Friday, November 18, 2011

BW: The Mortgage of the Future (and the Past)

A very insightful piece from BusinessWeek on the history of the mortgage in the United States (from the 1920s-1930s era) through the current mess.... and then a discussion of a potential framework to take us away from the current market which is almost completely socialized.  A lot of interesting things out the history of the housing market I did not know - especially how the thirty year fixed mortgage was born and how the fallout of the Great Depression was fixed (hint: a helpful Congress).  I also did not know that Denmark and the United States are the only 2 countries you can get a long term "low rate" 30 year fixed mortgage - adjustables seem to be the rule in much of the rest of the world.  (adjustables put less risk on the bank in case interest rates rise over time)

Here is a look at the history -- the rest of the article discussions potential changes to the future mortgage market:

  • Up until the 1920s, loans typically were for half the value of homes or less, which was good and bad: Lenders had a thick safety cushion, but creditworthy people were cut off from homeownership. 
  • Starting in the 1920s, building and loan associations started offering loans up to two-thirds of the home value as well as second mortgages that raised total lending to 80 percent of home value; by 1929 those institutions dominated the mortgage market.  It was, like the 2000s, a decade of innovation and overleverage. Private mortgage insurers grew rapidly. There was even an early stab at securitization: Collateral trust certificates of participation, as they were called, passed through to investors the cash flows on underlying mortgages. Housing finance was entirely private; there were no government guarantees.
  • The system came crashing down in the 1930s, destroyed by the bust in home prices and record unemployment that left homeowners unable to keep up payments. Private mortgage insurers failed, building and loans stopped making loans, and participation certificates lost most of their value. 
  • That’s when things got interesting. FDR concluded that fixing housing was not only merciful but essential to getting the U.S. economy back on its feet. On Apr. 13, 1933, he asked Congress for legislation to protect homeowners from foreclosures and to reduce the burden of mortgage debt.
  • Congress responded with a speed that modern lawmakers could scarcely imagine. “Senate hearings were started after a week’s delay but were terminated after two days to speed action,” C. Lowell Harriss of Columbia University wrote in a 1951 study of the episode. In pushing ahead, Congress turned aside objections from the New York State League of Savings and Loan Associations, which said “every reasonable consideration” was already being extended to worthy homeowners. (identical language we've heard the past few years from the TBTF banks)
  • Legislation establishing a Home Owners’ Loan Corp. passed the House 383 to 4 and sailed through the Senate in June 1933 on a voice vote. The new agency bought defaulted mortgages from lenders, generally at 100¢ on the dollar, and replaced them with healthier ones—fully amortizing loans with long terms (originally 20 years) and fixed rates of interest. Down payments were a conservative 15 percent. By 1936, when the Home Owners’ Loan Corp. stopped restructuring loans, it held mortgages on 1 in 10 owner-occupied homes in the U.S.
  • But to make safer loans possible, the federal government thrust itself into what had always been a private matter—borrowing to buy a house. Lenders were unwilling to make long-term fixed-rate loans without a safety net. So, through new agencies such as the Federal Housing Administration (1936), the government promised it would make lenders whole if borrowers defaulted. That opened the spigot of private credit.
  • The seat-of-the-pants experiments of the New Deal changed American housing finance forever, mostly for the better. Even today, the U.S. and Denmark are the only countries in the world in which borrowers can pay off their mortgage over a period of as long as 30 years and at an interest rate that never changes.

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