Homeownership has defined what it means to be a middle-class American since the 1920s (Megbolugbe and Linneman, 1993).
As a result, politicians in both the Democratic and Republican Parties have favored policies that promote homeownership. In practice, this has meant that the evolution of the housing market has been deeply entwined with the history of the welfare state in the United States since the Great Depression (Prasad, 2012).
Everything to do with government policy has consistently worked to try to favor homeownership. The government standardized mortgages by creating the rules that define a conventional mortgage as combining a low down payment (20 percent or less) for a long fixed term (fifteen to thirty years) with a fixed interest rate. It has helped underwrite the financing in the housing market directly in the case of the Federal Housing Authority and the Veterans Administration Home Loans and indirectly through the government-sponsored enterprises (GSEs). The interest deduction for home mortgages has provided a substantial tax break for middle-class Americans and promoted homeownership. The explicit policy purpose of creating the GSEs was to draw more private capital into the private housing market to increase the rate of homeownership.But this has not always been a smooth ride. Indeed, the history of government intervention into the housing market is a story of a burgeoning crisis and collapse of the banks and other financial institutions that were dominating the market for mortgages followed by a government attempt to resurrect the market. Republican and Democratic presidents and Congresses dominated by both parties have always ridden to the aid of the housing industry in its moment of crisis. This has happened four times since 1930: during the Great Depression of the 1930s, in the first crisis of the savings and loan banks in the 1970s, during the collapse of the saving and loan banks in the 1980s, and during the takeover of Fannie Mae and Freddie Mac in the wake of the financial crisis in 2008-2009.
Each of these reforms has been proposed by some set of banks in the existing banking community. Those who successfully lobbied for their alternative got rules changed to favor their business model. In return, the government has made sure that when the banks began to fail, a new set of rules would be in place such that most Americans who had enough income have been able to buy a home by getting a mortgage.In this chapter I take up how this process worked from the Depression until the rise of mortgage securitization. There are three parts to my story. First, the chapter begins by considering how the savings and loan banks came to dominate the mortgage industry in the wake of the collapse of the banking system during the Great Depression. At the behest of a trade association representing the savings and loan banks, the government oversaw the reorganization of the mortgage market by creating the Federal Home Loan Board, which acted as the regulator for the savings and loan system. It created depository insurance for account holders, making it safe for them to deposit their funds. It put ceilings on interest-bearing accounts to stifle competition between banks for those funds. The government defined the modern conventional mortgage, thereby providing guidance for mortgage terms. These changes restored the savings and loan banks and made them the principal mechanism by which Americans got mortgages. After World War II, the savings and loan banks' business model with the help of the government agencies promoting housing proved to be an amazing success, raising the rate of homeownership from about 43 percent on the eve of World War II to 63 percent in 1965.
The second part of my story takes up the fall of the savings and loan industry. Essentially, the bad economic times of the 1970s with high inflation and low economic growth undermined the business model of the savings and loans. High interest rates due to high inflation made the savings and loans unable to continue to borrow money at low interest rates.
It also meant that households had a harder time buying homes that were inflating in value and could not afford either the higher down payments or the bigger monthly payments. At the behest of the industry, the Carter and Reagan administrations intervened by changing the rules by which the banks could borrow and invest. For a few years, it appeared as if the savings and loans might be stabilized. But by the mid-1980s, it was clear that this had been built on risky lending, and the new business model began to fail. When the end came, there was a massive bankruptcy of the industry.The third part of the chapter tracks the rise of the mortgage securitization industry. I document how the GSEs came to create the market for mortgage securitization by working with both the government and the investment banks to create financial products that would be attractive to investors. It took fifteen years to produce the modern MBS. It required the use of financial innovation
around tranching the bonds. But equally important were changes in the tax laws that allowed mortgages to become securities and allowed investors to hold them without negative tax implications. Investment banks, led by Salomon Brothers' executive Lewis Ranieri, in cooperation with officials who ran Freddie Mac, were able to get Congress to pass legislation making the securities more attractive to investors. These changes occurred mostly during the presidency of Ronald Reagan with the enthusiastic help of Congress. When the savings and loan industry collapsed, the GSEs stood ready to organize the market for mortgages.
By the early 1990s, the crisis of the savings and loan industry had given way to a new way for Americans to get their mortgages. The mortgage market was now firmly joined to the financial markets because of mortgage securitization (Hendershott and VanOrder, 1989). This meant that mortgage lenders of all kinds had access to capital markets to fund their activities. It also meant that a new product, the mortgage security, became a major source of profits for those who made, sold, and bought the new bonds.
It was the joining of mortgages to the financial markets that propelled financial innovation through the 1990s and the growth and profits of that sector. The GSEs occupied the center of the mortgage market because of the assumption that the federal government would bail out any problems in the market for GSE-issued bonds. Their products became known as agency-backed bonds, and their safety and returns mimicked those of government securities, reflecting their privileged status in the market.It is fascinating that a Republican president, George H. W. Bush, oversaw one of the largest expansions of direct government action to organize a private market. Moreover, this takeover was little noticed by the public, the media, or Congress. Had the GSEs not taken the main role in organizing the market for mortgages, the public would have been unable to easily secure mortgages to buy homes. But the massive shift in the way mortgages were funded was little noticed as long as people could continue to get mortgages. Ironically, this more direct intervention was never perceived by the public as government intervention or ownership because it was so well hidden. Part of the subterfuge was to allow the GSEs to become publicly listed corporations while still maintaining the assumption that if there was a problem, the government would be there to bail the holders of MBSs out. When the crisis hit in 2008, the government did its part, and the GSEs came under direct government ownership and control.
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