When I was working on the last post about Cypress Sharpridge and their forward purchase strategy, I chose not to get too far down “into the weeds” about the mechanics of paydowns and leverage, but there was one idea that needed saying:
One of the few benefits of the American depression of the 1930’s was the introduction of long-term, fixed-rate, self-amortizing mortgages.
That introduction came through (horrors!) a government program that even a Fellow of the American Enterprise Institute could learn to love.
I notice, by the way, that Alex Pollock, by far the most knowledgeable housing economist at that august think tank, became much quieter after more partisan and less informed people at AEI insisted on pushing a bunch of bogus myths and even worse “solutions” for the mortgage crisis.
Still, the internet is forever, so the wisdom Alex showed before the subprime mortgage problem became a global crisis is still available. Here’s a very prescient piece he wrote in December of 2007, long before TARP, Lehman, AIG, Fannie and Freddie, and even before Bear Stearns threatened to become a spot on the sidewalk.
What was that great financial innovation the government introduced with the HOLC (Home Owners’ Loan Corporation)?
The self-amortizing fixed rate mortgage. HOLC issued new 4% mortgages to assist borrowers who couldn’t pay off their shorter term (and often floating rate) mortgages as they came due. As Alex points out in his article, the HOLC offered 20 and 25 year loans and folded its business in 1951, turning over a profit to the Government. Quite a success, and at its peak, the HOLC was providing financing for one in five American homes.
Over the course of generations, that single innovation has produced more beneficial stability for American working class families than, potentially, even Social Security.
It’s a virtual cliché that people sell their homes in the north after they retire, and move to Arizona or Florida. Of course, the reason they can afford to do that is because a working career of thirty years pays off the mortgage. In the UK, they substitute an insurance (investment) policy that is paid along with the mortgage to accrue up to the required principal payment at maturity.
In either scheme, the point is that our “standard” 30-year fixed rate mortgage is designed to de-lever a family’s financial situation over a normal working lifetime, so they end up with equity, equity that tends to track inflation over time as house prices do.
When Snidely Whiplash and Mr. Potter were foreclosing on their borrowers, they had the standard mortgage of the time helping to make that happen. In fact, that was the problem all over America during the deflation of the Depression. Mortgages were three to five years in length, and were typically refinanced at the end of each term.
When the value of the collateral (homes and farms) declined, even people who had jobs and income weren’t able to pay the additional cash their mortgage notes required when the notes came up for refinancing. That’s not unlike the situation with the responsible borrowers the Fed recently suggested should be allowed to refinance their “underwater” mortgages that are guaranteed by Fannie and Freddie.
So, even though the lenders have to charge more for the prepayment risk in fixed rate mortgages (30 to 60 basis points per annum seems to be the “real” cost), the result of building equity over time has paid huge dividends in family stability and decent retirements.
Something to keep in mind. Especially when the discussion turns to helping responsible borrowers, those who keep paying their bills even when the rate is far above current rates. They aren’t deadbeats. And if it works out as it did in the Depression, assisting these borrowers would turn a profit for taxpayers, not a loss.
Seems like a far better use of taxpayer money than paying over a million dollars apiece to a bunch of derivatives jocks who should have been replaced, but they were part of the most powerful union I’ve ever heard of, and they didn’t even have to pay union dues.