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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?