How the Mortgage Industry Was Built: Part 2

Whenever you hear talk about government bailouts, you rarely get to see behind the scenes. All you know is that some fuzzy entity called the US government is stepping in to fix big problems. You don’t really care when it started or why it happened, so long as it gets fixed. But the beauty of learning about how systems are built, is that you get to learn about them from the ground up—and that’s powerful when you think about how important housing is to the US economy.

We need to remember that the 30-year fixed mortgage was created as a solution to the US economic collapse in the ‘20s and ‘30s. It wasn't designed for homeownership—it was designed to dig the US out of the financial rut it was in. Nowadays, 20% of US GDP comes from physical real estate, while 55% of our national debt comes from mortgages. The US economy has grown right alongside the mortgage industry, and the bones of housing influence everything else.

HOLC Disbanded

As I mentioned before, the Home Owners Loan Corporation (HOLC) was established in 1933 as a way to save homeowners from foreclosure. By using government-backed bonds, HOLC bought up about a million homes and converted their previous 5 to 10 year variable rate mortgages into 20-year fixed rate mortgages. This was so homeowners could repurchase their homes from HOLC while managing to afford the new lower payments.

But HOLC was never meant to be a permanent solution, and the government was already working on a new administration to replace it: the FHA.

How the FHA was Born (1934)

Part of Franklin Delano Roosevelt’s New Deal program, the National Housing Act of 1934 created the Federal Housing Administration (FHA) a year after HOLC was formed. The FHA was the first administration of its kind, creating a federally guaranteed mortgage insurance program, which allowed banks to issue mortgages with lower interest rates and make housing accessible to more people. Because the government provided security to investors; if homeowners defaulted on their mortgage, then the US government would step in and pay off the rest of the loan.

Because the federal government didn’t want HOLC to remain responsible for the debt it had bought up during the Great Depression, it decided that it needed to make mortgages more appealing to potential homeowners and investors.

The FHA allowed for lower, fixed interest rate mortgages, and also offered lower down payment options. This caused investors to heave a huge sigh of relief, because these new mortgage terms, paired with the FHA’s insurance guarantee, meant that investors wouldn’t lose their money, and could invest with confidence.

How to Maintain Housing Liquidity?

The other reason that the FHA adopted longer term fixed rate loans was to avoid what had helped cause the Great Depression in the first place—forced refinances.

With HOLC and the FHA in place, the US economy started to stabilize and get back up on its feet. But even as the US economy stabilized, HOLC was already starting to crack under the weight of the debt it had taken on.

The trouble wasn’t buying up mortgages—it was selling them back to homeowners so that HOLC’s bank sheets would be freed up, ensuring market liquidity by giving them more room to lend. At the time, HOLC was too disorganized to buy up mortgages in the quantities that the government needed it to. So, in 1936, HOLC was disbanded, and in 1938, Fannie Mae stepped in to take its place.