Once upon a time, there was a nation where, during an era of prosperity, large numbers of citizens used short-term, interest-only loans to purchase their homes. They apparently were unaware that once the good times ended, they would be saddled with unbearable debt. Which is exactly what happened in America roughly 75 years ago.
During the Roaring ’20s, the typical mortgage was an interest-only loan that ended with a massive balloon payment. That bears a slight resemblance to the adjustable interest rates that were so popular in recent years. As the country lurched into the Depression, banks froze up and could no longer dole out credit, sometimes not even to the most qualified of borrowers. Because homeowners could not refinance, their only recourse was the soup line. By 1933, the year that Franklin Delano Roosevelt took office, many of those payments were coming due, resulting in 1,000 foreclosure filings a day.
During his first year in office, Roosevelt created the Home Owners Loan Corp., or HOLC, to help debt-laden borrowers pay off their mortgages. The HOLC took borrowers out of their high-interest loans and put them into 15-year loans, financed through federal bonds, with rates fixed at about 5 percent. Unlike many government bureaucracies, this was specifically designed to be a short-term program intended to extend loans for three years and then oversee those loans for an additional 15 years.
Roosevelt’s real goal was to create stability from both an economic and social perspective. With the HOLC and the Federal Housing Administration, his administration created the long-term loan, which soon evolved into the 30-year, fixed-rate mortgage. The local business community praised the program, which not only helped people keep their homes, but also provided employment for construction workers. From 1933 to 1936, more than 1 million people relied on HOLC loans. Close to 80 percent of the borrowers made good on their payments and kept their houses. When the HOLC shut down in 1951, it returned a slight profit to the government.
Many of the elements of the Home Owners Refinancing Act, which created the HOLC, would be useful today. Although foreclosure rates of the early 1930s still tower over today’s rates, foreclosures and defaults are advancing at a dangerous pace, as borrowers struggle to keep up with their adjustable-rate mortgages. “Our problems of today do not begin to approach those of 1933,” Kevin Pollock, a fellow at the conservative American Enterprise Institute, told Congress last year. “But I suggest that HOLC could be usefully studied by anybody thinking about this issue.”
Jack Guttentag, a Wharton School economist who was formerly chief of the domestic research division at the Federal Reserve Bank of New York, says the HOLC has greater strengths than some of the mortgage fixes being proposed by the White House, Congress or the Federal Reserve. Guttentag says the Bush administration’s main proposal has been for lenders to voluntarily freeze adjustable-rate mortgages for borrowers who have not missed a payment on their loans, but who would have problems making payments once the rates adjust upward. Economists estimate that Bush’s proposal would help as little as 7 percent of troubled borrowers. Moreover, the proposal would keep borrowers in adjustable-rate mortgages rather than transfer them to more stable fixed rates.
Unlike Bush’s proposal, a HOLC-like fix to today’s mortgage crisis would extend prime loans to subprime borrowers, putting them into long-term, fixed rates rather than the temporarily frozen adjustable rates promulgated by the White House.
HOLC loans would also be open to far more borrowers than Bush’s narrowly crafted proposal. Under Roosevelt, HOLC loans often went to help borrowers who had lost their homes buy them back out of foreclosure. Few people in the White House, Federal Reserve or Congress would envision enacting such a daring program today. But the fact is, it worked.
Proposals from the government have mostly concentrated on tightening mortgage-lending standards. While those proposals might have helped a year or two ago, the problem now is that credit is too tight rather than too loose. “Those are counterproductive ideas,” Guttentag says. “The market has changed so dramatically that clamping down on lending requirements has done no good whatsoever and may do some harm.”