The New Deal and Recovery, Part 28: A New Deal for Housing

On Apr 17, 2023

Because this series is about the New Deal’s contributions to economic recovery, it’s essential that we recognize the difference, as Roosevelt himself did, between recovery on one hand and relief and reform on the other. A New Deal policy that undoubtedly offered relief to those harmed by the depression, or one that achieved reforms with indisputable long-run benefits, might not have made the depression any shorter, and might even have lengthened it.

But some New Deal policies that had relief or reform as their most obvious aim could also hasten recovery. Any policy that meant more federal spending, and deficit spending especially, might do so simply by boosting aggregate demand, though Roosevelt himself wouldn’t have thought so until well into his second term. Nor was this the only possible way in which the lines separating the R’s could become blurred.

None of the Roosevelt Administration’s 100-day initiatives illustrates this point better than the creation, on June 13, 1933, of the Home Owners’ Loan Corporation (HOLC), a relatively small and little-known New Deal agency that was only active for just over two years and was wound-up altogether in 1951. In recommending the HOLC bill to Congress two months earlier, President Roosevelt explained that its immediate purpose was “to protect small home owners from foreclosure and to relieve them of a portion of the burden of excessive interest and principal payments incurred during the period of higher values and higher earning power.” But he first let Congress know that he considered the legislation an “urgently necessary step in the program to promote economic recovery.”

The HOLC has been called “one of the great success stories of the New Deal” (Carrozzo 2008, 22), and this opinion is widely shared. Nor is it difficult to see why: during its brief life, the Corporation refinanced mortgage loans for a million homeowners, sparing many the extreme hardships of foreclosure. Lenders benefited as well by trading their delinquent mortgages for the Corporation’s bonds. Yet instead of operating at a loss, the HOLC appeared to turn a tidy profit of $14 million!

In short, no other New Deal program seemed to deliver more obvious benefits at so little cost. But as we’ll see, although the relief the HOLC offered homeowners was palpable, it was mortgage lenders who benefited most from the bargains it struck. That this was so was a reflection of the HOLC’s overarching purpose of promoting recovery. Even so, the Corporation’s contribution to ending the Depression has proven difficult to pin down, and many say that its endeavors had far-reaching long-run consequences that were anything but benign.

Up, Up and Away…

To understand the severity of the Great Depression mortgage crisis, it’s necessary to step back in time to consider the housing boom of the 1920s, and the nature of the mortgage loans that financed a large part of it.

“In a decade of almost steady growth,” Eugene White (2014, 117-18) says, “the behavior of residential construction stands out.” Whereas the better-known boom of the first decade of the 2000s witnessed the construction of 1.3 million new homes, that of the 1920s, when the population was little more than a third as great, witnessed twice that number. For four years starting in 1924, residential construction accounted for more than 8 percent of the nation’s GNP (Field 1992, 785); and during 1925 and 1926 alone, the amount invested in new houses—almost $10 billion—was about equal to the value of new securities purchased in the peak stock market years of 1928 and 1929.

To some extent, the housing boom of the 20s was just the economy’s way of making up for the “crowding-out” of residential construction during WWI, when the government’s heavy borrowing left little aside for the financing of new homes. But according to White (ibid., 125), there was more to the boom than that. As happened during the 2000s, easy Fed policy, lax underwriting standards, equally lax bank supervision, and a roaring but heedless market for securitized mortgages, all played their part, by making it easier than ever for people to buy homes on credit.

…in Not-So-Beautiful Balloons

“Mortgages,” White (ibid., 134, 138) explains, “supplied over $2 billion of the $3.3 billion in financing for 1926,” which was about twice the 1922 level; and almost all of them were short-term, non-amortized mortgages, a type seldom seen either before the First World War or since the Second. Most commercial bank mortgages had terms of 5 years or less, at interest rates of 8 percent or more. Borrowers made interest-only payments until the loans matured, when a final, “balloon” payment, consisting of the loan principal, fell due; and because many were in no position to make that large payment so soon after taking out their loans, refinancing at least once, and often several times, was common.

But by far the most important institutional mortgage lenders in those days were parvenu building and loan associations (B&Ls). These were typically small, local institutions, mutually owned by their members and funded by members’ dues, that is, by their weekly or monthly purchases of association shares (Fishback et al. 2013, 12). B&Ls first rose to prominence during the last decades of the 19th century, thanks in part to relatively strict limits on mortgage lending by commercial banks: until 1914, national banks weren’t supposed to offer mortgages at all[1]; and the mortgages they offered afterwards, as well as those to be had from state banks, featured not only short terms but hefty minimum down payments (Price and Walter 2019, 2).

But the rise of B&Ls before 1900 was nothing compared to what came afterwards. Between 1910 and 1929, their numbers more than doubled, from 5,869 to 12,342, while their assets quadrupled. When the stock market crashed in October 1929, roughly one American in ten was a B&L member; and even in 1930, as the economy was starting to spiral downward, B&Ls were writing 1,000 mortgages a day, and accounting for as much outstanding residential mortgage credit as commercial banks, life insurance companies, and mutual savings banks combined (Mason 2004, 61; Rose 2011, 1076).

Although it resembled other mortgages in being non-amortizing, the standard B&L mortgage had a somewhat longer term—usually between 5 and 10 years. And instead of ending with a balloon payment equal to the loan principal, it allowed borrowers’ share accounts to serve as sinking funds for their loans. When the value of a borrower’s shares, augmented by occasional dividends, reached that of the loan principal, the loan was considered paid. Share accumulations beyond that were the homeowner’s, free and clear.

Thus, like those who took out interest-only mortgages with balloon payments, and unlike today’s holders of amortized mortgage loans, B&L borrowers owed the entire principal of their loans for the loans’ full life. It follows that, if a member defaulted, he or she “lost not only the house but also the accumulated value in the sinking fund” (Fishback et al. 2013, 14-15). Even so, as long as the value of a B&L’s shares stayed the same or rose, these were attractive terms. Borrowers could then avoid having to come up with lump-sum balloon payments, while enjoying a share in their association’s profits. And so they did throughout the 1920s. Only if share prices fell could things possibly turn sour.

That Sinking Feeling

It’s tempting, with the aid of 20/20 hindsight, including knowledge of just how much mortgage-financed home buying went on during the 1920s, to suppose that B&Ls and other mortgage lenders that came to grief afterwards did so because they’d lent recklessly. It’s tempting; but it’s hardly fair, for had it not been for the unprecedented severity of the downturn, most of their loans would have performed well, and their capital would have sufficed to protect them against those that didn’t.

In fact, two things had to go terribly wrong to cause the U.S. mortgage industry to suffer as it did. One was a collapse in house values; the other was a collapse in household income and wealth. Had house prices remained stable, those who could not afford to keep paying their loans at least had the option of selling their properties at prices that would allow them to pay their debts; and if they didn’t, their lenders might make themselves whole by foreclosing. If, on the other hand, house prices fell dramatically, but their owners’ earnings didn’t, though owners would suffer a loss of equity, they could still go on paying off their debts (Wheelock 2008, 1378).

The Great Depression was great in part because, in the United States at least, it managed to pull this “double trigger,” dealing a mortal blow to mortgage lenders by making it impossible for vast numbers of their clients to continue paying off their loans (Fishback et al. 2013, 19). Between 1929 and 1933, house prices fell by a third, while the unemployment rate rose to 25 percent….