FDR Solves The Mortgage Crisis

The New Republic: There Are Lessons In How Roosevelt Dealt With A Similar Housing Situation 75 Years Ago

(The New Republic) 
It is important to recognize that HOLC loans were never considered an entitlement program. Of the nearly 1.9 million applications to HOLC between June 1933 and June 1935, half were withdrawn or rejected. HOLC provided widespread assistance, but homeowners had to demonstrate a determination to meet their financial obligations and a history of doing so.

In order for the HOLC to issue a loan, it needed to pay off the existing liens. This potentially posed a serious problem, as HOLC loans were never to exceed 80 percent of the appraised value of a property, which was often below the outstanding loan balance. The HOLC had to convince the existing lenders to accept those losses. The HOLC was able to succeed because it made lenders an offer they couldn't refuse: A government guarantee of four percent interest in the amount of the new loan, which was worth far more (even at a reduced valuation) than the zero percent they were effectively getting from delinquent loans. Add to that the cost of servicing, foreclosure, and disposition, the decision was a no-brainer.

HOLC actively issued loans for only three years, between 1933 and 1936. It was a short-term entity designed to deal specifically with the problem of widespread foreclosures. After 1936, the HOLC existed as a shell of its former self, servicing existing loans and disposing of the properties it acquired through foreclosure. The HOLC was liquidated in 1951 at a small profit. Despite its short active lifespan, its innovations have had a long-lasting impact, from the government-insured loans offered by HOLC's successor, the Federal Housing Administration, to the long-term, fully amortizing "conforming" loans offered to most home buyers.

That's the kind of leadership needed today. The U.S. home mortgage marketplace of the 21st century resembles the 1930s not at all, yet the expectations of President Bush, financial regulators and some congressional leaders that creditors will rescue borrowers are still misplaced. Most banks and other lenders today only briefly keep the mortgages they make before onselling those loans to Wall Street, which repackages them into mortgage-backed securities for sale to institutional investors worldwide. Unfortunately for most Americans facing delinquency and foreclosure (and their neighbors, who are as susceptible to losing their equity in falling markets), the proposals to help homeowners center on reopening the flow of mortgage funds, be it through an expanded role for the Federal Housing Administration or more latitude for Fannie Mae and Freddie Mac to securitize more and bigger loans.

Expanding the amount of credit available for home loans is not going to be helpful in the short term, as the homeowners who need the most help are unlikely to be deemed creditworthy for refinancing. By directly lending to homeowners, we also circumvent the very real moral hazard of creating incentives for lenders to engage once again in the behaviors that put homeowners at risk. The president and Congress, therefore, must focus on the needs of homeowning neighborhoods and work from there. We have a proud history in this country of directly aiding families at risk of losing their homes through no fault of their own in order to preserve neighborhood wealth created through homeownership; it is time we learned from it.

Economists estimate that each foreclosure within an eighth of a mile corresponds to a 0.9 percent decrease in house value. Neighborhoods with high rates of vacant properties attract violent crime and are more prone to fires, both of which threaten neighborhood stability and significantly drain municipal resources. Given that many of the homes most at risk of foreclosure are concentrated in less expensive neighborhoods, the threat of eroding the wealth of low- and middle-income families is quite real.

Moreover, as the threat of eroding house prices looms larger, a neighborhood's downward spiral can be hastened by panicked homeowners willing to take any offer before their house becomes nearly worthless. By providing direct assistance to homeowners through a government entity modeled on the HOLC but with the ability to negotiate the complexities of the present securitization process, we can eliminate the panic and stabilize neighborhoods in addition to helping individual homeowners.

Most of the time, financial marketplaces efficiently intermediate between home loan borrowers, lenders and investors, but sometimes preserving neighborhood wealth requires an old-fashioned solution. That time may well be at hand.