The History of Mortgage Lending and The Liquidity Factor.
At the peak of the Great Depression, the Hoover administration realized the importance of the liquidity factor. Their policies bolstered the S&L’s, securing them as the main channel to provide the necessary liquidity to the mortgage market. The Federal Home Loan Bank supplied millions of dollars to the local banks and Savings and Loans for lending.
The importance of the S&L’s was, unintentionally, immortalized in the holiday classic, It’s A Wonderful Life. George Bailey was struggling to save his father’s Building and Loan business (essentially a Savings and Loan) from being taken over by the evil Henry Potter. George Bailey’s father built the business around the principle that the common worker needed the ability to borrow money for a better home and quality of life rather than living in the horrid conditions of Henry Potter’s slumlord developments. Mr. Potter, being a significant shareholder in the Bailey family Building and Loan, admonishes the board for lending money to the ‘rabble’ types (or the lower classes; the common people) that live in Bedford Falls.
In the famous scene, George Bailey rallies the board with the inspiring lines directed toward Mr. Potter, “You… you said… They had to wait and save their money before they even ought to think of a decent home. Wait? Wait for what? Until their children grow up and leave them? Until they’re so old and broken down that they… Do you know how long it takes a working man to save $5,000? Just remember this, Mr. Potter, that this rabble you’re talking about… they do most of the working and paying and living and dying in this community. Well, is it too much to have them work and pay and live and die in a couple of decent rooms and a bath?” Watch the full scene:
This scene typifies the great American dream that everyone should have the same opportunity to own their own home. George even points out what current research has verified when he asks the board a simple question “…doesn’t it make them better citizens?”Home ownership has social benefits and every president from Herbert Hoover to present has tried to further that sentiment.
But the scene also points out, inadvertently, the weakness of the Savings and Loan. That weakness was its localized business philosophy: meaning the small town, ‘good ol boy ‘ way of doing business. In every community across the country, S&L’s were the dominant player in the savings and lending business. Decisions were often based on who you knew or a set of standards and dynamics that was specific to a particular area or community.
When Roosevelt was elected in 1933, policies regarding how to supply the mortgage lending market with liquidity changed. Roosevelt saw the disadvantages of the small town, local S&L’s and opted for a nationally standardized way of supplying liquidity. In 1934, The National Housing Act was authorized which created three particularly significant changes to the housing market. First, the Federal Housing Administration (FHA) was formed to improve housing standards and to insure the mortgages against default to the lenders, bringing stability to the financing market. Fixed rate loans were introduced with terms in excess of 20 years and smaller down payment requirements. Lastly, a government-sponsored enterprise (GSE) was authorized to purchase originated mortgages from lenders and securitization of those loans in the form of Mortgage Backed Securities (MBS).
In 1937, the Federal National Mortgage Association (FNMA or Fannie Mae, a GSE) was created to provide liquidity to the mortgage market by buying the newly originated FHA loans from lenders. This technique gave the lender the ability to replenish their cash assets so they could continue to provide additional FHA loans. FNMA, at that time, only bought FHA loans and did not enter the conventional financing market until 1970 when her younger brother, Federal Home Loan Mortgage Corporation (FHLMC or Freddie Mac), another GSE, was formed. As a result of the expansion of the GSE’s role in the liquidity market, Fannie Mae and Freddie Mac became the largest private mortgage companies in the country. Although the GSE’s are publicly traded and non-government owned, the US government gives its full backing to the loan products they purchase. The full backing of the US makes these mortgage bond investments one of the best investment choices in the domestic and foreign markets.
It is essential to note, the commercial banks were generally the only lending institution participating in the newly created FHA loans. The majority of the S&L’s continued with their long developed business practice of keeping originated mortgage products on their books. If they needed to create liquidity, they just sold their portfolio loans to other S&Ls across the country. This decision to not participate in government loans and the diversified liquidity it would provide them would play a future key role in the collapse of the S&Ls.