Mortgage Lending: The Liquidity Factor, Part I
In Mortgage Lending, it has always been said that the two largest purchases families will ever make are homes and cars. Since the 1900s, those two items have not only revolutionized the way we live but also the way we spend. In 1901, the Oldsmobile sold for $650 which works out to be approximately $16,000 in today’s dollars. Home prices were on an average of $5000. In 2019, the average home price peaked to a historic high of $227,000. New car prices hit highs of roughly $35,000 in 2018.
What helped home values to soar so high?
The Housing Hour points to its own terminology, The Liquidity Factor. The Liquidity Factor is the ready availability of loanable funds made possible by the Federal Government and private companies, through varied techniques of government policies and created business entities, which help individuals and companies purchase goods and services that they otherwise would not be able to afford. Simply put, without liquidity in the marketplace buyers only options are to pay with cash. No liquidity means values stay at the levels of what consumers can afford to pay in cash.
The liquidity factor is the key to mortgage lending and home ownership.
The history of Mortgage Lending and The Liquidity Factor.
“In the 1900s, homes generally had to be paid for in cash.”
Mortgage Lending has several historic moments worth noting since the 1900s. The most remarkable pieces of information revolve around long term financing options available in the 1900s, there weren’t any. Mortgage Banks were formed in the 1870’s to help finance the expanding western territories, but they never offered ‘long term’ financing. It tended to be in the 5 to 10-year term range. But unsound underwriting guidelines caused high default rates which led to the demise of these Mortgage Banks by the 1900s, resulting in homes having to be purchased with cash.
The Great Depression: Unemployment exceeds 20%
It wasn’t until the roaring 20’s that expanding credit markets created enough liquidity to spur a mini real estate boom. Insurance Companies saw an opportunity to capitalize on the housing market bubble and got into the home lending field. But whatever a robust market giveth, a declining market taketh away. Black Tuesday struck, leading to The Great Depression. High unemployment and acute deflation caused high foreclosure rates, which collapsed the home lending market for the second time in 30 years. Facing a countrywide crisis, the Federal Government created its own 1929 version of TARP, Troubled Asset Relief Program with the creation of The Home Owners’ Loan Corporation and Reconstruction Finance Corporation (RFC). These entities (like TARP) sole jobs were to liquidate non-performing loans and remove them from the Banks ledgers keeping the banks from insolvency. They were toxic assets. Interestingly enough, homeowners took advantage of this bailout opportunity and intentionally defaulted on their loan. These created government entities are estimated to have purchased over one million mortgages from banks.
The government buying toxic assets may keep the banks from insolvency but it doesn’t cure the lack of liquidity in the market place. No liquidity means no lending, so the Hoover administration started to form (Roosevelt signed into law) the Federal Home Loan Bank. The main goal of the FHLB was to supply the needed liquidity to banks and Savings and Loans, as well as requiring specific lending guidelines, such as mortgage term limits of 10-15 years, as well as other stringent policies. The main lending institutions benefiting were the Savings and Loans. The S&L’s grew rapidly across the country, serving small community areas, creating a small town ‘good ole’ boy feel. Each S&L were owned and managed privately by individuals or groups, giving great control to the board of directors and president. But the expanding S&L’s demanded more flexibility from the government. The S&L’s were not full-service banks. They could not offer checking accounts and other typical banking products. As a result of Banks and S&L’s waging a savings rate war, Congress, in 1966, regulated and limited the amount that banks and S&L’s could pay to customers. However, as a carrot to preserve their savings and lending, the S&L’s were given an award by the Federal Government with permission to increase the savings rate paid to customers in the amount 50 basis points over what traditional banks could offer their saving account customers. This regulation was known as Regulation Q. But the intentions of the regulation were more than just an award for the S&L’s; it also served as a back door liquidity technique. Regulation Q created a cash-rich environment for the S&L’s and helped secure them as the leading mortgage lending institution in the nation, supplying the market with the necessary liquidity until the collapse of the S&L’s in the ’80s, paving the way for the expansion of FNMA and Freddie Mac.