THIS QUOTE, attributed to President Herbert Hoover’s 1928 election campaign, epitomizes the mass psychology characteristic of the Roaring ’20s. In a country that had long enjoyed a remarkable period of prosperity, it was felt that the trajectory of the boom’s trend would eventually lead to an eradication of poverty.

The Industrial Revolution brought about a tremendous increase in productive capacity and living standards beginning with its origins in the mid-19th century. But the advent of consumer installment credit in the Roaring ’20s was the mechanism that shifted business into overdrive. Entrepreneurs all along the chain of production, from commodities to retail, geared up for demand that, in hindsight, was short-lived.A credit-fueled bubble that affected nearly every corner of the economy — encompassing everything from consumer credit, to business loans, to margin debt at stock brokerages — crested the following summer. Alas, historians have thoroughly documented what happened when this euphoria morphed into panic.

With the onset of the Great Depression, priorities for many gradually shifted from return on capital, to return OF capital, to concern that modern industrialized society was unraveling at its seams.

The Consequences of a Credit Bubble

As the panic that engulfed Wall Street spread to the banking community, pain that was previously only felt by those involved in the speculative stock market quickly consumed the business community. Consumers reined in spending, so business owners rationally cut expansion plans and investments in inventory.

Bankers comprised the heart of the capital allocation function of the time period; in the modern global economy, it’s quite another story, as the business of providing credit has shifted toward such institutions as hedge funds, private equity, and government-sponsored enterprises like Fannie Mae. Also taking share from bankers has been the secondary market for credit derivatives, including mortgage-backed securities, collateralized debt obligations, and collateralized loan obligations.

Take the example of mortgage-backed securities: pools of mortgages of similar size, credit risk profile, and loan-to-value ratios that provide a yield similar to that of a bond. It used to be that you’d apply at your local community bank for a 30-year mortgage where you’d make monthly principal and interest payments over the entire life of the loan. The banker carefully weighed the risks of extending the mortgage on the home you sought to purchase and the sustainability of your present income because he would have to live with the consequences of default.

Over the course of the past 5-10 years, however, the financial system has evolved to the point where bankers have more incentive to sell the right to collect your future monthly payments into a secondary market. This secondary market is created by large Wall Street firms who make commissions and fees in a fashion similar to that of the stock market. Therefore, the local banker has been transformed into an agent of institutional and individual investors looking to invest in an income-producing security that pays a yield greater than Treasury bonds.

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