Democracy Unchained by Unknown

Author:Unknown
Language: eng
Format: epub
Publisher: The New Press
Published: 2020-08-14T16:00:00+00:00

Regulating Housing Finance

The mortgage finance system also required drastic overhaul. Until the 1930s, a mortgage was typically a short-term note, often of just five years. The homeowner paid only interest until the note came due. In normal times, the note was rolled over at prevailing interest rates. But during financial panics when banks were short of funds, homeowners lost everything because they could not get a new mortgage.

In the Great Depression, housing values collapsed and thousands of banks failed. Even a bank that had money would not make a mortgage loan on a house that was worth less than the loan amount, and many people could not afford to meet their payments because they were out of work. In the spring of 1933, half of the mortgages in America were in default, and banks were failing by the thousands.

In response, the Roosevelt administration invented deposit insurance and remade the entire mortgage system, starting with the Home Owners Loan Corporation, which eventually refinanced about one mortgage in five. The 1934 National Housing Act created long-term, self-amortizing mortgages with low down payments, and a new agency, the Federal Housing Administration, to insure them. Over time, a changing mix of interest and principal would not just carry a loan, but also pay it off. A secondary mortgage market, the Federal National Mortgage Association, was created in 1938 to purchase mortgages from banks and thrift institutions so their funds could be replenished and they could make more loans. Under the GI Bill of Rights in 1946, down-payment requirements were lowered even further.

The whole system worked like a Swiss watch. Standards were high but not punitive. The homeownership rate rose from 40 percent to around 62 percent by 1960. Defaults and bank failures were vanishingly rare.

In the 1970s, inflation began to stress the system. The thirty-year fixed rates that banks had offered effectively accrued negative interest as inflation increased. Bank losses led to calls for deregulation so the banks could pursue other profit opportunities. As corporate political power increased and free-market conservatives took over government, Wall Street’s capacity to “innovate” overwhelmed regulators’ capacity or appetite for protecting the public interest. The non-regulation and deliberate deregulation that followed, were cheered on by neo-liberals in government and by their allies in the financial industry.

The consequence was a proliferation of new forms of financial instruments, whose risks were opaque to both consumers and regulators. As allies of the financial industry took over government, regulators regarded these new instruments with studied incuriosity. Wall Street simply had its way with the economy. As in the 1920s, the result was a pyramiding of hidden, speculative debt unbacked by actual capital, and it all finally came crashing down in the collapse of 2008. The Federal Reserve and the Treasury responded by pumping several trillion dollars into the financial system to bail out banks that were insolvent, but not to clean them out.

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