Mortgage industry - Business in United States of America

Definition: Enterprises that negotiate, broker, issue, underwrite, bundle, and exchange loans secured with real estate
Significance: Mortgage loans have long been a major form of credit for households and business firms, and they provide major assets for banks and other financial firms.
From colonial times, the pursuit of income and profit led many people to borrow extensively to buy and develop land. Several colonial governments created land banks, lending on mortgage security by issuing paper currency.
During the nineteenth century, the majority of Americans lived on farms. Farmers relied on mortgages to finance the acquisition and improvement of land, construction of buildings (including the family home), and other expenses. Mortgage credit was also important for business firms. As railroad building expanded after the 1830’s, many of the railroad bond issues involved mortgage claims on the land involved in the right-of-way.
As commercial banking developed, there were misgivings about mortgage lending by banks. Mortgage loans were liquid and were quite risky. When the national banking system was created in 1863, the national banks were forbidden to make mortgage loans. By that time, however, there were other financial institutions for which mortgage lending was appropriate, notably savings banks and insurance companies. Bankers in rapidly developing areas would initiate mortgage loans, sell them to Eastern investors, and continue to service the loans for a commission. Non-national banks had much more freedom to initiate mortgages, and by 1909, one-fourth of their assets were mortgage loans. However, as late as 1910, three-fourths of farm mortgages were held by individual investors.
In 1900, total mortgage debt was around $6.7 billion, of which one-fourth was farm debt. Despite urbanization, farm mortgages increased to $11 billion in 1922, 40 percent of the total mortgage debt, reflecting boom times for farmers. The Federal Farm Loan Act of 1916 authorized the creation of federal land banks, which became large farm-mortgage lenders. By 1927, they held $1 billion of farm mortgages. In that year, over $2 billion was held by life insurance companies and over $1 billion by commercial and savings banks. Joint stock land banks, also created by the 1916 legislation, held $600 million.
Urbanization brought rapid growth in nonfarm residential mortgages. By 1900, these totaled about $2.9 billion, of which half was held by financial institutions. Mutual savings banks were the largest lenders ($632 million), followed by savings and loan associations (which had developed primarily to provide home-mortgage loans—$371 million).
The proportion of nonfarm residents who were homeowners rose steadily in the prosperous early twentieth century, from one-third around 1900 to nearly half by 1930. By then nonfarm residential mortgages exceeded $30 billion, two-thirds held by financial institutions. Savings and loan associations were the largest lenders, accounting for over $6 billion.

An 1888 advertisement for the Equitable Mortgage Company. (Library of Congress)

The Great Depression

Plummeting incomes and prices following 1929 increased the burden of debts of all kinds. During the Great Depression, in some cities, half of all residential mortgages were in default, dragging down banks and other lenders. New loans for home building virtually ceased.
The federal government created a multitude of new agencies and programs designed to ease debt burdens and promote new home building. The Reconstruction Finance Corporation (created in 1932) lent $100 million to savings and loan institutions and lesser sums to federal land banks, joint stock land banks, and mortgage loan companies. A system of Federal Home Loan banks was created in 1932; by mid-1933, they had lent $22 million to mortgage-finance institutions.
Under President Franklin D. Roosevelt, mortgage programs multiplied. The Federal Farm Mortgage Corporation (created in 1933) issued bonds and made loans to the federal land banks. The Home Owners Loan Corporation (HOLC, created in 1933) bought many defaulted mortgages from lenders and restructured most of them. By the time it closed in 1936, the HOLC had made about one million loans totaling $3 billion and refinanced about one-fifth of all mortgaged dwellings. By the end of 1935, the federal government had plowed nearly $6 billion into mortgage markets, about equally divided between farm and nonfarm. The Federal Housing Administration (FHA), created in 1934, was authorized to insure long-term amortized home mortgages. This insurance primarily protected mortgage lenders against loss from borrower default. By 1941, FHA insurance covered about $3 billion of the $18 billion of nonfarm home mortgage debt. Nonfarm home mortgages had reached $30 billion in 1930; they declined to $23 billion during the mid-1930’s and returned to $30 billion only in 1946. By then, a new mortgage guarantee program had been created for military veterans.
Expansion of home ownership and mortgage lending were important parts of the economic growth and prosperity that followed World War II. High income-tax rates provided a subsidy for home ownership, as interest paid on mortgage debt was a deductible expense. The proportion of homes that were occupied by their owners rose from 53 percent in 1945 to 63 percent in 1970. Over the same period, nonfarm residential mortgage debt rose from $25 billion to $338 billion. Of this total, $280 billion covered one-family to four-family structures, of which $60 billion was FHA-insured and $37 billion was insured by the Veterans Administration. Almost 90 percent of nonfarm residential mortgages were held by financial institutions, of which savings and loans were the largest, with $139 billion.
A relatively new institutional player was Fannie Mae (Federal National Mortgage Association, FNMA), which had been created in 1938 to provide a secondary market for home mortgages but did not purchase on a large scale until the 1960’s. It became a shareholder-owned corporation in 1968. At that time, Ginnie Mae (Government National Mortgage Association, GNMA) was spun off from Fannie Mae to provide a secondary market for government-guaranteed mortgages. In 1970, the Home Loan Bank Board created Freddie Mac (Federal Home Loan Mortgage Corporation, FHLMC). All three of these sold their own bonds and used the proceeds to buy mortgages.

Total Home Mortgage Debt Outstanding, 1990-2005

Source: Data from the Statistical Abstract of the United States, 2008 (Washington, D.C.: Department of Commerce, Economics and Statistics Administration, Bureau of the Census, Data User Services Division, 2008)

Turbulent Times

Rising interest rates following 1965 brought on deregulation of deposit institutions and the savings and loan crisis. Longstanding institutional differentiation of mortgage lenders largely disappeared. A new crisis emerged in the twenty-first century, focused even more sharply on home mortgages. A rapid rise in house prices encouraged both home buyers and mortgage lenders into speculative activities. Subprime loans (loans made at above prime rates to borrowers who do not qualify for prime-rate loans) were made without much attention to the buyer’s ability to repay, on the assumption that increases in the value of the house would enable the buyer to refinance at a lower interest rate. A huge number of mortgages were used as the basis for collateralized debt obligations (CDOs), issued in large amounts by Fannie Mae, Freddie Mac, Lehman Brothers, and other private firms. These were layers of bonds differing in priority and risk. The highest priority bonds were regarded as risk free and were eagerly purchased by conservative investors at home and abroad, at very low interest rates. Often these came with guarantees against default from the issuing agency or from firms specializing in creating credit-default swaps. A second layer of bonds received payment only after the first layer was paid in full. These had higher risks and required high interest rates. A final layer represented an equity interest with lowest priority and highest risk. These appealed to speculative buyers such as buyers of hedge funds.
As mortgage default rates began to rise in 2007, financial firms with substantial mortgage operations rapidly showed signs of trouble. They were holding long-term assets (mortgages or CDOs) financed by short-term loans whose lenders were reluctant to renew. Fannie Mae, Freddie Mac, and other mortgage operators had very small capital accounts; thus, the value of their assets barely exceeded their liabilities. When mortgage defaults began to reduce asset values, these operators soon showed indications of insolvency. This was accentuated by marking-to-market accounting rules requiring that reported assets be reported at their (supposed) current market value.
Mortgage involvements brought about bank failures involving IndyMac, Washington Mutual, and Wachovia. Lehman Brothers, a large issuer of CDOs, went bankrupt. Its closing precipitated its creditors falling into financial distress. Fannie Mae and Freddie Mac were taken over by the government. Under the supervision of the Federal Housing Finance Agency, they became the chief source of continued credit to the home-mortgage sector.
The mortgage crisis was especially acute in California. Although U.S. home prices declined about 10 percent over the year ending October, 2008, prices in California fell by one-third. About one third of all the mortgages in an average mortgage backed security were written on California properties. California mortgages were a major reason for the failures of Countrywide, IndyMac, and Washington Mutual. Housing and housing finance were in a severe slump by late 2008. In the second quarter of 2008, more than 9 percent of home mortgages were in default, compared with 6.5 percent a year previous. Sales of foreclosed properties made up 45 percent of existing-home sales in October.

Further Reading
Bogue, Allan G. Money at Interest: The Farm Mortgage on the Middle Border. Ithaca, N.Y.: Cornell University Press, 1955. Case studies humanize the interactions among lending institutions, agents, and farm borrowers in the nineteenth century.
Chandler, LesterV. America’s Greatest Depression, 1929- 1941. New York: Harper & Row, 1970. Devotes much attention to the debt crisis and the extensive federal programs that attempted to deal with it.
“Credit and Housing Markets.” Economic Report of the President, 2008. Washington, D.C.: Government Printing Office, 2008. Simple but comprehensive review of the subprime mortgage mess and its macroeconomic effects.
Markham, Jerry W. A Financial History of the United States. Vol. 3. Armonk, N.Y.: M. E. Sharpe, 2002. Chapter 2 reviews the savings and loan crisis; Chapter 5 gives an excellent overview of the complexities arising for mortgage markets from the 1970’s on.
Quigley, John M. “Federal Credit and Insurance Programs: Housing.” Review, July/August, 2006, pp. 281-321. Recommends limiting the activity of the FHA and government-sponsored enterprises to first-time home buyers.
See also: construction industry; Deregulation of financial institutions; Farm Credit Administration; U.S. Department of Housing and Urban Development; Commercial real estate industry; Residential real estate industry.

Deregulation of financial institutions: Financial Crisis of 2008

Deregulation of financial institutions: After World War II

Truth-in-lending laws

Savings and loan associations (S&Ls)

Financial crisis of 2008

Farm Credit Administration

Deregulation of financial institutions

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