A Brief History Of Mortgage Financing In The United States

It’s easy to dismiss a historical and introspective review of the mortgage as a tool to finance homeownership; after all, getting approved for a mortgage is still an aspiration of millions of Americans. At the most basic level, a mortgage is a long-term consumer loan taken for the purpose of eventually paying off the loan and owning a house and the land it sits on “free and clear.” This ownership entitles the successful borrower to the benefits of the full appreciated value of the asset. But how did this particular instrument emerge as the preferred way of achieving what we now commonly call “homeownership.”

It’s fair to say that there has been borrowing and lending going on since there have been people in advanced societies, and perhaps even before that. It is a basic human need and interaction to try to acquire things of value even when one doesn’t have the goods or the money to pay for it outright. One of the earliest pieces of evidence of using land to borrow goes back to the Code of Hammurabi, chiseled into stone almost 4,000 years ago. Laws 49 and following outline the rules around borrowing money using land and the crops they produce as collateral.

The Roman’s understood the concept of hypothecation, the practice of using an asset like land as collateral, using a fixed asset to borrow money without giving up ownership of the land. The lender could take the land if the money wasn’t paid back. This system is a basic concept familiar to almost everyone in contemporary times. Later, the development of feudalism was dependent on land and service and the conveyance of land was complicated. In 1536, to address tax evasion, the Parliament under Henry VIII passed the Statute of Uses. This might seem arcane, but the term “fee simple” and “deed” emerged from this period. Conveyances had to be recorded – a term familiar to anyone who has done anything with real estate – to keep track of who owned what.

As feudalism faded and trade, money, and land practices became more transactional and freer from political obligations, and the term mortgage became more common. The term, like many terms in English Common Law is of Anglo-French origin and means “dead pledge” or “death pledge” meaning when the promise to pay a loan is met, the obligation is dead or void. This notion, that loan terms would be set and paid over time, would set the stage for building societies in England and building and loans in the United States. Individuals would buy shares in a building and loan, and the organization would then loan the shareholder the money for a home. Paying for the shares over time also meant getting a dividend as others paid their loans. The “building and loan” is a familiar term to fans of It’s a Wonderful Life, a feature of the plot of the film that unfolds in the 1920s and 1930s.

What’s compelling and worth pointing out here, is that up to the 1930s in the United States, longer term debt to acquire a home was a cooperative effort; the acquisition of a home by people earning less money was incremental, but accomplished by pooling resources to create enough assets to support lending to people who otherwise couldn’t qualify for a loan because of their limited assets and earnings. In other words, it was a pooling of money and risk within a community of individuals.

But with the passage of the National Housing Act of 1934 (the Act) and the creation of the Federal Housing Administration, the notion of homeownership became more of the individual enterprise we’re familiar with today. The Act is the root of our current view that housing needs to be subsidized to be affordable, something I wrote about as being not just about financing but a stubborn cultural shift. What the creation of the Federal Housing Administration (FHA) did was also a fundamental shift, shifting the risk of lending for eventual homeownership from local, cooperative enterprises like buildings and loans, to banks and large-scale lending.

Not long after the passage of the Act, the government created the Federal National Mortgage Association (Fannie Mae) which began buying mortgages insured by the FHA. This dramatically reduced the risk taken by banks when making a loan to a person with limited income and few or no fixed assets – collateral – that could be claimed for lack of payment. The home and land itself would become the collateral but the real spark that lit the flame of rapid growth in the mortgages we know today was the amelioration of the risk because all the debt would be covered by the federal government.

A valuable rundown by the Federal Reserve Bank of Richmond, A Short History of Long-Term Mortgages, quotes a scholar who characterizes the boom in long-term, 30-year mortgages, once the risk was removed from the equation for lenders.

“In 1940, about 44 percent of Americans owned their home. Two decades later, that number had risen to 62 percent. Daniel Fetter, an economist at Stanford University, argued in a 2014 paper that this increase was driven by rising real incomes, favorable tax treatment of owner-occupied housing, and perhaps most importantly, the widespread adoption of the long-term, fully amortized, low-down-payment mortgage.”

This means that today, a bank originating a mortgage very likely uses standards set by the federal government to evaluate a borrower and set the terms. It allows for a small down payment and low monthly debt service. But the lender is simply a pass through, making the loan, then selling the loan to the federal government or its chartered enterprise. If you have a first-time mortgage, it’s very likely that the bank you’re making payments to is simply servicing the loan, not holding it. The further securitization of mortgage debt led to the 2008 financial crisis, when the allure of profitable transaction costs and government backing sparked “a no credit, no down payment, no problem” run on mortgages.

What this historical sketch reveals, is that mortgages are not necessarily the best way to borrow for the acquisition of a place to call home, but simply the most recent. What is also vivid is that to make a loan for the purchase of a very expensive fixed asset like a house on a piece of land, there needs to be some very deep pockets to reduce the risk of such lending. But that backing can create distortions in the market which fuel lending that can lead to more risky lending. But it is just as important to see that shifting the risk from fellow community members toward larger financial institutions (think of this key scene from It’s a Wonderful Life), has broad and pervasive affects as well.