Sunday, February 21, 2016

A History of the Home Mortgage Part #2 - The Early to Mid 1900’s

In the prior edition of this history on the home mortgage series, we discussed the heavy handed nature of lenders in medieval times and the advancement of mortgage laws to protect borrower’s equity. Throughout history and leading up to the early 1900’s, the mortgage markets were very different then what we know today.  Home mortgage loans were provided by life insurance companies, trust companies, or in many cases, smaller individual lenders or mortgage companies. 

For those of us who have seen the movie “Its A Wonderful Life”, we can fondly remember the scene where they discuss how money deposited at the bank is not actually sitting in the bank’s vaults but has been used to make loans and is now sitting in peoples’ homes.  But, in the US and Canada before the creation of the central banks and government sponsored housing loan insurance organizations, banks were not significant players in the mortgage markets.  The reason for this was simple, if a bank could have a surprise wave of customer withdrawals in a short amount of time and needed to call on loans to gather cash for covering the depositors’ requests, mortgages against real estate could not be collected fast enough to meet liquidity demands.  For insurance companies and mortgage companies, daily access to cash was not as big of a concern because none of their customers would come and demand their money back on a given day of the week. 

The creation of the central bank, the guarantee on deposits later provided by governments following the great depression, and the creation of home loan insurance organizations were the three big changes the banks needed to finally get into mortgage lending. 

1. Central banks allowed the individual banks to co-operate together more easily to manage each of their own liquidity needs. In effect, if one bank needed cash on a given day of the week to meet depositors’ withdrawal requests, it could borrow the money overnight from another bank. This took pressure off the bank and allowed for less liquid loans to be made. 

2. A government guarantee on deposits reduced the probability and magnitude of a potential bank run. This also made it more comfortable for a bank to lend on longer term mortgage loans.  

3. And most important of the three for housing, with the creation of home loan insurance organizations the banks could mitigate loan loss risk if borrowers defaulted or the value of homes went down below outstanding mortgage balances.

From the 1940’s onwards, the banks began to dominate the mortgage markets and ultimately became the leading lenders.  Additional local chartered lenders began operating much the same way, called Credit Unions in Canada or Savings and Loan Co-operatives in the US. These smaller regional players filled geographical gaps or provided loans to borrowers where the larger banks could not.

Part 1 of this series started by describing how individual direct lenders were the only source of mortgage loans prior to the 19th century, followed by outlining how mortgage companies expanded late in the 1800s. This second part to the series covers the portion of history when the banks became active with the invention of central banks and housing loan insurance organizations. 

Part 3 of this series will cover the next big evolution in housing finance which occurred with the introduction of mortgage securitization and mortgage banking. Starting in the 1970’s, the wide spread adoption of national mortgage agencies like the Government National Mortgage Association - GNMA (Ginnie Mae), the Federal National Mortgage Association - FNMA (Fanny Mae), and the Federal Home Loan Mortgage Corporation - FHLMC (Freddie Mac) helped mortgage banking to become a new home financing force.

The following chart shows a progression of housing finance systems starting with simple direct individual lenders, evolving through corporate intermediaries like mortgage companies, followed by the entrance of the banks, and finally to the creation of mortgage banking and the securitization model. 

What is interesting to see, now looking back on these stages of the mortgage market evolution, is the increase in homeownership with each successive development. 

By 1930 home ownership reached 47.8%. Before dropping to 43.6% after the great depression the homeownership rate then rose up to just over 60% by 1970 as a result of the banks becoming the leading lenders.

In the 3rd part of this series we will look at how much the addition of securitization increased home ownership, personal debt levels, and the quality of housing.

*Mortgage Markets World Wide - Blackwell Publishing
*Housing Finance Systems A Comparative Study - Croom Helm Ltd Publishing
*Mortgage Banking in the United States, 1870–1940 Research Institute for Housing America.

*The Historical Origins of America’s Mortgage Laws, Research Institute for Housing America.