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448 pages, Hardcover
First published May 10, 2011
As the train bearing Reed and his party sped west from Chicago in the summer of 1887, a spectacular property boom was burning itself out in southern California and the Great Plains. In Los Angeles, the average price of a business lot had jumped to $5,000 from $500 in only 12 months. In Wichita, according to the historian John D. Hicks, “A clerk who put his $200 into a lot sold it two months later for $2,000. A barber who dabbled in real estate made $7,000. Real estate agents, many of whom made much larger fortunes, swarmed over the place by the hundreds; they were so numerous that the city derived a considerable revenue from the license fees they had to pay.”
Mortgage debt was on the rise throughout the United States. From 1880 to 1889, the value of cumulative mortgage transactions reached $9.5 billion, up 156 percent from the previous 10 years. In comparison, population grew by a quarter and wealth by a half. In other words, observed a senior official of the Census Bureau, “real estate mortgage debt increased proportionately about three times more than wealth and about six times more than population.” “Subprime mortgage” was a phrase for the future, but the lenders and borrowers of Reed’s day anticipated the excesses of a later time even without their descendants’ specialized vocabulary or their evolved financial and regulatory systems. Reed himself, an investor in land in Holt County, Nebraska, was a loser in the speculative collapse of the early 1890s.
For a proper bubble, the prerequisites are a compelling story and a ready source of finance, and these the western land markets had in spades. The story seemed to write itself: The frontier was vanishing, and land, long cheap, would soon become dear. Advertisements promised would-be emigrants to the Plains and Dakotas rich soil, easy mortgage lending terms, big crops and—of all things—salubrious weather. The weather was indeed a pleasant surprise in Kansas and Nebraska. Eighteen to twenty inches of rainfall was necessary to make a good crop, and this quota was annually met in the early and mid-1880s, even in the normally arid western portions of the states. Old-timers scratched their heads: What could explain the anomalous succession of wet seasons? Human activity, some authorities reasoned: By breaking sod, irrigating crops and planting trees, the settlers had effected a kind of benign climate change. A professor at the University of Nebraska lent his authority to this pleasing hypothesis.
Mortgage money was available on terms that a 21st century borrower might find hauntingly familiar. Thus, for instance, the Union Pacific lent up to 90 percent of the value of the property at 7 percent over an 11-year term, with no principal amortization until the fourth year; for the first three years, the borrower paid interest only. Loans were available for the asking, though it was not always strictly necessary to make a formal application. The loan companies would come knocking at the farmhouse door.
American savers (and some foreign capitalists) were in the throes of a great yield hunger. Interest rates had peaked with the war-induced inflation of the 1860s. By the mid-1880s, New Englanders were earning just 4 percent at the bank and slightly less on high-grade railroad bonds. Inasmuch as the cost of living was actually falling (down by an average of 0.50 percent a year in the 1880s), a modern-day economist would judge that inflation-adjusted, or “real,” interest rates were generous. But western mortgages, yielding 6 to 8 percent, were still more generous. Loans secured by livestock, farm implements and rolling stock—so-called chattel mortgages—fetched 10 percent and up. To the objection that nothing is actually free in investing and that pioneer agriculture is inherently risky, the promoters smilingly pointed to the good crops and high prices of recent seasons. Why should they not persist? And again to quote Hicks, “The mortgage notes themselves, ‘gorgeous with gold and green ink,’ looked the part of stability, and the idea spread throughout the East that savings placed in this class of investments were as safe as they were remunerative. Small wonder that money descended like a flood upon those who made it their business to place loans in the West!”
Back east, bank regulators urged the smitten depositors to go slow. “Eastern states found it necessary to pass laws for the examining and licensing of western investment companies in order to protect individuals who were being induced to withdraw their deposits from savings banks and invest them in western securities,” relates the historian Hallie Farmer. A lot of good it did: “Competition existed not between borrowers but between lenders. ‘I found drafts, money orders and currency heaped on my desk every morning,’ said the secretary of a western loan company. ‘I could not loan the money as fast as it came in.’ The manager of another company stated that ‘during many months of 1886 and 1887 we were unable to get enough mortgages for the people of the East who wished to invest in that kind of security. My desk was piled high every morning with hundreds of letters each enclosing a draft and asking me to send a farm mortgage from Kansas or Nebraska.’”
Presently, the demand for lendable funds rose to meet the generous supply. No self-respecting town wanted to be without its streetcar line, jail, school or—especially—railroad junction. “Confidence was high,” recounts Farmer, “money was easy to obtain and the West entered upon such an orgy of railroad building as the world had never seen before. Old companies extended their lines. New companies were organized. Within six weeks in the spring of 1887, the Northwestern Railroader recorded the incorporation of 16 new railroad companies and the letting of contracts for work on 13 new branches of old roads. Kansas more than doubled her railroad mileage between 1880 and 1887. That of Nebraska was quadrupled and Dakota had 11 times the mileage in 1890 which she had in 1880.” And when, as sometimes happened at around this time, the railroad magnates fell to cutthroat competition, the traveling public was the winner. At the peak of the price wars of 1886, the fare between Kansas City and Los Angeles on the Santa Fe Railroad cost exactly $1.
Frontier standards of due diligence in the 1880s proved little better than the big-city kind 120 years later. “Securities which could not have been sold in ordinary times found a ready market,” according to Farmer. “Bonds of Capitola Township, Spink County, Dakota, were sold in this period and changed hands many times in eastern markets before it was discovered that no such township existed.”
None could doubt the existence of Los Angeles. Settlers by the thousands saw the place for themselves, and they watched the levitation of its real estate values. By 1885, Isaias Hellman, president of the Farmers and Merchants Bank and leader of the boomtown’s banking community, had decided that a good thing had gone far enough. Against the ever-present temptation to run with the herd (especially if the herd seemed to be running in the direction of money), Hellman ordered his bank to restrict its lending. And in the fall of 1887, he announced that the Farmers and Merchants would have nothing more to do with the speculative bubble. Hellman’s example was evidently a powerful one, for at that critical juncture less than half the assets of the Los Angeles banking community were out on loan. Within six months, only a quarter were. It was thanks to the restraining influence of the bankers, notably Hellman, that the southern California economy did not burst along with the local property bubble. But rare, then as now, is the financier of detached and sober judgment. More common in 1887 was the attitude of the editor of the Nebraska State Journal, who protested that there was nothing like a bubble in property prices in Nebraska or Kansas. “It is simply,” he asserted, “the effect of the exhaustion of the public lands and the prosperity of the trans-Missouri region.”
That prosperity was then receding. The alleged new era of man-made moisture ended in 1887 and a persistent drought began. Grain prices peaked; by 1890, the price of a bushel of corn was 28 cents; it had been 63 cents in 1881. Lending dried up with the moisture. In the years 1884 to 1887, 6,000 farm mortgages, in the sum of $5.5 million, were written in Nebraska, Farmer relates. “In the next three years, only 500 such mortgages were placed with a total value of $633,889.... Eastern investors refused to place more money in the West and much of the money already invested was withdrawn as the lenders became frightened over the agitation of the debtors for relief in the form of stay laws.”
The available data suggest, if anything, that the citizens of Kansas borrowed not recklessly but in moderation. Mortgage debt was just 26.8 percent of the value of Kansas real estate, according to estimates compiled by the 1890 census-takers. Per capita private debt, counting only adults, amounted to $347. However, those statistics paint a misleadingly conservative picture. Per capita indebtedness in Kansas, for instance, was four times the national average. And though just 60 percent of the taxed acres in the state were encumbered by mortgage debt, that was the highest such proportion in the union. Then too, any debt is oppressive in the absence of income with which to service it, and such was the plight of the drought-stricken Jayhawk farmers. By 1892, half the population of western Kansas had trekked back east. On some of the wagons that bore what remained of the settlers’ possessions, there was emblazoned the motto “In God we trusted, in Kansas we busted.” To this portion of the American electorate, the tariff battle seemed rather an abstraction.