Henry Paulsen as Mary Bailey
posted by Mark Edwards
The disjointed and ad hoc reaction of the Bush administration to this mortgage crisis stands in stark and disappointing contrast to the systemic reaction of the Roosevelt administration to the last similar mortgage crisis. Henry Paulsen seems to have been assigned the role of Mary Bailey during the bank run scene from It’s a Wonderful Life: rushing into the room with a wad of cash, but with little thought of the future.
The Obama administration would be wise to approach the crisis much as the Roosevelt administration did – as a set of difficulties each requiring a specific institutional tool dedicated to its correction, which should function together as a whole to create a new (and hopefully this time, lasting) housing finance superstructure.
To contrast the Bush and Roosevelt approaches, it is useful to recall the ingenious public/private hybrid housing finance system the Roosevelt administration developed. Consider:
The Roosevelt Administration recognized that — just as today — credit was frozen for home lending institutions. It empowered the Federal Home Loan Bank (FHLB) to provide loans to these institutions, so that they in turn could lend to home buyers. The greater availability of loans from home lending institutions could lower the cost of borrowing for home buyers. More home buyers could create demand in the housing market and slowly raise home values (which had plummeted). Rising home values could allow some homeowners to refinance their mortgage loans to avoid foreclosure.
But, the Roosevelt Administration realized, many delinquent mortgages could not be saved by refinancing, if home owners had to wait for home values to rise. So, it created the public/private hybrid Home Owners’ Loan Corporation (HOLC) (financed partly publicly, and partly through tax-favored private investment). This institution had a simple but crucial mission: buy delinquent mortgages from home lending institutions, then work with home owners to refinance them on less risky and more responsible terms. As a result, banks were able to sell mortgages they most wanted to be rid of, reducing their bad debt and increasing their liquidity. For homeowners, short-term, adjustable rate, and balloon mortgages were converted to long-term, fixed rate mortgages. Borrowers were required to present proof of sufficient income relative to their debt to qualify for the restructured loans.
To encourage similar responsible lending standards by home lending institutions, the Federal Housing Administration (FHA) offered to insure mortgages that met its quality and risk standards. The FHA required that the loans it insured were fixed-rate, long-term, and had a minimum loan-to-value ratio of 80% (in other words, a 20% down payment was required of home buyers).
The creation of the Federal National Mortgage Association (now known as Fannie Mae) was a masterstroke. The FNMA created a secondary market in which home lending institutions could sell mortgages that met FNMA quality standards. In other words, the FNMA would buy mortgage loans from home lending institutions at some percentage of their present value. The lenders would receive a one-time cash payment and be relieved of any risk from the home buyer’s potential default. That risk was transferred to the FNMA. Not only did banks receive a great incentive to increase their home lending activity, the FNMA was able, through its purchase standards, to impose quality standards that lasted for decades.
The system as a whole created the structure that became the invisible backbone of the American dream. The FHLB provided liquidity, the HOLC purchased and refinanced delinquent mortgages, the FHA insured quality mortgages, and the FNMA created a secondary market on which quality mortgages could be sold, increasing lender liquidity, removing risk, and standardizing quality.
The Bush administration, by contrast, seems to have empowered Henry Paulson to spend $700 million as he sees fit. To date, he seems unable to decide how best to proceed. At first we were told the money was to be used to buy bad debt, which was once half of HOLC’s function. No mention was made of the other half of HOLC’s function — refinancing delinquent mortgages. Now, Paulson seems to have reversed course, intent instead on infusing lenders with liquidity, similar to the function once provided by the FHLB, but directed at commercial banks rather than home lending institutions. The FDIC has stepped out of its traditional mission to propose a system for refinancing delinquent mortgage loans, the other half of HOLC’s function, but it has been rebuffed. And the FNMA, privatized for 40 years, rather than being a tool available to help solve the crisis, became one of its earliest victims.
In short, Roosevelt’s administration either created or empowered a series of housing finance institutions, each designed to address a specific need revealed by the mortgage crisis, and to work in tandem with each other to create a new housing finance superstructure that allowed the market to function while imposing, and thus guaranteeing, quality standards. Let’s hope the Obama administration can do the same.
November 29, 2008 at 11:47 pm
Posted in: Property Law
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Responses (4)
JP - December 1, 2008 at 3:53 pm
“the systemic reaction of the Roosevelt administration to the last similar mortgage crisis.”
Of course, it appears “systemic” when, with the benefit of hindsight, you cherry pick certain programs. (Specifically, those related to one part of the problem that weren’t killed by the S. Court or discontinued during WWII.) The actual response to the Great Depression at the time was pretty “ad hoc and disjointed.”
Also, the Federal Home Loan Bank Act was passed during the Hoover administration. Did Roosevelt change it in some way?
Moreover, it doesn’t make much sense to compare Bush’s policies over the last 3-4 months with a selection of programs created between 1932 (FHLB) and 1938 (FNME). (Much less to compare Roosevelt with a lame duck President with an opposition Congress).
Finally, Congress, as well as the Bush administration, “seems to have empowered Henry Paulson to spend $700 [billion] as he sees fit”
Mark Edwards - December 1, 2008 at 5:24 pm
Yes, Roosevelt changed the FHLB — by funding it and staffing it.
Bush has had far, far longer than “the last 3-4 months” to address this crisis; the fact that he failed to do so in a coherent way is why the crisis is as deep as it is now. Just like Roosevelt, he’s had years to formulate an approach to resolving the crisis. Unlike Roosevelt, he’s fiddled while the system burned.
Congress has the responsibility to provide funding for the tools for the President uses to address a crisis. Unfortunately, the Bush administration’s only tool has been the wad of cash Congress provided, and it seems at a loss about what to do with it.
JP - December 2, 2008 at 11:31 am
The FHLB was a program Hoover fought pretty hard for. As far as I can tell, Roosevelt did not support the efforts of congressional Democrats to repeal the FHLB, and he augmented it with the HOLC. The Federal Home Loan Banks were operating before he got into office, and the Board was essentially left to defend its existence on its own.
Your assertion that Bush’s situation is “Just like Roosevelt” is pretty unconvincing. Roosevelt took office at the low point of the Great Depression. Bush has been a lame duck throughout this “crisis.” It would make more sense (though still not much) to compare Roosevelt’s response to the 1937 recession.
Are you suggesting that it was clear several years ago that there was a housing bubble and Bush should have formulated an approach then? If so, should the administration have deflated the bubble? Propped it up? And how, without adverse effects?
(I certainly think that Bush [and Clinton, and Greenspan] unfortunately encouraged the housing bubble, but I haven’t seen any kind of consensus as to how one goes about deflating that sort of thing.)
JP - December 2, 2008 at 11:35 am
By the way, Roosevelt’s response to the 1937 recession was basically to spend a big wad of cash.
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