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History
of the Mortgage Market
Brian
Trumbore
President/Editor, StocksandNews.com
The other day in Jackson Hole, Wyoming,
Aug. 31, Federal Reserve Chairman Ben Bernanke gave
a widely anticipated speech about the housing market.
Among his quotes addressing the current mortgage crisis
were:
"It
is not the responsibility of the Federal Reserve -
nor would it be appropriate - to protect lenders and
investors from the consequences of their financial
decisions. But developments in financial markets can
have broad economic effects felt by many outside the
markets, and the Federal Reserve must take those effects
into account when determining policy."
"Obviously,
if current conditions persist in mortgage markets,
the demand for homes could weaken further, with possible
implications for the broader economy. We are following
these developments closely."
But
the chairman also delved into the history of the mortgage
market, so I thought it would be appropriate to pass
on his thoughts for this column, Bernanke being a
noted academic in addition to his current job of overseeing
our nation's monetary policy.
The
following is a bit dry, but contains a nugget or two
that should be of interest to junior historians out
there; including myself in this group, of course.
---
Ben
Bernanke
[Excerpts]
The
early decades of the twentieth century are a good
starting point for this review, as urbanization and
the exceptionally rapid population growth of that
period created a strong demand for new housing. Between
1890 and 1930, the number of housing units in the
United States grew from about 10 million to about
30 million; the pace of homebuilding was particularly
brisk during the economic boom of the 1920s.
Remarkably,
this rapid expansion of the housing stock took place
despite limited sources of mortgage financing and
typical lending terms that were far less attractive
than those to which we are accustomed today. Required
down payments, usually about half of the home's purchase
price, excluded many households from the market. Also,
by comparison with today's standards, the duration
of mortgage loans was short, usually ten years or
less. A "balloon" payment at the end of the loan often
created problems for borrowers.
High
interest rates on loans reflected the illiquidity
and the essentially unhedgeable interest rate risk
and default risk associated with mortgages. Nationwide,
the average spread between mortgage rates and high-grade
corporate bond yields during the 1920s was about 200
basis points, compared with about 50 basis points
on average since the mid-1980s. The absence of a national
capital market also produced significant regional
disparities in borrowing costs. Hard as it may be
to conceive today, rates on mortgage loans before
World War I were at times as much as 2 to 4 percentage
points higher in some parts of the country than in
others, and even in 1930, regional differences in
rates could be more than a full percentage point.
Despite
the underdevelopment of the mortgage market, homeownership
rates rose steadily after the turn of the century.
As would often be the case in the future, government
policy provided some inducement for homebuilding.
When the federal income tax was introduced in 1913,
it included an exemption for mortgage interest payments,
a provision that is a powerful stimulus to housing
demand even today. By 1930, about 46 percent of nonfarm
households owned their own homes, up from about 37
percent in 1890.
---
The
New Deal and the Housing Market The housing sector,
like the rest of the economy, was profoundly affected
by the Great Depression. When Franklin Roosevelt took
office in 1933, almost 10 percent of all homes were
in foreclosure, construction employment had fallen
by half from its late 1920s peak, and a banking system
near collapse was providing little new credit. As
in other sectors, New Deal reforms in housing and
housing finance aimed to foster economic revival through
government programs that either provided financing
directly or strengthened the institutional and regulatory
structure of private credit markets.
Actually,
one of the first steps in this direction was taken
not by Roosevelt but by his predecessor, Herbert Hoover,
who oversaw the creation of the Federal Home Loan
Banking System in 1932. This measure reorganized the
thrift industry (savings and loans and mutual savings
banks) under federally chartered associations and
established a credit reserve system modeled after
the Federal Reserve. The Roosevelt administration
pushed this and other programs affecting housing finance
much further. In 1934, his administration oversaw
the creation of the Federal Housing Administration
(FHA). By providing a federally backed insurance system
for mortgage lenders, the FHA was designed to encourage
lenders to offer mortgages on more attractive terms?.
by the 1950s, most new mortgages were for thirty years
at fixed rates, and down payment requirements had
fallen to about 20 percent. In 1938, the Congress
chartered the Federal National Mortgage Association,
or Fannie Mae, as it came to be known. The new institution
was authorized to issue bonds and use the proceeds
to purchase FHA mortgages from lenders, with the objectives
of increasing the supply of mortgage credit and reducing
variations in the terms and supply of credit across
regions.
Shaped
to a considerable extent by New Deal reforms and regulations,
the postwar mortgage market took on the form that
would last for several decades. The market had two
main sectors. One, the descendant of the pre-Depression
market sector, consisted of savings and loan associations,
mutual savings banks, and, to a lesser extent, commercial
banks?.Notably, federal and state regulations limited
geographical diversification for these lenders, restricting
interstate banking and obliging thrifts to make mortgage
loans in small local areas - within 50 miles of the
home office until 1964, and within 100 miles after
that. In the other sector, the product of New Deal
programs, private mortgage brokers and other lenders
originated standardized loans backed by the FHA and
the Veterans' Administration (VA). These guaranteed
loans could be held in portfolio or sold to institutional
investors through a nationwide secondary market.
No
discussion of the New Deal's effect on the housing
market and the monetary transmission mechanism would
be complete without reference to Regulation Q - which
was eventually to exemplify the law of unintended
consequences. The Banking Acts of 1933 and 1935 gave
the Federal Reserve the authority to impose deposit-rate
ceilings on banks, an authority that was later expanded
to cover thrift institutions?.
The
original rationale for deposit ceilings was to reduce
"excessive" competition for bank deposits, which some
blamed as a cause of bank failures in the early 1930s.
In retrospect, of course, this was a dubious bit of
economic analysis. In any case, the principal effects
of the ceilings were not on bank competition but on
the supply of credit. With the ceilings in place,
banks and thrifts experienced what came to be known
as disintermediation - an outflow of funds from depositories
that occurred whenever short-term money-market rates
rose above the maximum that these institutions could
pay. In the absence of alternative funding sources,
the loss of deposits prevented banks and thrifts from
extending mortgage credit to new customers.
---
Under
the New Deal system, housing construction soared after
World War II, driven by the removal of wartime building
restrictions, the need to replace an aging housing
stock, rapid family formation that accompanied the
beginning of the baby boom, and large-scale internal
migration. The stock of housing units grew 20 percent
between 1940 and 1950, with most of the new construction
occurring after 1945.
In
1951, the Treasury-Federal Reserve Accord freed the
Fed from the obligation to support Treasury bond prices.
Monetary policy began to focus on influencing short-term
money markets as a means of affecting economic activity
and inflation, foreshadowing the Federal Reserve's
current use of the federal funds rate as a policy
instrument. Over the next few decades, housing assumed
a leading role in the monetary transmission mechanism,
largely for two reasons: Reg Q and the advent of high
inflation?.
The
impact of disintermediation on the housing market
could be quite significant; for example, a moderate
tightening of monetary policy in 1966 contributed
to a 23 percent decline in residential construction
between the first quarter of 1966 and the first quarter
of 1967. State usury laws and branching restrictions
worsened the episodes of disintermediation by placing
ceilings on lending rates and limiting the flow of
funds between local markets.
---
The
Emergence of Capital Markets as a Source of Housing
Finance
The
manifest problems associated with relying on short-term
deposits to fund long-term mortgage lending set in
train major changes in financial markets and financial
instruments, which collectively served to link mortgage
lending more closely to the broader capital markets.
The shift from reliance on specialized portfolio lenders
financed by deposits to a greater use of capital markets
represented the second great sea change in mortgage
finance, equaled in importance only by the events
of the New Deal.
Government
actions had considerable influence in shaping this
second revolution. In 1968, Fannie Mae was split into
two agencies: the Government National Mortgage Association
(Ginnie Mae) and the re-chartered Fannie Mae, which
became a privately owned government-sponsored enterprise
(GSE), authorized to operate in the secondary market
for conventional as well as guaranteed mortgage loans.
In 1970, to compete with Fannie Mae in the secondary
market, another GSE was created - the Federal Home
Loan Mortgage Corporation, or Freddie Mac. Also in
1970, Ginnie Mae issued the first mortgage pass-through
security, followed soon after by Freddie Mac. In the
early 1980s, Freddie Mac introduced collateralized
mortgage obligations (CMOs), which separated the payments
from a pooled set of mortgages into "strips" carrying
different effective maturities and credit risks. Since
1980, the outstanding volume of GSE mortgage-backed
securities has risen from less than $200 billion to
more than $4 trillion today. Alongside these developments
came the establishment of private mortgage insurers,
which competed with the FHA, and private mortgage
pools, which bundled loans not handled by the GSEs,
including loans that did not meet GSE eligibility
criteria - so-called nonconforming loans. Today, these
private pools account for around $2 trillion in residential
mortgage debt.
These
developments did not occur in time to prevent a large
fraction of the thrift industry from becoming effectively
insolvent by the early 1980s in the wake of the late-1970s
surge in inflation. In this instance, the government
abandoned attempts to patch up the system and instead
undertook sweeping deregulation. Req Q was phased
out during the 1980s; state usury laws capping mortgage
rates were abolished; restrictions on interstate banking
were lifted by the mid-1990s; and lenders were permitted
to offer adjustable-rate mortgages as well as mortgages
that did not fully amortize and which therefore involved
balloon payments at the end of the loan period. Critically,
the savings and loan crisis of the late 1980s ended
the dominance of deposit-taking portfolio lenders
in the mortgage market. By the 1990s, increased reliance
on securitization led to a greater separation between
mortgage lending and mortgage investing even as the
mortgage and capital markets became more closely integrated.
About 56 percent of the home mortgage market is now
securitized, compared with only 10 percent in 1980
and less than 1 percent in 1970.
Source:
Federalreserve.gov
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Next
week, back to bubbles.
Brian
Trumbore
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