The U.S. construction industry boomed through most of the 1920s as new office buildings, factories, warehouses and homes were built across the country.
A developing securities market, in which commercial bonds could be sold to finance construction, helped boost the housing surge. In 1928, however, the Federal Reserve tightened monetary policy to stem speculation, especially in the stock market, and housing investment began to fall.
When the global economic crisis triggered widespread unemployment and bankruptcies, property owners’ abilities to make mortgage payments crumbled. This was particularly unsettling because many home mortgages were five-year agreements with a balloon payment due at the end. Banks had repeatedly renewed these contracts, adjusting interest rates to prevailing levels.
As home values rose, families had made frequent use of second mortgages with high interest rates to make improvements or to realize cash for other purposes. By 1932, renewals had vanished and second mortgages went unpaid.
This mortgage-finance system rapidly fell apart. Foreclosures multiplied, to 1,000 a day by late 1932. Assets underlying mortgage loans were deflating even as householders’ payments became unreliable. What was the government to do?
President Herbert Hoover, though reluctant to support big government programs, recognized the scale of this looming disaster. He proposed that Congress create a system of Federal Home Loan Banks, with 12 districts and a membership drawn from mortgage-holding institutions, including insurance companies, cooperative banks and homestead associations.
The core idea was that "bonds, guaranteed by mortgages accepted by the home loan system, will be offered to the public to increase the circulation of money," the New York Times reported.
The 12 banks would loan as much as $125 million, initially supplied by the Reconstruction Finance Corporation, to distressed building-and-loan firms, taking in good mortgages as collateral. They then would securitize these holdings, thus restoring their cash accounts to fund further lending, increasing the country's cash flow.
Opposition from the banking industry was immediate. The primary objective was that the loan-bank system “further intrudes the government into private business," the New York Times reported. "There is no lack of funds at present for the use of home mortgage institutions. The bill would encourage unhealthy home building." Even worse, the home-loan banks’ bonds couldn't be sold.
Despite objections, House and Senate committees pushed the bill forward, and on July 22, 1932, Hoover signed the legislation. The new institution's chairman, Franklin Fort, soon called for a mortgage holiday to stop foreclosures until the system could get up and running. Forty states confirmed their assent.
The Federal Home Loan Banks opened their ledgers on Oct. 15, though it was far from clear, as New York Representative Fiorello LaGuardia put it, whether “the influence of selfish institutions would predominate” over the needs of hard-pressed homeowners.
Hoover had tried his best, and Election Day was just three weeks ahead.
(Philip Scranton is a Board of Governors professor of the history of industry and technology at Rutgers University, Camden, and the editor-in-chief of Enterprise and Society. He writes "This Week in the Great Depression" for the Echoes blog. The opinions expressed are his own.)
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Philip Scranton at email@example.com