Origins of the Indebted American Homeowner
Not long after the economic crisis began, the president's landmark Conference on Homeownership reported that "down payments of 10 percent, 5 percent, and even nothing down" had become common practice in the home-mortgage market. Reliance on second mortgages and novel financing terms, the report noted, were also widespread.
Although these developments sound all too familiar, this Conference on Homeownership was held in 1931 and the president sponsoring it was Herbert Hoover, not George W. Bush or Barack Obama. We often think of the expansion of easy mortgage financing as a relatively recent development, but the growth of indebted homeownership has older and more complicated origins.
The rules and institutions for financing homeownership weren't always as conducive to buying as they are today. In the 19th century, most Americans bought or built a home outright, or saved substantial nest eggs to make large down payments, because financial institutions either didn't lend to average homebuyers or did so on relatively stringent terms. National banks were actually prohibited from lending on real estate and state banks typically limited mortgages to 50 percent of the underlying value of a property. Such loans also matured in a relatively short period, usually three to five years. These terms meant that buying a home often required years of saving and typically wasn't an option for young families.
Although historians commonly view the New Deal as the moment that changed these lending practices, the easing of credit terms to homebuyers actually began decades earlier. In the late 19th century, many states sought to promote homeownership by passing legislation that enabled the formation of building-and-loan associations, which offered small amortized loans secured on homes. Building-and-loans were structured to accept lower down payments and make longer-maturity loans. Policy makers promoted them partly as conduits for ordinary Americans to gain greater economic security by accumulating property.
By the early 20th century, other types of institutional lenders started seeing mortgages as safe and attractive investments, especially as real estate prices rose in urban America. National banks successfully lobbied to relax the rules prohibiting them from lending on real estate. Residential mortgage lending by financial institutions grew about 20-fold from 1890 to 1930. As institutional lenders waded into the market, wealthy individuals and home sellers, who had once been the main suppliers of loans to homebuyers, were increasingly pushed into offering second mortgages with junior liens. By the 1910s and 1920s, these developments had made low-down-payment financing increasingly common.
Ordinary Americans welcomed these developments. For many, the easing of loan terms was crucial to buying into the American dream of economic stability and mobility. Homeownership became accessible even for relatively young families. As Robert and Helen Lynd noted in their 1920s study of Muncie, Indiana, the custom of "rent hunting" among newlyweds was steadily being replaced by home-buying. Labor Department studies from the period suggest that the expansion of indebted home-buying by young families was the linchpin in a broader shift in household economic planning that included increasing investment in children's education, decreasing dependence on income from children and increased equity-building in the home in lieu of traditional saving.
Yet the expansion of indebted homeownership also introduced risks, which became clear during the Great Depression. In particular, for many buyers indebted homeownership entailed the risk of owning a highly leveraged asset at a moment in their economic lives when they were especially undiversified and vulnerable to shocks. The decline of real estate values during the Depression not only devastated these families, but also spilled over into the economy by inhibiting mobility, reinforcing downward pressure on home prices, and depressing personal consumption and investment.
New Deal programs responded by extending and institutionalizing credit practices in federal policy as a way of restimulating the borrowing that had become an essential element of economic growth. The Federal Housing Administration further extended the maturity of loans and assumed the risks that financial institutions bore in making them. And Fannie Mae created a secondary market for such loans. These programs were bold and novel in interjecting the federal government into real estate finance. But they were also betting that recovery would be based on re-establishing the trend toward indebted homeownership that had started decades earlier.
Our current housing problems force us to revisit the risks of indebted homeownership. Simple attempts to "fix" the American inclination for ownership by promoting renting seem naive in historical perspective. Long-held preferences for ownership in family economic planning; the cultural and political support for owning; and the economic interests of financial institutions have made indebted ownership a persistent feature of the U.S. economy -- despite the crises it has experienced (and created) over the past century. A recent Pew Research Center poll found that 81 percent of Americans still believe that "buying a home is the best long-term investment a person can make."
The idea that the pain created by the most-recent crisis will completely change such preferences seems misguided.
A more useful approach would be to mitigate the economic risks that indebted homeownership has introduced, particularly for highly leveraged and undiversified homeowners. A century of financial innovation and policy making has focused on making homeownership accessible. The same creativity ought to be devoted to the devising products, markets and policies to better deal with risks so that people can stay in their homes when crises arise. Risk-sharing policies and insurance innovations that protect homeowners against price fluctuations seem particularly promising.
Ultimately, harnessing innovative public policy to address the risks of indebted homeownership is a solution that fits our history -- and prepares us for a future in which home prices will inevitably decline again.
(R. Daniel Wadhwani is Fletcher Jones Assistant Professor at University of the Pacific and is the author, most recently, of “The Institutional Foundations of Personal Finance,” published in the Business History Review. The opinions expressed are his own.)
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