging on, many had already given up and been foreclosed upon, and thousands more would soon join them. As the farmers failed, so too did their lenders.
.

 

[kernals12]

The subprime mortgages that Bear Stearns and Lehman were dealing with weren't that risky. Fidelity and Vanguard handle much more volatile securities on a daily basis. The problem wasn't their assets, it was their liabilities. Stearns was borrowing $30 for every $1 of their own money they put into subprime mortgages, so even a small increase in defaults meant enormous losses. The logic behind the Chicago plan was simple, risky liabilities should be backed by safe assets while risky assets should be funded with safe liabilities.

 

[Johnrankins]

Nahh, FDR's problem is the social constraints he is working under, that can be summed up as 'America is a capitalist country'.

Capital whines a lot about regulation and so on, but it doesn't stop them investing. What stops them investing is no prospect of making profit to selling to customers.

Once the War Stimulus happened, funded by borrowed money, then you got full recovery.

The principle problem with the Chicago Plan is you're imposing structural change in the middle of a crisis. The FDIC, by allowing privatising profits but socialising losses, was just more achievable.

It's not just that there were regulations but that the regulations kept changing. At times it was nearly the exact opposite of the previous changes. Part of the reason the War Stimulus worked is that everyone one knew what the chief goal of Washington was "win the war" so everything was geared towards that. Business had at least a decent idea of what was coming down. Another part of it was patriotism which effected businessmen as well as average citizens. After all, they were Americans too and were also caught up in the war rhetoric. Also, the money wasn't wasted on things like art. Art doesn't increase further production nor adds much to demand. All you need is a paintbrush, paint and some paper.

 

[vpsoccer]

I note that the Chicago Plan was proposed some three years before Keynes explained the nature of the liquidity trap that was the cause of the Great depression (as it was also the reason the Great Recession of 2008-20xx went on for so long). While some of those proposing this plan may have had some inkling of the problem, none would have had any idea of what the remedies might be. Looking at the eight signatories, two worked on banking and/or finance, but while a couple of the others worked on business cycles to some extent, they were largely focused on other fields (or are more-or-less unknown) so even with the great and insightful Frank Knight among them they are unlikely to have seen how their plan could/would interact with the liquidity trap. I suspect that despite whatever contortions might have arisen in efforts to boost prices, the "narrow money" approach would have shrunk the money supply even more dramatically than was the case.

FDR had the right sort of approach, even if he didn't know why - he was acting out of compassion for people and the pragmatic approaches he was known for. He did have to battle many forces to do as much as he did, with much approval coming only later. (I note in passing that those who study this stuff more than I do report that in general the states where they took advantage of FDR's social spending to retrench and balance state budgets by cutting state social and other spending had slower recoveries and a longer depression than those that leveraged additional spending on top of the federal.)

 

[kernals12]

I note that the Chicago Plan was proposed some three years before Keynes explained the nature of the liquidity trap that was the cause of the Great depression (as it was also the reason the Great Recession of 2008-20xx went on for so long). While some of those proposing this plan may have had some inkling of the problem, none would have had any idea of what the remedies might be. Looking at the eight signatories, two worked on banking and/or finance, but while a couple of the others worked on business cycles to some extent, they were largely focused on other fields (or are more-or-less unknown) so even with the great and insightful Frank Knight among them they are unlikely to have seen how their plan could/would interact with the liquidity trap. I suspect that despite whatever contortions might have arisen in efforts to boost prices, the "narrow money" approach would have shrunk the money supply even more dramatically than was the case.

FDR had the right sort of approach, even if he didn't know why - he was acting out of compassion for people and the pragmatic approaches he was known for. He did have to battle many forces to do as much as he did, with much approval coming only later. (I note in passing that those who study this stuff more than I do report that in general the states where they took advantage of FDR's social spending to retrench and balance state budgets by cutting state social and other spending had slower recoveries and a longer depression than those that leveraged additional spending on top of the federal.)

Leaving the gold standard meant that the Fed could've created as much money as it wanted.

 

[vpsoccer]

Leaving the gold standard meant that the Fed could've created as much money as it wanted.

Increases to the money supply were almost useless in the liquidity trap. Hence we got to negative interest rates without much effect on boosting the economy.

 

[marathag]

Increases to the money supply were almost useless in the liquidity trap. Hence we got to negative interest rates without much effect on boosting the economy.

All that QE didn't get to Main Street: it was just for Wall Street, and they did great with 'Free' Money

 

[kernals12]

All that QE didn't get to Main Street: it was just for Wall Street, and they did great with 'Free' Money

You actually believe the dramatic reduction in interest rates didn't help the economy?

 

[kernals12]

Increases to the money supply were almost useless in the liquidity trap. Hence we got to negative interest rates without much effect on boosting the economy.

Actually, the Fed never dropped the Funds rate to 0 during the depression, the lowest they got was 3%.

 

[vpsoccer]

Actually, the Fed never dropped the Funds rate to 0 during the depression, the lowest they got was 3%.

Rates for some commercial short-term loans did hit negative amounts. For obvious reasons these don't get into generally used (household and commercial) lending, but more for overnight money and other short-term stuff. The fact that any at all are this low is a sign that the central banks were trying to push money into the economy.
And various rates were often below the rate of inflation, which is negative real interest rates. I would have to look back at specific years, but may have had mortgage money at rates below inflation, certainly they were very close.

 

[marathag]

You actually believe the dramatic reduction in interest rates didn't help the economy?

It did, slowly.
took time for it to trickle down. Velocity of that money transfer was poor. that's one reason why that Recovery was one of the slowest, most gradual Recoveries since 1879

 

[kernals12]

It did, slowly.
took time for it to trickle down. Velocity of that money transfer was poor. that's one reason why that Recovery was one of the slowest, most gradual Recoveries since 1879

The claims about the slowness of the recovery don't account for the slowdown in productivity growth or the slowdown in the growth of our working-age population. Both of which will hold down GDP growth and the latter will hold down employment growth. The reduction in unemployment was in line with past recessions, albeit from a much higher base.

 

[Ian_W]

So all the regulations that were imposed (seperation of lending and investment, ban on interest earning checking accounts) weren't structural changes?

Regulating what interest you can offer in what accounts is just regulation.

Saying 'No, you can't have branches in more than one state' or 'You can't do lending and investment in the same entity' is structural.

 

[Ian_W]

The subprime mortgages that Bear Stearns and Lehman were dealing with weren't that risky.

I'd hate to see what you qualify as risky.

"But by July 2008, serious delinquencies on adjustable-rate mortgages had risen to over 29 percent"

https://www.federalreserve.gov/pubs/feds/2008/200859/200859pap.pdf