September 14, 2007
Time for a New Deal Posted by Joshua Zeitz at 03:25 PM EST Readers might be interested in an article by Andrew Jakobovics in the online edition of The New Republic. The associate director of the Economic Mobility Program at the Center for American Progress, Jakobovics finds striking parallels between the current mortgage market crisis and the crisis faced by millions of Americans in the early 1930s. Before the New Deal, most mortgages were short-term and non-amortizing and included a large, backloaded balloon payment. Most homebuyers thus acquired very little if any equity in their houses, unless those houses rose in value, and they relied on refinancing and new debt to pay off the end-of-term balloon payments. When credit dried up in the early years of the Depression, homeowners were unable to refinance and faced foreclosure. Sound familiar? Jakobovics urges a new program similar to Franklin Roosevelt’s Home Owner’s Loan Corporation, which used government funds to issue long-term amortizing loans to replace existing mortgages. In order to qualify for refinancing, applicants had to demonstrate a history of responsible debt payment and an ability to afford the new loan. Ultimately, the HOLC bailed out about one million property owners. The banks were happy to go along, for as Jakobovics explains, “in order for the HOLC to issue a loan, it needed to pay off the existing liens. This potentially posed a serious problem, as HOLC loans were never to exceed 80 percent of the appraised value of a property, which was often below the outstanding loan balance. The HOLC had to convince the existing lenders to accept those losses. The HOLC was able to succeed because it made lenders an offer they couldn’t refuse: A government guarantee of four percent interest in the amount of the new loan, which was worth far more (even at a reduced valuation) than the zero percent they were effectively getting from delinquent loans. Add to that the cost of servicing, foreclosure, and disposition, the decision was a no-brainer.” Ultimately the HOLC reduced its operations as another New Deal agency, the Federal Housing Authority (FHA), used mortgage insurance to cajole lenders into offering customers long-term, amortizing mortgages with little money down. Jakobovics makes a case for a similar program today. Economists estimate that a house loses 0.9 percent of its value for every foreclosed property within an eighth of a mile. As in the 1930s, the government has a clear interest in seeing that billions of dollars in wealth do not vanish in a general foreclosure epidemic. Jakobovics’s article is a fine example of applied history, and I’d strongly recommend it to our readers.
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