The History of the American Mortgage
Obtaining a mortgage has long been a pursuit that has inspired mixed emotions from hope to fear amid triumphant feelings of achieving the seemingly Universal Dream—and all the confusion and stress that entails. Theories and practices of the mortgage market have evolved with the ever-changing face of home loans in America. The history is fraught with booms and busts that have seen rapid expansion and success for individuals and families entering the market as well as recessions and depressions of devastating consequences. Nevertheless, the mortgage is a widely used form of money lending because, in most cases, the property remains with the debtor in the good faith that the debt will be paid—with interest, of course. In other words, the mortgage is meant to be a beneficial arrangement for both parties.
Perspectives on Loans, Pledges, and Mortgages throughout History
An article in the American Law Register from the middle of the nineteenth century hypothesizes that prior to written record any favors taken out on property would have been “by way of pledge rather than by means of a mortgage” (American Law Register [ALR] 1856). The idea is appropriate given the etymology of the word mortgage, from the Old French mort and gage meaning literally “dead pledge.” As morgage, the word occurs in Middle English from the fourteenth century (though evidence of actual mortgages in England date further back) but, according to the American Heritage Dictionary, it was the preeminent English jurist from the sixteenth century, Sir Edward Coke, who first made sense of the etymology within his compilation of English common law. Coke considered the question of uncertainty between mortgagor and mortgagee and concluded that if someone takes out a mortgage and does not handle the debt, then the real property mortgaged is handed over and the pledge is dead. Similarly, should the mortgagor pay off the debt, the pledge is likewise dead.
Multicultural influence abounds in early writing on mortgage law. The Code of Manu is early Hindu law from ancient India that rejects deceptive and fraudulent mortgages. Though, perhaps because of the inherent risk involved in money lending of any kind, mortgages are often criticized. Creditors and lenders who charge too much interest, or usurers, even had a special place in Dante Alighieri’s Inferno, in the seventh circle of hell. Money lending is also condemned by God in Jewish law (Jackson 1968). Indeed, the American Law Register identifies the origin of the modern system of mortgaging real property in early Jewish sacred writings such as the Talmud. And the ancient Greek and Roman civilizations seem to have borrowed the idea from Judaic sources. Roman law divided the concept of debt security into two categories. In the pignus, or pledge, the creditor takes possession of the property, while in the hypotheca, the property remains with the debtor until the debt is paid. The hypotheca is clearly a predecessor to the modern mortgage (ALR 1856). Jewish practices and law also had direct impact on English common law including, but by no means limited to, the standard for mortgage bonds and virtually all forms of the money-lending business (Rabinowitz 1945).
Like auto insurance, the mortgage also has precedent in ancient marine insurance. Early maritime law made allowance for bottomry bonds, which were loans made on merchants’ ships that were repaid with interest once the ships safely arrived at their destinations. The ancient idea of loans made on ships was especially useful after World War II when the United States had an immense surplus of merchant shipping. For private ownership, both domestic and foreign, the most logical method of advancing a loan for the acquisition of a ship was by mortgaging the ship itself (Lord and Glen 1947). Clearly, while the American mortgage market has been a consistently topical news story for the better part of the last century, it has ancient precedent and has prompted countless writings to help people understand the law and its seemingly ever-evolving complexity.
Emergence of the American Home Mortgage Market
The focus on the changing mortgage market is due to the startling fact that between 1949 and the turn of the twenty-first century, mortgage debt relative to total income of the average household rose from 20% to 73%, and from 15% to 41% relative to total household assets. In 2005, Green and Wachter observed that aside from the rapid growth in home mortgages in America, the mortgage itself had evolved with the intervention of the American government to provide a unique array of options that set the American mortgage apart from much of the rest of the world. But the uniqueness of the American mortgage has roots in American independence and the revolutionary government when “the first legitimate commercial bank” was founded in 1781. The move initiated a system of exchange of banknotes and limited-liability bankers within a nascent governmental infrastructure.
Commercial banks, and later mutual savings banks and property banks, greatly expanded into the early nineteenth century beginning in the port cities and working inward, adapting to the unique characteristics and needs of each new region. Banks in rural regions, in particular, thrived on mortgage-based lending by providing loans for farmers. Throughout the antebellum United States from 1820-1860, the number of banks increased dramatically along with the volume of loans, from about $55 million to nearly $700 million (Bodenhorn 2008). Such widespread diversity in American banking led D. M. Frederiksen to note near the end of the nineteenth century that American mortgage loan companies were so numerous in large part because of the absence of a single national bank or central mortgage company like those that existed in some European countries. Indeed, the National Bank Act of 1864 established charters for national banks and greater security and oversight for the federal treasury to develop a nationalized currency (primarily to finance the Civil War), replacing the individual state and bank bonds.
Such charters allowed the American banking system to expand even more, though national banks were technically restricted from directly investing in mortgages (though loopholes were extensively used) until 1913 (Davis 1965)--but further amendments and restrictions long kept the national banking system from controlling the long-term investing market (Keehn and Smiley 1977). But by the time of Frederiksen’s writing in 1893, when the mortgage business of America was still relatively new, small state banks such as the Iowa Loan and Trust Company had begun issuing bonds acknowledging debts based on the trust and credit of the debtor alone. These mortgages were immensely popular throughout the United States though the face of such mortgages was much different from that of today: the average life of a mortgage was less than six years and accounted for less than 40 percent of the real property value.
The mortgage market in the postbellum period and through the end of the nineteenth century was a disintegrated network of unevenly allocated mortgage funds that had direct impact on western farming and, in particular, spatial patterns of urban growth at the time. Market segmentation favored the Northeast with lower interest rates while hitting the areas of the greatest growth in the West with the highest rates. The majority of lending institutions were concentrated in the Northeast and urbanization throughout America meant “substantial injections of investment funds for city development and expansion” throughout the country (Snowden 1988). Forty percent of the loans were provided for residential construction, and Western cities nearly doubled in population in a single decade between 1880 and 1890 in spite of interest rates higher than their eastern counterparts’. Snowden speculates that such growth was inevitable, but the asymmetry in lending practices may have slightly curbed growth in new cities while still allowing established cities to grow and urbanize at a high rate (1988).
Clearly, mortgage banking growth in and around that decade helped vast amounts of capital move into the West. Western mortgage companies made numerous loans and then sold them to the East. But when drought caused farm foreclosure and other companies failed, Eastern investors were hurt and, for a number of years, were hesitant to continue investing. Such uncertainty temporarily delayed the development of a national long-term investment market of the kind that later prompted housing booms in the twentieth century. But as ventures out West recovered and confidence rose, interest rates leveled across the United States and, following on the success of life insurance companies, funds starting moving across regional borders and the American mortgage market began to take shape (Davis 1965).
The Twentieth Century American Mortgage Market
By the early 1900s, mortgages “featured variable interest rates, high down payments, and short maturities. [And b]efore the Great Depression, homeowners typically renegotiated their loans every year” (Green and Wachter 2005). Mortgages began to take more modern shape as a result of the intervention of the federal government during the Great Depression. The most important institutions that resulted were the Home Owner’s Loan Corporation (1933), the Federal Housing Administration (1936), and the Federal National Mortgage Association (1938) later known as Fannie Mae. Property values had plummeted during the Depression and mortgages were destabilized. Holders “refused to refinance loans…[and] as a result, borrowers defaulted” (Green and Wachter 2005). Nearly a tenth of all homes at the Depression’s lowest point were in foreclosure and further downward pressure ensued with the attempted resale of repossessed property. The Depression-era institutions were designed to provide government-sponsored bonds to reinstate mortgages in default by extending terms and fixing rates to create self-amortizing loans for the borrower. Other provisions were for mortgage insurance and investing confidence, especially to stabilize mortgages in less-affluent communities.
Among the many provisions in the G.I. Bill created for veterans of World War II was the formation of the Veterans Administration mortgage insurance program. The program provided excellent rates on mortgages for veterans and was designed as part of the total deferred compensation package for service in the armed forces, as well to stimulate the housing market. Loan-to-value ratios rose to 95 percent and the maximum mortgage term was extended to 30 years. The Government National Mortgage Association (Ginnie Mae) was established in 1968 to “bring uniformity to the mortgage market and invent financial instruments…that would help keep the mortgage market liquid from the mid-1980s until today” (Green and Wachter 2005). In 1970, the Federal Home Loan Mortgage Corporation, known as Freddie Mac, was formed to further promote home ownership by “providing liquidity in the [secondary] mortgage marketplace” (Reed 2007). In the 1980s, adjustable rate mortgages returned to the scene, though whenever the Federal Reserve is able to curb inflation rates, fixed-rate mortgages have remained desirable. By 2003, governmental mortgage institutions held 43 percent of the total mortgage market while mortgages subsequently sold on the secondary market were designed to manage risk from such massive lending practices (Green and Wachter 2005).
The Mortgage Market Today
The vocabulary of the mortgage process is extremely daunting and, like any occupation, it is managed by a unique trade with specialized knowledge that can be difficult to comprehend. As a result, understanding the difference between mortgage bankers, brokers, and correspondent lenders—as well the guidelines regulating the business of the commodity of mortgage loans—to avoid predatory lending practices is critical. Throughout the entire process of obtaining a mortgage, buyers encounter a number of terms that are important to understand. More importantly, buyers entering into adjustable-rate and hybrid mortgages have to be prepared to handle the potential for rising interest rates after the terms of cut-rate and fixed-rate mortgage loans expire. In recent years, as the economy has cooled, many were not prepared, and foreclosures have skyrocketed, shaking the American economy (Reed 2007).
Indeed, to look up “mortgage” online or at the library is not to find succinct, manageable histories of housing loans, but to be faced with an overwhelming array of mortgage-made-easy advice books by real estate aficionados who learned how to make the most of the unique market. Titles such as Home Buying by the Experts, Real Estate Debt Can Make You Rich, Idiots Guide, and Mortgages for Dummies promise help navigating the complicated Mortgage Maze, especially now in light of the impending American Nightmare of housing foreclosures. But real estate booms and busts are the enduring model in the housing market—a constant cycle.
-- Posted April 13, 2008
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