The Mortgage Market

One of the most terrifying aspects of the Great Depression was the rise in mortgage foreclosures. People who had lost their homes, or simply witnessed friends and neighbors losing their homes in the depression, were often scarred for a lifetime. Mortgages at that time were typically short-term “interest only” or they were sometimes called “balloon” mortgages: The borrower would agree to pay, say, 5 percent interest each for five years and then repay the principal of the loan. Often the borrower would be unable to pay when the mortgage came due, and the bank would roll over the loans. Thus, a family could live in a home for years without building up any equity. When the depression hit and the borrower fell behind in the mortgage payments, the bank would foreclose and the borrower would end up with nothing. The Roosevelt administration addressed this problem by establishing the Home Owners’ Loan Corporation. This agency bought troubled mortgages from financial institutions and then issued new mortgages to the borrowers, substituting long-term, amortized (you pay a little of the principal each year) for the traditional short-term balloon mortgages. Thus, what we now think of as a standard, plain vanilla mortgage—a long-term, fixed-rate, amortized mortgage—was a product of the Great Depression. The corporation, which ceased making new loans in 1935, helped over a million borrowers.

The Home Owners’ Loan Corporation was intended as a relief measure. For the long term the government created the Federal National Mortgage Association (Fannie Mae) in 1938. Fannie Mae worked by establishing a secondary market for mortgages issued by private lenders. By buying these loans Fannie Mae provided the lenders with new funds with which to make new loans. Fannie Mae, like the Home Owners’ Loan Association, pushed long-term, fixed-rate, amortized loans as a way of creating long-term financial stability and security for the borrower. An underlying assumption was that the price level would remain relatively stable, a reasonable assumption at the time. During the inflation and rising interest rates of the 1960s and 1970s, however, these mortgages would prove problematic for the institutions that held them.