What do houses, tulips, railroads, and Internet companies have in common?

They’ve all caused speculative bubbles that burst, leaving widespread financial distress in their wake.

With foreclosures soaring, financial institutions scrambling to cover losses, and the federal government desperately trying to prevent a recession, the subprime mortgage crisis proves again that historically investors are most likely to lose their shirts where the pickings appear easiest.

In the late 1920s, legendary Wall Street financier Bernard Baruch saw a bubble in the making. As a result, he sold his holdings amid a historic stock market boom, just before the crash of 1929 and Great Depression of the 1930s.

What alerted Baruch to the impending market collapse? A stock tip from a beggar on the street.

He later wrote, “When beggars and shoeshine boys, barbers and beauticians can tell you how to get rich it is time to remind yourself that there is no more dangerous illusion than the belief that one can get something for nothing.”

It’s a lesson investors never learn. Numerous other investment bubbles have collapsed over the centuries, like tulip bulbs in Holland in 1637, U.S. railroad securities in 1873, and American dot-com stocks in 2000. These all resulted from easy money financing new industries, where their novelty and hype caused over-valuation.

Such speculation increases prices dramatically – in the short run. But the bubbles burst, prices plummet, investors panic and many become financially ruined.

In the herd mentality of the Roaring Twenties, the wide availability of money for investment produced bubbles in shares of industrial, mercantile and utility companies (and holding companies that owned multiples of these).

Interest rates were low, and banks and brokerage firms offered “call” or “margin” loans for common stock purchasers to “leverage” their money – say, by buying $10 of stock with $1 cash and $9 borrowed funds. When stock prices rose, the buyer could sell, pay the margin and pocket many times the profit from just banking the $1.

If the prices fell, however, the loan was “called” and the purchaser either had to cover it with cash, or the lender would sell the stock and pocket the proceeds as repayment. As more and more loans were called in the overheated stock market of late 1929, prices went into freefall. Sound familiar?

Now, the staid home mortgage industry has burst its bubble.

Mortgage-backed securities have long been viewed as safe, moderate-yield investments. After all, homeowners making monthly mortgage payments are dependable debtors and their owner-occupied houses reliable collateral.

Right?

Not if borrowers are uncreditworthy, lending terms imprudent or homes overvalued.

After 9/11, low interest rates and a flood of investment money into mortgages led to competition among lenders seeking to attract borrowers by making it easier to qualify for loans. Adjustable-rate loans became popular, with low initial rates that increased to less affordable levels later in the life of the loan.

Some lenders also allowed buyers to borrow 100 percent of a home’s purchase price, instead of requiring a traditional down payment of at least 20 percent.

And many lenders dispensed with the traditional practice of verifying borrowers’ income to determine whether they could afford to make monthly loan payments. Instead, the borrower paid for mortgage insurance policies to cover the bank if default made foreclosure necessary, and many insurers wrote more policies than they had reserves to cover.

Easy money drove demand for homes and escalated housing prices, prompting many to see opportunities to make quick profits by purchasing second, vacation or rental homes as investments. Infomercials touted get-rich-quick real-estate schemes in hot housing markets like Florida and California.

The result? Many people who could not really afford a home were able to buy them, which put them at increased risk of defaulting with even the slightest shift in the economy or their lives.

And, because banks and mortgagers bundled and re-sold them as mortgage-backed securities to investors in the “secondary market,” these vulnerable loans spread by the hundreds of billions throughout the financial system.

So, the robust mortgage market was yet another bubble waiting to burst.

Now that it has, the question is whether the government should rescue lenders and borrowers by assuming or guaranteeing their bad loans, or simply wait for the housing and mortgage markets to re-adjust and risk a long-term economic downturn while they do.

It would have been far easier to have simply heeded Bernard Baruch’s lesson in the first place. But, as history shows, investors never learn.

Elliott L. Epstein, a local attorney, is founder and board president of Museum L-A and an adjunct history instructor at Central Maine Community College. He can be reached at [email protected]