In the early 1860’s there were few advocates for states rights influencing federal policy since they had all withdrawn from the union. During that period Congress got into the railroad business, handing over very large tracts of land to the transcontinental railroad project.

The railroads solicited settlers for these vast tracts to be served by their new transportation. The railroads became de facto real estate and mortgage companies offering loans at 90% of value. They even made the loans interest only (can you imagine) for the first few years, so certain were they that the farmers could earn the price of their new fertile property with a single crop. The population of Kansas tripled.

Low interest rates back east had the investors eager to finance the Kansas boom with their higher interest rates. (Similar to the recent attraction of subprime loans.) Money poured into the boom at a reckless rate. Due diligence suffered.

“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.”

Clerks and barbers were making fast money in real estate. Just the licensing fees from the growing population of real estate brokers were an important source of revenue for the new towns.

Before the bubble burst land prices ran higher than they have ever been since in inflation adjusted terms. A drought killed farm output, real estate prices and the mortgage related securities collapsed, and an exodus of eager settlers returned east.*

We were on the gold standard and there was no Federal Reserve or SEC to keep the market prudent. All that was needed was an investing population willing to divest reason and common sense from their investment decision. But booms and busts are unclear when you are in the middle of them. There is always a new ‘plateau’, or a ‘paradigm shift’ to explain away the harsh reality lurking around the corner.

The US dealt with recessions and depressions (often called Panics) in 1893, 1907 and in 1921 with relatively quick adjustment and recovery. The American people and their leaders decided that they did not want to trust the stability of the financial system to the market so the Federal Reserve was formed for that purpose. Its creators truly expected to tame the financial cycles and to usher in a new era of prosperity.

It may have been the false sense of a new stability that led to the boom of the Roaring 1920 and the ensuing crash. Yet the new stabilizing Federal Bank failed to avoid the Great Depression which lasted longer than any previous recession in American history.

During the reign of the Fed our money has depreciated in value, and we painfully see today that booms and busts are still with us.

The idea of a national bank was hotly debated since our founding. It was at the center of the contested debates on the character of our country between Jefferson and Hamilton and was strongly opposed by Andrew Jackson.

As much as we insist on the independence of the Fed it has clearly, if reluctantly, become a servant of political self interest. It became a tool to finance Truman’s war and it may be serving larger political interests today. In a global economy with other countries generating capital seeking the safety and opportunities of the United States, the Fed may have less control over capital flows than it used to.

While America tired of the cycles that seemed to be a given in a system of economic self interest, we must question whether an economy directed by political self interest is not considerably worse. There are clear gaps in our regulatory agencies that must be corrected, but those gaps are often by political choice.

Fannie Mae and Freddie Mac were given special status and exempt from the oversight of the SEC by the Congress. Warnings of excess and calls for further controls were ignored vehemently often along straight party lines. As long as these agencies served the political desires of political constituents (low income home owners), prudence was shunned.

I f we want to better understand the economic convulsions and appropriate solutions we would be better served by paying less attention the mass media and perhaps picking up a history book. We should also learn that political self interest serves our national needs no better than economic self interest.

* This story of the Kansas land boom is summarized from James Grant’s Mr. Market Miscalculates- The Bubble Years and Beyond.