The Revolutionary Pen - beta

The Era of Market Triumphalism Is Over

By Frank Schiavone

“I feel that in some small way we are doing something important. Satisfying a fundamental urge. It’s deep in the race of man to want his own roof and walls and fireplace, and we’re helping him get those things in our shabby little office.”

- George Bailey (It’s a Wonderful Life)

The fully amortized, long-term mortgage is a relatively new invention. Prior to the Great Depression, home ownership was well below 40%. Mortgages were the exception, not the rule (unless you were a farmer). If you did take a mortgage, it was short-term. During the term of your loan, you paid only interest. Your final payment was the amount you owed. If you could not “renew”, you were just plain out of luck.

In 1932, nervous lenders refused to renew mortgages resulting in over a half million foreclosures. House prices fell precipitously and new construction came to a standstill (sound familiar).

FDR responded affirmatively to the crisis by using the power of the central government in new ways. First, the Federal Home Loan Bank Board was set up to encourage and supervise local mortgage lenders known as Savings and Loans. Depositors were reassured that their money was safe. The Federal Deposit Insurance Corporation would guarantee their savings. A new Home Owner’s Loan Corporation stepped in to refinance existing mortgage with fifteen year terms. Finally, the Public Works Administration spent aggressively (nearly 15% of its budget) to build low cost homes and clear slums.

The New Deal changed the way Americans bought homes, radically increasing opportunities for home ownership. In effect, the Roosevelt Administration democratized home ownership. Investing in mortgages became “even safer than houses”.

But it was the creation of the Federal Housing Administration (FHA) that made the real difference for American homebuyers. FHA completely reinvented the mortgage market. Through the use of federally backed insurance, FHA incentivized mortgage lenders to make long term (twenty years), low-interest, fully amortized loans.

Moreover, the standardization of long-term mortgages and the system used to inspect and value homes laid the groundwork for an emerging secondary market. This new market exploded with the creation of the Federal National Mortgage Association in 1938. Fannie Mae was federally authorized to sell bonds and use the cash to purchase mortgages from local thrifts (Saving and Loans), infusing these institutions with fresh liquidity.

The new system facilitated lower monthly payments making home ownership affordable for millions of Americans. Uncle Sam was now effectively underwriting the mortgage market. Property ownership soared after WW II reaching 60 per cent by 1960.

But not everyone benefited. Redlining and discrimination were stubborn stains that our Nation could not come to grips with. “Change”, however, “was blowin in the wind”. The Civil Rights movement resulted in not just landmark legislation but also aggressive steps to broaden home ownership in disenfranchised communities.

In 1968, Fannie was restructured, becoming two entities. The Government National Mortgage Association (Ginnie Mae) was created to serve poor borrowers (including veterans). The newly rechartered Fannie Mae became a privately owned government sponsored enterprise (GSE) and was now permitted to buy both conventional and government-guaranteed mortgages.

To provide some healthy competition and broaden the secondary market, the Federal Home Loan Mortgage Corporation (Freddie Mac) was created two years later. The overarching goal was to place downward pressure on interest rates.

Since the days of Bailey Building & Loan, America has extolled the virtue of home ownership. Home ownership rose to 65% under Bill Clinton, to 68% under George W Bush. But it turns out we hit a tipping point. Many of those new owners simply could not afford the homes they purchased. Moreover, the artificially created demand caused home prices to soar which further exacerbated the affordability problem.

My point is not the blame the victims. Government policies that loosened regulations and the supervision of our financial institutions let loose the gates of hell unleashing the darkest of our dark angels.

The Grapes of Wrath long since forgotten and blinded by greed, we lost sight of the genius of New Deal bulwarks like Glass Steagall and the mortgage system that served us so well for so long. Demolition began during the Reagan era but continued steadfastly through subsequent administrations. It was a Democrat, after all, that signed the repeal of Glass Steagall.

In place of the time-tested New Deal regulatory and financial frameworks we built a shiny new colossus. But it turns out its foundation was laid on sinking sand. The new pillars of our economy – deregulation, globalization, market populism, securitization, and the democratization of capitol – failed catastrophically. Clearly, the Efficient Market Hypothesis did not result in the long awaited “market triumphalism” that Free Market zealots had prophesied. Speculation, credit derivatives, hedge funds, and short selling did not enhance, facilitate, or stabilize the market as we were repeatedly promised. Rather, these practices contributed to its downfall.

In the end, our economy succumbed to the based of human frailties – selfishness. Too much risk, too much leverage, too much complexity, too much hype, and too little oversight were its and our undoing.

>Copyright © 2008 Frank Schiavone