Economist Price Fishback: The Real Facts About the Original Home Owners’ Loan Corporation (and What They Mean for a Modern Incarnation)

More and more people are calling for the government to create a Home Owners’ Loan Corporation (HOLC) modeled after the New Deal version that went by the same name. The first person I heard suggesting this was economist Alan Blinder in a startlingly prescient New York Times Op-Ed piece back in February of this year.

More recently, Hillary Clinton has proposed a new HOLC. Norman Ornstein of AEI has also endorsed the idea, as have many others.

Price Fishback, an economist at the University of Arizona, is one of the world’s leading economic historians. He has been studying the original HOLC for a number of years, and he has been kind enough to write the following guest post describing the original HOLC and raising important concerns as to whether a modern incarnation is the right solution to the current problems.

Does a New HOLC Fit the Current Situation?
By Price Fishback
A Guest Post

INSERT DESCRIPTIONFrom the HOLC files at the National Archives.

A large number of people have called for the introduction of a new Home Owners’ Loan Corporation (HOLC) in response to the recent crises in the financial and housing markets. Nearly every call for a new HOLC includes a brief two-sentence description and then extols its virtues without details.

Yet the key to a successful program is the details. My goal is to describe the original HOLC’s operations and speculate on what a current HOLC would look like.

Between the late 1920’s and 1933, the average value of homes fell between 30 percent and 40 percent, mortgage-foreclosure rates rose sharply, and a large number of states adopted mortgage moratoria that prevented foreclosures.

In response, the Roosevelt administration adopted the HOLC to aid home owners “in hard straits largely through no fault of their own.” There were plenty of people that fit this description, because 25 percent of the workforce was unemployed and many others were working less than full time.

Between 1933 and 1936, the HOLC bought slightly more than one million troubled mortgages from lenders and then refinanced the loans with new terms for the borrowers. The mortgages accounted for roughly 10 percent of the number of owner-occupied nonfarm homes.

The borrowers aided were all considered prime loan candidates when their loans were made. They typically had made down payments of 50 percent of the house price and faced more stringent loan terms than found for current prime loans. The HOLC rejected over 800,000 applications — some because the household was not in dire need, others because the borrower was not likely to repay the loan.

The program contributed to a major transformation in the nature of housing lending. The HOLC offered a subsidized interest rate of 5 percent when low-risk private home loans were offered at 6 percent. The loan-to-value ratio was allowed to rise from the traditional 50 percent of the value of the home to 80 percent. In many cases, the 80 percent figure was applied to the value of the home from better times, so the true percentage loaned on the value of the house was much higher.

The length of the loan was expanded from 5 to 15 years. Equally important, instead of the borrower paying interest for five years and then paying a balloon payment of the loan principal at the end, the HOLC loan payments were amortized so that the borrower made equal payments throughout the life of the loan.

The typical mortgage refinanced by the HOLC in 1933 was more than two years in default on the principal. The borrower had been allowed — by the forbearance of the lender or by government moratoria — to put off paying the vast majority of the loan for more than 40 percent of the original life of the loan. In addition, the typical loan refinanced had not paid taxes on the property for two to three years. The HOLC also reconditioned about 40 percent of the homes to raise their values as collateral on the loan.

People who anticipated that the HOLC would fully resolve the problem were likely disappointed.

The mortgage-foreclosure rate only fell slightly over the next three years. In June 1936, nearly 40 percent of the HOLC borrowers were more than three months behind on their mortgage payments. By 1940, the HOLC had foreclosed on 17 percent of its loans.

At some point between 1936 and 1940, the HOLC owned and then resold roughly 2 percent of the owner-occupied nonfarm dwellings in the United States. All of the dwellings were eventually sold off at an average loss of 33 percent per foreclosure.

People have claimed that the HOLC made money, although this is a fiction of government accounting. Current accounting standards for financial institutions would have shown the HOLC to be insolvent in the late 1930’s.

In the peak lending year, 1934, the HOLC employed a sizable bureaucracy of over 20 thousand people, and it still employed 10 thousand people in 1940. Unlike many agencies, however, the HOLC closed down in 1951 with a skeleton staff of less than 400 and the repayments of the last of the fifteen-year loans. The HOLC benefited many home owners who had been in dire straits, and a surprising number repaid the loan in full well before the 15 years were up.

Is a new HOLC the solution to our current mortgage problems?

At 6 percent unemployment, the economy is not remotely in the disastrous territory of the 1930’s. Yet mortgage-foreclosure rates have risen sharply in the past few months, the share of homeowners has risen from less than 50 percent in 1929 to 68 percent now, and the population is much larger.

The mortgage holders bailed out in the 1930’s held substantial equity in their homes — unlike today when many people contemplating default have put down small down payments and can walk away from mortgages after essentially “renting” a house for two or three years.

How many of the modern borrowers are “in hard straits largely through no fault of their own”? In 1933, housing prices had been falling for four to six years after having risen only about 40 percent in the 1920’s. The CaseShiller housing index shows that current housing prices have fallen to their 2004 level, which is still 66 percent higher than the 2000 level.

How much will a new HOLC cost? The average loan from the original HOLC was $3,000 — roughly $48,000 in today’s dollars; therefore, the HOLC loaned out about $48 billion in 2008 dollars. It took 20,000 HOLC administrators to deal with about two million applications. If we use ratios from the 1930’s, conservatively, we might see six million applications for a new HOLC.

If the administrative ratio is similar, this means 60,000 administrators at an average of $50,000 or $3 billion per year spent on administration.

Maybe we can reduce this cost substantially by asking Fannie and Freddie to administer the loans. However, the loan length will likely be 30 years, so we extend the life of the federal-housing bureaucracy for another 30 years. If the average loan refinanced is $200,000 and we refinance half the applications, the U.S. will purchase and refinance $600 billion in mortgage loans.

Providing over $600 billion to troubled home borrowers does not sound so bad to Main Street. After all, President Bush just signed a bill handing over $700 billion to buy “toxic paper” from the Wall Streeters who built the flimsy house of credit-default swaps and mortgage-backed securities on top of the original mortgages.

A new HOLC could contribute to solving the current dilemma by making the mortgages, the underlying assets for the toxic paper, stronger. Will it resolve the Wall Street problem? Who knows. No one really seems to understand the tangled structure built on top of the mortgages.

Then there remains the “moral hazard” worry. How do we set the appropriate incentives to prevent this problem from developing again in the future?

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  1. NM says:

    About that “moral hazard.”

    It’s telling it’s mentioned only when common people are mentioned, and not the wall street types.

    Second, those people have only been doing what the lenders have told them to do. How is it one’s fault to fall for the massive propaganda of those past few years? People got dozens of offers through the mail or other means. Mortgage brokers used questionable tactics to get new clients.

    Most people ‘at fault’ probably didn’t have enough education to be able to understand the deal they were making. How is not being smart enough a moral fault? Most of them were’nt trying to pull a quick one; the same can’t be said of Wall Street.

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  2. David D says:

    Price Fishback may be the best name an economic historian could possibly have.

    Oh, and thank you for the clear and thorough explanation, too.

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  3. captain democracy says:

    Greedy investment speculators created this financial mess with the help of the U.S. Congress. The U.S. Government allows this type of ‘ponzi scheme” to wipe out the “greed” that lurks in the hearts of most Americans that see and use money as a “God.” Money is a “tool” and the sooner we teach this from grade school to college “we” the people can resign the U.S. Congress to common sense solutions rather then “GOTCHA” games at taxpayers expense.
    Robert E. McCullough B.A., Arch.
    Coit Tower, North Beach San Francisco Ca.

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  4. steve pesce says:

    Why do people have to OWN homes? This is a misnomer. The government has long used home buying and home ownership as proof of economic prosperity. We have given tax breaks and allowed banks and SNL’s to do many fiscally rotten things to make sure that home buying is up and stays up. However, there is nothing wrong with renting and using that additional money you’re saving in order to pay down your credit cards or say put money away for your son or daughter’s college tuition. Renters should be given the same tax incentives as home buyers. This would create a more mobile society who can move where the jobs are. This will keep us investing more of our money in the economy instead of parking that money in a home. The concept of every soldier returning form WW2 deserving a home is long gone. When we talk about home buying, we’re talking about speculative investment by people who hope to build equity and sell in a few years. That’s why we got hurt in this current crisis. When home prices fell, these ridiculous mortgages were a noose around people’s necks. And the FED raising interest rates when things were bad didn’t exactly help. But basically the government needs to stop promoting everyone to BUY. Renting can be as economically viable.

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  5. ruralcounsel says:

    “Moral hazard” only has meaning when talking about individuals … business entities are not humans with a morality, just legal fictions.

    The analog for a financial institution is the often-mentioned free market “creative destruction” argument.

    Not being “smart enough” to understand what you are doing may not be a moral fault, but it sure is a Darwinian factor to be considered. Stupidity is bad for your financial health.

    Plus, for many of those “not smart enough”, the failure to get the help they needed to understand what they are getting in to shows an additional level of naivete or pride … you need to know your limitations, and when it is time to get professional help.

    Perhaps more bizarre was the inclination for them to just believe what they were told by someone whose finaincial interests were directly at odds with thier own. How many times do we need to tell people to watch out for “used car salesmen?”

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  6. Victor Grauer says:

    “6% unemployment” doesn’t begin to describe the employment picture in this country at this time. We got into this mess in the first place because we were already in a mess, due to the lack of meaningful employment, at meaningful wages. People didn’t max out their credit cards and fall for phony mortgage schemes because they were stupid or irresponsible, but because there was no other alternative, short of moving into the street. The trickle down thinking has GOT TO STOP and the needs of ordinary working people have to be addressed. Soon!!!!

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  7. JD says:

    Mr. Levitt, thank you for asking an economic historian to write an article about economic history.

    Dr. Fishback, thank you for taking the time to write this article. We need to understand the problems before we start hurling solutions at them.

    Please keep this up!

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  8. Mike M says:

    @ #1,

    The government pushed, circa 1999, for relaxed critera for mortgage lending. The aim was to allows everyone to own a home and a piece of the so-called “American Dream”. The government implicity backed Freddie and Fannie in extending these questionable loans. It’s great policy as long as home prices are surging, but obviously that gravy train couldn’t continue indefinately.

    I don’t contend to know the solution to the problems we now face, but ‘bailouts’ of individual mortages is a direct slap in the face to every reasonable and financially reponsible indivdual in America.

    Furthermore, let’s examine what most of those defaulting homeowner are really losing when defaulting on their mortgages…nothing! It isn’t they are losing substantial downpayments, since they never made them in the first place. Let them go back to renting-which is what they would have been doing prior to the relaxated guidelines.

    Ignorance is no defense. By your logic, we should bail out those whose poor educations allowed them to be “tricked” into running up huge credit card debt. People got dozens of offers through the mail for those too.

    I don’t think that Wall Street should be given a blank check for their failings, but since they were to some degree caused by goverment intervention in the first place, some type of assistance seems to make sense.

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