Interestingly every generation thinks theirs is the first to innovate, the first to experience trauma, the first to experience love; such is life. Modern historical documents regarding loan securitization are written as if history began in 1970 with government created securitization. Yet, history repeats itself and just as the human condition includes repeated greed, history contains repeated cycles of societies frenzily feeding greed. As long as there have been housing and mortgages, there have been greed driven boom cycles that were fed by mortgages. In fact, our last two great boom bust cycles, the long depression of 1871 and the great depression of 1929 were both proceeded by housing booms.
Between 1921 and 1929, housing debt tripled from $9 billion to $30 billion. Home ownership jumped from 41 percent to 46 percent (a similar percent jump to our modern housing boom). The commercial lenders that fed the boom at the time were banks, buildings and loans, insurance companies and mutual savings banks. They sold loan originations into two types of securitization of the time, mortgage guarantee companies and real estate bond houses. In 1910, only 10 companies were active in the business but by the crash over 50 were. Even the numbers of companies are eerily familiar with our boom bust cycle.
With mortgage guarantee companies, insured mortgages came to be placed in trust accounts with collateral trust certificates of deposit. Real estate bonds, a method that had been used in the previous cycle during the 1800’s, were also in use in the 1920s to absorb commercial mortgages. Mortgages were used to as collateral in the development of bonds denominations of $100 or more and sold into a secondary market. The securities market even had its own association, the National Association of Security Commissioners, to oversee codes of standards for the secondary mortgage industry.
But as in every boom bust cycle, the boom busts. By the height of the Depression, half of the 18,000 building and loan companies had closed and the majority of loan guarantee security companies were seized by the federal government for liquidation. By 1935, 80 percent of all real estate bonds were in default. Later investigations showed that companies had violated standards, substituting bad loans for performing ones and maintaining inadequate guarantee funds.
In response to the housing emergency, the federal government passed the Home Owners Loan Act of 1933 to offer new loans to delinquent home owners. They essentially wrote down the existing mortgages and offered new principal amounts on the loans to over ten percent of existing home owners in the United States. The 1930’s federal government moved fairly quickly to stem rising bankruptcies, evaluating over 40 percent of existing mortgages in three years. The building and loan industry reorganized and the remaining solvent companies formed the basis for our savings and loan industry.
Now by placing the word “modern” on our current structure of commercial institutions that were born from the previous crisis, and mixing this modern financial architecture with the interest rate risk du jour of the 1970’s, out came the most recent securitization structure within Ginnie Mae. From there, as my previous post suggests, multiple milestones were reached to bring us to our current crisis, including the invention of the default swap which took the process to wuthering heights.
Yes our predecessors knew nothing of real trauma or real love and they certainly did not have a clue regarding securitization. Come to think of it, neither did we.