Thursday, August 12, 2010

Deja Vu All Over Again

I found these paragraphs in Katherine Stone's NYT op-ed today to be especially ironic, emphasis mine:

"Until recently, most Americans paid for their homes through 30-year self-amortizing mortgages, in which interest and principal are paid at the same time. These work well as long as homeowners have stable, long-term jobs that enable them to regularly make their monthly payments. 

But these days such careers are increasingly scarce. Therefore, any effort to recover from the crisis must include more flexible mortgages that take today’s employment landscape, with its frequent job-hopping and episodic unemployment, into account. 

It’s not as if the 30-year self-amortizing mortgage has been around forever. In fact, it is a fairly recent invention. Before the 1930s, homes were financed by three- to five-year balloon loans. Homeowners made interest-only payments for the duration of the loan, then typically rolled them over into new loans when they came due

During the Great Depression, however, many borrowers were unemployed when their loans came due; banks were reluctant to offer new loans, and owners had not accumulated enough money to pay off their loans. The result was a wave of foreclosures."

Sound familiar?  "Homeowners made interest-only payments for the duration of the loan then typically rolled them over into new loans then they came due."   Deja vu all over again.  It didn't work then, and it didn't work this time.



wcw said...

An opinion piece, under the peculiar ethics of the op-ed page, is not fact-checked. Here I think this bites us, since that description of pre-1930s housing finance is incomplete. This canonical history of US residential mortgages can help.

It is true that before ~1880, mortgages 'generally were for only one-third to one-half the purchase price of the to three years.' (Note the very low LTVs.) By the latter part of the 19th century, S&Ls emerged with amortized mortgages up to 12 years with 60-75% LTV. Then:

'Between 1920 and 1930 total residential mortgage debt tripled. The
S&Ls alone mortgaged 4.35 million properties, totaling more than 1.5 billion dollars in loans. Debt-to-equity ratios were changing dramatically as people were borrowing much larger amounts relative to the total purchase prices and to their incomes and savings. However, much of this financing consisted of a crazy quilt of land contracts, second and third mortgages, high interest rates and loan fees, short terms, balloon payments, and various other high risk practices..'

What didn't work then was indeed what broke down recently, but it wasn't some mythical paleo-loan. It was having the bulk of people go past the long-extant amortizing mortgage for a crazy-quilt of high risk practices.

rabbit said...

wcw, thanks for the .pdf. The article didn't go into detail on the "crazy quilt", but its description of S&L loans--up to 75% LTV, 12 year terms, amortizing schedule--doesn't seem to explain the "crazy quilt" description. Most sources I've read indicate that average LTV ratios hovered below 50% leading up to the Depression. With that much equity at stake, it seems unlikely that 5-year revolvers would indicate a mortgage bubble.