The real-estate market is suffering now, but it was worse then
By Lew Sichelman
Realty Q&A is a weekly column in which Lew Sichelman, a nationally syndicated columnist who has been covering the housing market for more than 35 years, responds to readers’ questions on real estate.
WASHINGTON (MarketWatch) — Question: I know that the New Deal created the Home Owners’ Loan Corp. I have been eager to read an article by someone who has looked at the way that mortgage crisis was handled ... and compared it to government efforts in our present crisis. If you are familiar with anything written on this subject I would appreciate your informing me where to find it. If you are not aware of anything, I might suggest that you would be an excellent person to explore it. —M.N.
Answer: Actually, you’re in luck. I do know of one such study; it was done a few years ago by Alex Pollock, a resident fellow at the American Enterprise Institute in Washington and the former president of the Federal Home Loan Bank of Chicago.
Pollock looked back to 1933, when Congress created the Home Owners’ Loan Corp. as a temporary fix “to relieve the mortgage strain and then liquidate.”
While the current mortgage meltdown and resulting — or corresponding, depending on your point of view — housing bust has been described as the worst since the Great Depression, it is nothing when compared to what happened in ‘33, when a financial and economic collapse occurred that is all but impossible to imagine today.
Back then, about half of all mortgage debt was in default. Unemployment reached 25%, thousands of banks and savings and loans had failed and annual mortgage lending had fallen by some 80%. New residential construction had dropped by 80% as well.
The prelude to the crisis might sound familiar. It was a period of grand economic growth and overconfident lending and borrowing. The 1920s featured interest-only loans, balloon payments, an assumption of ever-rising prices and the firm belief in the easy availability of a string of refinancings.
And then came the crash, the defaults, and the markets froze.
By comparison, only 2.95% of mortgages as of Oct.1, 2007, when Pollock wrote his paper, were labeled seriously delinquent, meaning roughly 1.5 million loans 90 days past due or in foreclosure. That’s risen to 9.11%, as of the second quarter this year, according to the latest figures from the Mortgage Bankers Association. Read more on foreclosures drop, but delinquencies rise, in MBA's second-quarter report.
In sheer numbers, that’s a lot of troubled borrowers. But as a percentage of a much, much larger base than in the early ‘30s, their number is relatively small.
How to fix the problem
Of course, if you are one of those who is unable to make mortgage payments, or are facing the prospect of an unaffordable house payment, you don’t want to hear about percentages. You want help, if not from your lender, then from your government.
Lenders claim they are doing their damnedest to work with delinquent borrowers. But consumer groups say they need to do more, and the public discussion is full of proposals at both the state and federal levels for some sort of government intervention.
The current debate about what to do is a common theme that follows almost all housing busts, Pollock said. “This is a recurring phase,” he wrote in his paper. “There is a political imperative to do something. History is clear that government actions are always taken. It is only a question of which ones.”
While there is certainly no dearth of ideas on how to fix the mortgage markets, Pollock suggested that it is well worth taking a look at what was done to clean up the 1933 bust and save millions of homeowners from catastrophe.
Historical perspective
Since AEI is a private, nonpartisan, not-for-profit public policy research institute, and since neither AEI nor Pollock have a dog in this fight, it seems to me to be a good idea to peer backwards before trudging forwards, if only because it is always good to bring some historical perspective to any issue of such magnitude.
Seventy-seven years ago, with a law that took only 3½ pages of text, Congress created the Home Owners’ Loan Corp. to acquire defaulted residential mortgages from lenders and investors and then refinance them at more favorable and sustainable terms.
In exchange for the loans, lenders would receive HOLC bonds. While the bonds would earn a market rate, the rate was lower than that of the original mortgage, But since the bond took the place of what had become a non-earning asset, and one with little prospect for ever turning a profit, banks eagerly agreed to the trade.
In addition, lenders often would take a loss on the principal value of the original mortgage. This, according to Pollock, was “an essential element of the reliquification program, just as it will be in our current mortgage bust.”
The Home Owners’ Loan Act called for the directors of the government-sponsored corporation to liquidate the company when it’s “purpose had been accomplished” and pay any surplus or accumulated funds to the U.S. Treasury. In 1951, during the height of another housing boom, they did just that, closing the pages on a period of history that has long been forgotten.
Eighteen years was probably a little longer than lawmakers originally expected. But during its life, the Home Owners’ Loan Corp. made more than a million loans to refinance troubled mortgages, according to Pollock, who had spent 35 years in banking when he left the Chicago Fed in 2004. That’s about 20% of all mortgages in the country at that time.
By 1937 alone, in what the AEI scholar calls a “remarkable scale of operations,” the Home Owners’ Loan Corp. owned almost 14% of the dollar value of all the nation’s outstanding home loans.
HOLC’s investment in any mortgage was limited by law to 80% of the underlying property’s appraised value, with a maximum of $14,000. With an 80% loan-to-value ratio, then, the maximum house price that could be refinanced would be $17,500.
A mere pittance, by today’s standards. But that was in 1933 dollars. After adjusting the $17,500 ceiling by the Consumer Price Index, the maximum today would be about $270,000, Pollock said. And based on changes in the Census Bureau’s median house price since 1940, the limit would be something on the order of $1 million.
Therefore, Pollock contends in his paper, a modern HOLC could very well operate all over the country, even in high-cost markets like California and New England.
The 1933 law also set an interest rate ceiling of 5% on the new loans HOLC could make to refinance the old ones it acquired. The spread between this rate and the cost of the bonds the HOLC Corp. issued averaged about 2.5%, according to Pollock. And with long-term Treasury rates now at about 4%, an equivalent spread would lead to a loan rate of about 6.5%.
That may be a tad higher than some borrowers would like. But at least it would be a fixed rate, never to change over the loan’s life. Read more on mortgage rates fall to new record low.
According to Pollock, HOLC tried to accommodate as many borrowers as possible. But there were some borrowers that could not be rescued, no matter what. Eventually, it foreclosed on about 200,000, or 20%, of its loans. In other words, for every four borrowers who were saved, another family lost its home.
An acceptable outcome? Maybe, maybe not. But since each and every home owner who refinanced through this program started in default and was close to foreclosure anyway, Pollock, for one, says the result was “quite respectable.”
“We don’t need something of the same scale” this time around, Pollock said of the HOLC, which had as many as 20,000 employees. “But I think the concept offers a pretty intriguing historical perspective. What I especially like about it is that it set up to do a job, and when it was done, it closed down.”
Nationally syndicated columnist Lew Sichelman has been covering the housing market for more than 35 years. Because of the volume of mail he receives, he cannot answer individual questions, nor can all questions be answered in this space. Email lsichelman@aol.com
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