Housing and the New Financial Mark

Richard L. Florida

• Publisher: Routledge
• Year: 2019
• ISBN:
  9781000677454
• Edition: 1
• Topic: Politics & International Relations
• Subtopic: City Planning & Urban Development
• Index: Politics & International Relations

This book explores how deregulation affect housing finance, and gives the broad patterns of development of institutions participating in mortgage markets. It also explores how the new housing finance system influences the cost and affordability of shelter.

Part I

The New Deal System of Housing Finance

The New Deal system of housing finance was characterized by its insulation from the rest of the financial structure. This section focuses on the institutional mechanisms and functions of that insulated system. The paper by Barbara Miles begins by discussing the economic functions performed by mortgage markets and provides an overview of actual mortgage financing institutions. The appendix to this paper provides a concise listing of the major types of intermediaries involved in mortgage finance. The article by Semer et al. explores the economic rationale behind the creation of two primary components of the New Deal system—the Federal Home Loan Bank system and the Federal Housing Administration mortgage insurance program. This paper argues that highly localized and generally small institutions were thought to be “natural” housing lenders; their source of capital (savings deposits) was thus clearly distinguished from other types of funds. FHA mortgage insurance was similarly devised to show private lenders the viability of providing housing credit on a long-term basis. The final contribution, by Williams, outlines the development of a secondary mortgage market in terms of both its functions and its institutions.

1

Housing Finance: Development and Evolution in Mortgage Markets

Barbara Miles

Introduction

The structure of mortgage markets is key to an understanding of housing industries for two major reasons. First, a large majority of housing sales and construction is financed through debt. As a result, the provision of housing is crucially dependent upon the availability and cost of credit. Second, from a larger point of view, residential mortgage financing is one of the largest uses of available credit in the economy, generally accounting for about a fifth of all funds raised in U.S. credit markets and a third of funds raised by the Nation’s private, non-financial sectors. The proportion and amount of credit going to housing changes dramatically, however, in response to interest rate swings, resulting in considerable cyclical instability in both home building and real estate sales, and usually leading to similar instability in the overall economy. Within this context, the development of mortgage lending institutions and patterns has occurred in direct response to the perceived failure of markets to provide housing consistently at the level desired as a matter of public policy.

This paper is intended to give a broad overview of the structure of residential mortgage financing. It first outlines the workings of mortgage markets; second, gives the broad patterns of development of institutions participating in those markets; and third, provides a brief sketch of the major institutional actors and the functions they perform.

Functions of Mortgage Markets

Mortgage institutions are structured to provide for five basic functions in raising and distributing capital for housing: origination, servicing, investment, transformation, and insurance.

Origination is the initial making of a mortgage loan. That is, origination occurs when a lender gives a loan to a borrower in exchange for a mortgage or lien against real property. For example, a home buyer receives a loan from a lending institution, uses the funds to close the purchase, and grants the lender a mortgage on the house as security to ensure repayment. Originations of home mortgages¹ totaled about $62 billion in the first three quarters of 1982, and apartment building mortgages were another $8 billion. By comparison, total originations for the peak years of the late 1970s were about $185 billion annually for home mortgages and $16 billion annually for project mortgages. These figures reflect sales of previously occupied housing as well as new construction.

Servicing is the function of collecting monthly repayments of principal and payment of interest, keeping records, maintaining escrow accounts for taxes and hazard insurance where needed, and similar chores. Should the original or “primary” lender (originator) choose to sell a mortgage or an interest in a mortgage to another party, servicing may also include passing the monthly payments through to that “secondary” lender. Servicing may be provided by the originator or the holder who purchased the loan, or may be contracted out for a fee to a third party.

Investment is the function performed by the lender who is the ultimate holder of the loan and, thereby, the source of funds for the mortgage loan. If the originator holds the mortgage, then that primary lender is also the investor. If the originator sells the mortgage, then the secondary lender to whom it is sold is the investor. Investors can and do trade in both new and “seasoned” mortgages, interests in mortgages, and interests in groups of mortgages. In the first three quarters of 1982, $77 billion in home mortgages and $9 billion in apartment building mortgages were purchased by secondary investors, more than were originated during that period.

Transformation is the function of changing an ordinary mortgage loan into a form which is more easily sold to investors. The most common such form today is the pass-through security backed by a pool of mortgages. Typically, a mortgage is placed into a pool with a large number of similar mortgages, and securities representing a share in the value and income of the pool are sold to investors instead of the individual mortgages. Purchases into pools in the first three quarters of 1982 totalled about $34 billion in home and $4 billion in apartment mortgages, representing about 44 percent and 42 percent, respectively, of all secondary mortgage purchases.

Insurance is the function of sharing risk of late or non-repayment of a loan. Typically, a lender will require insurance on any home mortgage loan with a loan-to-value ratio over 80 percent (a downpayment of less than 20 percent). Such insurance pays off in the event of foreclosure and can result in losses to the insurers if the resale value of the property is insufficient to cover the outstanding balance of the defaulted loan plus the costs of foreclosure and property sale.

Insurance is available for securities backed by mortgage pools as well as for individual mortgages. In such cases, what is usually insured is not simply that the securities holders will be paid in the event of default, but rather that the regular amount due to securities holders will be paid on the agreed-upon schedule. In the first half of 1982, net new mortgage insurance issued by private insurers totalled $7 billion with another $4½ billion covered by insurance programs of the Federal Government.

All of these functions are performed in three rather distinct stages: commitment, the closing (or primary) stage, and the secondary stage. The commitment stage is one in which the necessary lines of credit are established. For example, a builder who wishes to assure the availability of financing for a new development will request mortgage commitments from an originator, perhaps a mortgage banker or savings and loan association. That lender may decide to make the commitment based on funds already on hand, or may apply to a secondary lender such as the Federal National Mortgage Association (FNMA) for a secondary commitment to purchase the mortgages. If the mortgages are to be Government-insured (FHA or VA), the originator may apply for a pool arrangement to be insured by the Government National Mortgage Association (GNMA). When the commitments are all secured, the builder can proceed with sales and construction. The same process applies to resale housing, except that a broker or the seller or the home purchaser secures the lender’s commitment.

In the primary stage of lending, the home buyer agrees to buy a house and requests financing. The builder-seller uses the commitment obtained from the originator to arrange the loan, and arranges insurance, if necessary under terms of the commitment. The originator then executes the loan, the buyer-borrower uses the loan proceeds to pay the builder and the deal is closed.

In the secondary stage, the originator may elect to keep the mortgage, sell it to, for example, FNMA under the commitment price or to another investor if the FNMA commitment was optional, or pool it with other mortgages for GNMA or other insurers’ approval and insurance. In the last case, the pool of Government-insured mortgages is placed with a trustee, securities are issued to investors who purchase them, and the monthly payments for each loan in the pool are paid into the pool and then passed through to the securities holders.

At any given time, virtually any mortgage-oriented financial institution can be performing any function in any stage. Since the first major governmental intervention in home mortgage financing during the Depression of the 1930s, however, the development of mortgage markets has been characterized by separation and differentiation of these functions and stages, and an increasing specialization of mortgage institutions in their provision.

Development of Mortgage Institutions

The housing finance system as we know it is generally dated from the 1930s when the Federal Government intervened in financial markets in an attempt to stabilize the economy. The major mortgage lenders at that time were mutually owned building and loan societies and banks, which took deposits from households and relent the funds for mortgages. Financial panics in the early years of the Depression set off a severe liquidity crisis among the intermediaries, and forced them to call in the loans they had made in order to cover withdrawals. A preponderance of mortgages were relatively short-term (three to five years), interest only, roll-over or balloon payment² mortgage loans. Often mortgagors could not repay the balloons and, when they were unable to obtain refinancing, were forced into default. The private mortgage insurers in existence at that time did not, in general, have the reserves to handle the huge foreclosure losses which resulted from falling real estate values, and they failed. A variety of temporary measures were taken by the Government in order to prevent fore-closures, ameliorate other hardships, and maintain some liquidity in the banking system.

With relation to housing, the Federal response also included a series of structural changes in lending practices and institutions. The changes were perceived as separating housing finance from commercial and other business banking and, thus, protecting home buyers and owners from the vagaries of general capital markets. It was this series of changes which set up the basic market structure within which current institutions and practices have evolved. The major actions taken included establishment of the Federal Home Loan Bank (FHLB) System under a central Board (FHLBB) as a supervisory agency and central credit facility for home lending institutions.³ Provision was made for federally chartered savings and loan associations (S&Ls) within the FHLB System⁴ and the accounts of depositors were insured by the Federal Savings and Loan Insurance Corporation (FSLIC) which was part of the FHLB System.⁵ The Federal Housing Administration (FHA) was established for the purpose of promoting and insuring long-term, fully amortized mortgage loans.⁶ The Federal National Mortgage Association (FNMA) was founded to be a purchaser of, and thus a guaranteed source of funds for, any FHA-insured loans made by private lenders.⁷ Through the legislation and regulation which followed, S&Ls were designated to be the major instrument of Federal homeownership policy. They were intermediaries with insured, household-oriented savings deposits, Federal sources for emergency funds, relatively secure assets, and a requirement to originate and hold home mortgages.

In the three decades that followed, there were many refinements of the system. Following World War II, the Veterans Administration’s (VA) guaranteed, no-downpayment mortgage loan program was intended to aid returning servicemen in buying houses,⁸ and the Farmers Home Administration (FmHA) was directed toward assisting home purchase in rural areas.⁹ The Housing and Home Finance Agency (HHFA) was established to administer the various housing programs of the Federal Government, and the FHA became a part of the HHFA.¹⁰ In 1949, the Housing Act which declared “a decent home and a suitable living environment for every American family” to be a national goal, became law.¹¹ Attempts to meet that goal over the years used both housing subsidies for lower-income families and tax incentives and Federal support for the mortgage finance system for more affluent households.

In the mid-1950s, two events leading toward a more “private” housing financial system occurred. The first was a major reorganization of the FNMA.¹² FNMA was given a Federal charter under mixed public-private ownership, and was ordered to keep separate accounts for the “special assistance” functions for subsidized housing, the management and liquidation function for mortgages acquired prior to reorganization, and the more general and potentially profitable secondary mortgage market operations. The second event was the incorporation in 1956 of the Mortgage Guarantee Insurance Corporation (MGIC) as the first important private mortgage insurer since the 1930s. MGIC was a direct competitor with the FHA, insuring conventional loans with fewer restrictions on transactions than those of the FHA.

Other adjustments included extending FHA insurance to more kinds of mortgage loans, including home improvement loans, easing FHA down-payment and maturity term...

Table of contents

• Cover
• Half Page
• Title Page
• Copyright Page
• Table of Contents
• Acknowledgment
• Overview
• Part I The New Deal System of Housing Finance
• Part II Early Deregulation Initiatives
• Part III The New Financial Regulation
• Part IV Housing Finance Under Reagan
• Part V The Reorganization of the Thrift Industry
• Part VI The Secondary Mortgage Market
• Part VII Alternative Mortgage Instruments
• Part VIII The Future of Housing Finance
• Suggestions for Further Reading
• Index