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?


Matthew Helms

Price, this is the kind of perspective this discussion needs. A well written article from a great professor. As a first time home buyer about to close on a bank owned home I'm proof that we don't want or need another HOLC in the US. Keep it up!

superheater

Many excellent, innovative and job-creating opportunities fall by the wayside because it's inefficient for professional investors - the minders of concentrated capital - to make investments in "small" opportunities. If trickle-down had any legs those opportunities would be snapped right up.

And a good deal of that required scale is necessitated by the often noxious and exhaustive rules to engage in a interstate IPO that are promulgaged by the SEC.

We've had 75 years of the government "protecting" investors and the capital markets. There's fewer things more regulated than banks and mortgages and all we've gotten is amplified and diffused financial distress.

Omair

Price Fishback seems like the sort of name one should be able to make lots of good economics jokes about, but I can't think of any. Oh well, good post.

Dewey Munson

First -Doesn't renting just add a layer to the financing parties?

Second - Why do economists speak to the problem of applying a number to an asset whose value is intrinsic. Our monetary number system lacks "store of value" which makes future time planning more difficult than it should be.

Illus: I am 87 yrs old. I have a bank account into which I put my 1st 6 months pay (1939). Today (2008) that acct is insignificant.

My MBA advisor says "but you have to invest"

Why should we be forced to play the losers (for most) game which has brought us to today?

Mitchell

This looks like a great article and discussion. I haven't had time to read it all but want to respond to the first post I read. The comment bemoaned that the borrowers were "forced," "tricked," and otherwise made to accept the bank's terms. No matter how much pressure is put on someone it is still their personal responsibility to understand the transaction. First, ignorance of the law is no excuse. Second, if you want to blame someone blame government non-education (that's public schools for those of you from Rio Linda) for consumers being ignorant and lacking the ability to understand the transaction. Another example of a predatory financial transaction, which the government aids and abets and consumers are tricked into by sleazy salespeople (read their trusted financial advisors), check out annuities. With commissions that can reduce the principal invested by thousands of dollars and a huge percentage they are one of the biggest rip-offs out there. And right now you can bet the sales weasels are out there selling the heck out of them to scared investors. So, as Rush Limbaugh says, ignorance is our most expensive commodity. Get out there and educate yourselves and your family and friends and don't let them get ripped off, next time.

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derek

@ruralcounsel

I'm not sure that you understand correctly what an economist means by the term moral hazard. In this field, moral hazard is when the entity exposed to risk does not have the proper incentives to avoid this risk. Below are two examples to make it more clear, in the case of both an individual and a business entity:

1) In this post, the HOLC bails out homeowners who are in danger of foreclosure. However, future homeowners may deduce that the government will again bail them out in the case of future economic turmoil. Therefore, they will not properly evaluate the risks of buying a home (fall in value, carrying too much debt).

2) The "too big to fail" policy is an incarnation of this idea in business, so I am not sure why people think that no one mentions moral hazard with respect to the financial system. Anyway, if someone is "too big to fail", they know that they will just get rescued if something bad happens, so they don't worry about as much about risk as they should.

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c. perry

Since all of you have internet access I suggest you "google" the Home Owners Loan Corp. There is a world of information that will free you from any prejudice as you make up your own mind.
You may decide a HOLC is just the thing.

c. perry

We are all paying for the busted real estate bubble. Look at your 401ks and IRAs. All home owners are getting poorer each month. More home loans are going under water.
In fact, the HOLC saved one million homes. In fact, the HOLC paid off all of the bonds that financed it. In fact we have no program in place to save one million homes. In fact eighty percent of the new mortgages were paid off. In fact, the HOLC is an example of dedicated government. In fact, all those supply siders hate the fact that government can do anything and the Bush administration has been busy proving government is incompetent. They do it by example.
In fact, if the government can create an organization to process all of the junk they are offering to buy from the banks and manage all of the money they are investing in the top of our problem,they should be able to manage help at the street level.

Lawrence

Mr. Fishback, thank you for your explanation on HOLC.

Is it even possible to do this today? The mortgages have been securitized to the point where no one knows who owns what anymore. In addition, all parties involved in the loan would have to agree to refinance the loan, including the owners of the derivatives.

steve O

As one who has worked in the mortgage industry, I believe that gov't guaranteed sub-prime loans are ok, but must be based on present RE value, and ARMs must not contain artificially low initial payments.

IE. The borrower must be able to afford the house, right now, with realistic mortgage payments.

Jake

Thanks for the explanation. It sounds like the HOLC was intended to only help those who were justified in taking out a loan to begin with, not people who got a loan but should have not. My understanding of the current situation is that a vast majority of prime (creditable) borrowers are still paying their loans on time as they should. The problem is with the fringe group of people who could not afford their loans when they received them, let alone now. This is an important distinction and I'd like to know how this impacts the cost/benefits of restarting a HOLC program.

Patrick

Heh. Nice map there. There is a reeeally gritty background to those pretty colors, yet I was surprised at no mention! And those colors might go a long way to explain how we wound up in this predicament.

charles

Victor Grauer - Are you kidding? You should hear the people I talk to - financially suicidal. Sorry, but trickle down happens if you want it to or not - we are indeed in a web. Ordinary working people need to "get with the program" grow up, invest in education, and on and on. I'm one of them I should know.

Skip Wenz - I disagree. They need to be smarter. Yes it's all so sad. We want all of the good of a free market economy and none of the uncertainty. You break my heart.

The post was excellent. No preaching, no sides, thought provoking, factual and concice...great job.

Johnny E

I still haven't heard anybody factor in the recent change in the tax code where the limits for mortgage deductions were raised substantially. So now instead of taxpayers having an incentive to own a basic home it created an incentive for building MacMansions, speculaors to buy extra homes, people to deduct vacation homes, etc. Builders stopped building low-cost homes so low-income people were forced to buy homes above their means.

That change in the deduction limit turned an incentive for everybody to own their own homes into a subsidy for high income people. It was a massive transfer of wealth from low income taxpayers to high income people.

Paul K

@8, "The government pushed, circa 1999, for relaxed critera for mortgage lending. The aim was to allows everyone to own a home" - this is not the cause; that is talk-show fodder, but is not true. The government allowed Freddie/Fannie to include just below prime loans to pick up more people normally held off by older style criteria. But, this is not what caused this mess. What caused this was way below prime loans, "exotic" loans (e.g. interest only, 0 down, 5 year bump), and then the securitization and CDS "insurance" of packages of these loans. The default rate on the 1999 loans is no higher than prime loans were.

skip Wenz

Something has to be done about the mortgage crisis. While it's true that today's situation isn't as bad as that of the 1930s, do we want to let it get worse?

While it's wise to examine the details of any program before launching it, it's important to remember that it's not just the abstraction called "the economy" that's at risk. It's also real, flesh-and-blood people who are liable to loose not just their house but their home. Foreclosures disrupt lives and destroy neighborhoods, as well as leaving banks with worthless assets and frequently destroying the original asset - the house - through neglect and vandalism.

Mr. Fishback's statement - "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." - is bunk.

While we tend to minimize the dollar value of people's down payments - "Oh, they only put down 5 percent" - we should realize that for many people that was a huge amount of money, and it was often borrowed from relatives. If they lose their homes, it might take them a decade or more before they are able to recover financially to the point that they can try to buy another house - if they ever recover. (They still have to repay their relatives, after all.)

What those people were trying to do is live the American dream and own a house. They were optimistic that they would somehow find a way to keep their house once they got in, and fearful that they would never get in if they didn't buy when they had the chance, as the price of houses had been rising steeply for years. What's so criminal about that?

Whether we recreate the HOlC or try a different approach, we have to help at-risk people stay in their homes. To fail at that would be criminal.

Skip Wenz

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SCB

"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"

How can you extrapolate that in today's world it would take 60,000 administrators to run a new HOLC? There were no computers available to the 1930s HOLC, there was no electronic banking system. Everyting during the time period of the HOLC had to done by hand. Certainly, it is possible that through mismangement a new HOLC could have an bloated staffing, but not 3 times as much.

Ethan D

What I like about a new HOLC is it would restore primacy to direct lender-borrower relationships, which does not seem to be the topic of any reforms currently proposed. It seems de-coupling of this relationship is the ultimate factor in the housing crisis, and tellingly describes the problem with CDS's as well. If the original parties to a contract are not the ultimate parties, no amount of imposed incentives, whether private or regulatory, can compensate for the erosion of natural alignment.

AK

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.

Plenty of people were stupid and irresponsible. Buying restaurant meals, gigantic cars, and televisions on credit didn't help. And no one had to take a dangerous mortgage. They could have rented or moved into a smaller house.

JD

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!