Home Sweet Home, part 2

                         -Our lives begin to end the day we become

                                    silent about things that matter                                                  -Martin Luther King 

First published online April 26, 2010
In September 2008 President Bush informed shocked Americans that the banking system was near collapse. Congress hastily passed a $700 billion bailout called Toxic Assets Relief Program (TARP) to ‘salvage‘ the system.  No Congressional inquiry has occurred to date on lawmaker involvement in the meltdown.
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It’s hard to imagine how difficult it used to be to buy a house. To acquire a home mortgage before 1938* banks required 50% down and the balance paid off within 5 years, an elusive task.  Savings and loans (S&L) existed since the 1830s but they had no depositors’ insurance so a crash or panic could wipe out everything. The creation of the insurance business as we know it began after the 1666 Great Fire of London and became a crucial component of growing wealth.  Not until Franklin Roosevelt (FDR) was it applied to home mortgages.

FDR passed the 1933 Glass Steagall Act to encourage public trust in banks again by insuring bank deposits up to $40,000, managed by the Federal Deposit Insurance Corporation (FDIC).  A vital provision of this act was closing loopholes that weakened the system, such as the prohibition of banks from owning other financial companies. 

If a bank or S&L controlled where and how its depositor’s money was invested what was to stop that bank or S&L from creating its own construction business, or travel agency, or buying its own Lear jet?  Remember the Glass Steagall Act-it comes back with a bang in Part 3.

Fannie Mae Invents the Home Mortgage Market

FDR’s 1938 Federal Housing Administration’s (FHA) Fannie Mae radically changed the meaning of home.  This federally backed insurance plan provided mortgage lenders protection on 20 year loans of up to 80% of the purchase price, with low interest, that were fully amortized, meaning gradually writing off the initial cost of the loan.

Thus began an experiment in expanding working class home ownership.  Fannie Mae helped millions become property owners for the first time, vesting them in the market economy.  While Europe created public housing projects, the U.S. government encouraged home-ownership,* up from 40% to 60% by 1960, using strict borrowing rules, specially by today’s standards.  The only deviation was for the 1944 GI Bill’s returning veterans.  Qualified veterans received low interest, zero down payment home loans.

Fannie Mae was authorized to issue bonds--a certificate issued by government or a public company promising to repay borrowed money at a fixed rate of interest for a specified time period--and use the proceeds to buy mortgages from local S&Ls.  The rules were sound including:
1. Borrowers must reside no more than 50 miles away from S&L offices
2. Regulation Q: Interest rate would be a minimum amount over the prime rate--the lowest rate of interest on commercially borrowed money.

Meddling-President’s Johnson, Nixon & Carter

In 1968, in tandem with civil rights legislation, Fannie Mae was split in two:  Ginnie Mae would cater to poor borrowers like vets and Fannie Mae became a privately owned government sponsored enterprise-GSE, which could buy conventional as well as government guaranteed mortgages.

In 1970 Congress created Freddie Mac as a government sponsored enterprise (GSE), to buy mortgages on the secondary market, pool them and sell them as mortgage-backed securities on the open market.  Although not backed by the U.S. government, Freddie Mac has special authority to borrow from the U.S. Treasury.  Freddie Mac’s purpose was to lower loan rates.  If you bought a home before 1970 you probably sent your monthly mortgage payment to the same lender for the life of the loan.  Not any more.

By 1977 Congress further adjusted FDR’s Fannie Mae formula.  The Community Reinvestment Act (CRA) mandated American banks lend to poorer minority communities.  ‘Sounds good on paper for it tried to address the smaller percentage of home ownership among some minority communities.  But Congress began pushing banks to weaken requirements for home loans, rules that had kept the mortgage market solvent since 1938. 

The CRA coincided with Savings and Loan (S&L) deregulation that allowed S&L members to invest in commercial property, junk bonds, stocks, credit cards, private housing, whatever, to anyone, anywhere.  Prior to deregulation S&Ls could only loan money for personal mortgages to account holders living within 50 miles of an S&L office.  That was the deregulation part.  The financially criminal part was the federal government continued to guarantee those loans--up to $100,000, raised from the $40,000 established in 1938.

Overnight lenders no longer feared losing their shirts if they didn’t screen out bad loans--they weren’t on the hook anymore, the taxpayers were.  This legislative tampering caused the collapse of the S&Ls by the 1980s.  Powerful politicians like the Clintons and John McCain were tainted with blowback.  The whole debacle ended up costing taxpayers over $1 trillion, according to some sources, the largest fraud in U.S. history.  Unfortunately we hadn’t seen anything yet.

Conclusion

I began my research with the premise Big Government is always too cumbersome and partisan to effect positive change.  Then I read about the 1933 Glass Steagall Act and the creation of Fannie Mae.  Unfortunately these laws should have had a unmitigated qualifier:  Not to be tampered with in ANY WAY after 1944. The Constitutional framers somehow understood that any federal infringement on the free market would always end badly.  They were right.  It was FDR's federal bureaucracy that adopted home ownership as an ideal, an ideal that morphed into a hydra of different federal agencies propping up the whole ownership scaffolding.  Which means everyone has paid a LOT more for our higher levels of home ownership than it could ever be worth.

In Part 3 you will see how the best intentions of government descended into the worst partisan politics. Republicans and Democrats administrations were equally engaged in removing vital Wall Street restraints that have catapulted our financial system to the brink of collapse. 

*U.S. Census home ownership rates from 1900 to 2000.

  Next: Roots of Hope:  Systemic collapse

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Sources:
The Housing Boom and Bust by Thomas Sowell, 2009
The Ascent of Money by Niall Ferguson, 2008
A Patriot’s History of the United States by Larry Schweikart, 2004
End of Wall Street by Roger Lowenstein
A Colossal Failure of Common Sense-The Inside Story of the Collapse of Lehman Brothers by Lawrence G. McDonald