Mortgages: Past and Future

The Mortgages of the Future

Excerpts:

Past:

During the housing crisis of 1933, for example, Congress created the Home Owners’ Loan Corporation to force some fundamental shifts in mortgage institutions. The HOLC swapped its own debt, which was guaranteed by the government, for mortgages of defaulting homeowners, and it reissued mortgages with some important new features. The new loans had a 15-year term and were self-amortizing — that is, the homeowner made the same fixed payment each month until there was nothing more to pay.

This was a huge change. Until 1933, home mortgages in the United States generally had terms of three to five years, and homeowners had to go back regularly to refinance them. If a mortgage could not be refinanced — because the homeowner was unemployed or because the price of the home had fallen too much relative to the loan amount — a homeowner had to pay back all principal, typically a huge payment, or lose the house.

Future:

Mortgages could be structured differently, so that adjustments in payments would be made as a matter of routine — systematically, automatically and continuously — starting even before any distress is perceived by borrower or lender. By avoiding thousands and even millions of individual family crises, we might also make institutional crises, like the collapse of Lehman Brothers and Bear Stearns, less likely.

We need to innovate, with the creation of “continuous-workout mortgages.” Such mortgage contracts, when originally signed, would specify a program for steady adjustment of the balance and payment schedule over the life of the mortgage, enabling most homeowners to continue to afford to make payments and maintain some home equity, even in harsh economic circumstances. These contracts might become the standard, with automatic adjustments based on shifts in national housing-cost indexes and futures markets (I’ve been involved in creating both), as well as economic indexes like the unemployment rate.

Continuous-workout mortgages would be privately offered. They would not be bailouts; the cost of workouts would be priced into the original mortgage rate. This transparency has a great advantage: when the actual risk to the investor is explicit from the beginning, mortgages are less likely to be initially overvalued in the market, and so the kind of financial crisis we are experiencing now would be less likely. It is, after all, the rapid decline in value of subprime mortgages, and of derivative financial instruments based on them, that has wreaked such havoc in the global financial system.

Comment: In my own view it's been the ARM, no-down payment or low-down payment loans, independent mortgage brokers, and "liar loans", that have brought us to the current crisis.