The following quote discribes the changes in housing as a response to events in the 1930’s as part of the Great Depression:

In response to these calamities, the federal government began intervening in the housing finance market. It created three particularly important institutions: the Home Owner’s Loan Corporation (HOLC), the Federal Housing Administration (FHA) and the Federal National Mortgage Association (FNMA)… The HOLC changed the terms of the mortgages drastically, converting variable-rate, short-term, nonamortizing mortgages into fixed-rate, long-term (20-year) fully amortizing mortgages. (An “amortizing” mortgage is one where the principal is repaid over the life of the loan, so that the borrower does not face a large lump-sum payment at the end of the loan.) The HOLC ultimately purchased, reinstated and converted one million mortgages.

“Because the federal government did not see itself as being in the business of holding mortgages in the long term, it needed to find a way to make these mortgages marketable. In particular, investors in the mortgages wanted assurance that they would receive the full principal balance and scheduled interest payments. While some private mortgage insurance companies were in business for this purpose before the 1930s, they were insufficiently capitalized and failed in the early 1930s. Consequently, the government established the Federal Housing Administration (FHA) to provide the mortgage insurance necessary for investors to purchase mortgages with confidence.’”

“Thus, the invention of the fixed-rate, self-amortizing, long-term mortgage was, above all else, a response to a general financial crisis, as opposed to a design for the promotion of homeownership per se. FHA adopted this form of mortgage to avoid the problem of people needing to refinance, which had clearly led to disaster. The combination of HOLC and the FHA represented a piece of early “financial engineering” that allowed illiquid financial institutions to become liquid again. The new long-term mortgage was of course no panacea for U.S. banking problems one-third of U.S. banks failed during the Great Depression (Friedman and Schwartz, 1963)-but it helped.”

Richard K. Green and Susan M. Wachter The Journal of Economic Perspectives, Vol. 19, No. 4 (Autumn, 2005), pp. 93-114 Published by: American Economic Association

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