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Adam Gant
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Adam Gant is a sports and entrepreneurial enthusiast with a keen interest in housing finance and home ownership.
Adam Gant is a sports and entrepreneurial enthusiast with a keen interest in housing finance and home ownership.

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A History of the Home Mortgage - Part #3: From the 1970s to the 2010s.

After we experienced the “great recession” following the credit market meltdown in 2008 and heard all about the impending regulation changes, one could begin to think mortgage securitization would disappear from modern financial markets. But, securitization is here to stay.

In Part 2 of this series, we looked at the impact of the banks entering the mortgage lending scene. Starting with the advent of securitization in the 1970s, the homeownership rate improved further based the greater availability of funding that securitization provided.

What exactly is securitization?

The most straightforward way to describe securitization is to compare it to the normal way banks fund mortgages. Some traditional options the Banks have are taking in deposits, issuing stock or issuing bonds all to raise capital for funding mortgages. In any of these cases, the investor is relying on the bank to make the interest payments on the bonds, deposits or dividend payment on the stock. The interest from the mortgages would go into the bank’s general income accounts along with everything else the bank is generating revenue from. Securitization is nothing more than taking a group of mortgages and transferring them from being owned by the bank to being owned directly by investors. As a stand-alone asset, an investor would only get the interest from the mortgages by themselves. Securitization can also eliminate any additional liability the bank would have to the investors beyond what the mortgages return. In order to provide investors more confidence when investing in these mortgages, in Canada and the U.S., there are government backed organizations like Canadian Mortgage and Housing Corporation (CMHC) or Fannie Mae, which provide guarantees to the investors to make funding these groups of mortgages more attractive.

Securitization sounds so simple. It is hard to imagine how this could create the crisis of 2008. Enter subprime mortgages, moral hazard (for both the mortgage banking companies and the borrowers taking out these mortgages) and exponential leverage with increased complexity. All of this created a true lack of understanding of where the overall market was going. For those that have never heard the term before, moral hazard can be described as the situation where someone has the financial incentive to do something bad. Like a lender generating more revenue from lending on a riskier mortgage but not being exposed to that risk because the loan is immediately sold. Or, like a borrower choosing a mortgage option which is cheaper up front but may become unaffordable down the road because they didn’t have to put up any money of their own as a down payment.

While sub-prime loans (or what were previously labeled sub-prime) have all but been eliminated from the marketplace as seen in the chart below, the mechanics of securitization are still alive and well and form a significant part of our mortgage markets today.

What is also important to understand is that mortgages funded through the process of securitization in Canada and the U.S. can have the lowest “cost of capital” for the lender. This means the lender can provide a mortgage to homeowners with the most competitive interest rate, naturally making them attractive to borrowers.

People are always going to want to find the lowest interest rate mortgage option and as long as securitization is a way to bring more funding into the mortgage market it will be a core building block to a properly functioning housing market. Let's go back to the formative years of mortgage securitization and see how it all began.

One could point to the beginning of mortgage securitization in 1970 which was the year when the Department of Housing and Urban Development in the U.S. created the first real residential mortgage-backed security. The Government National Mortgage Association (GNMA, nick-named Ginnie Mae) started issuing investment securities based on an underlying portfolio of home loans.

At the same time, the mortgage market also significantly expanded following when Congress passed the Emergency Home Finance Act. This new act created the Federal Home Loan Mortgage Corporation (FHLMC, nicknamed Freddie Mac) to provide thrifts a better ability to manage interest rate risk by purchasing mortgages from them. Near the end of the decade in 1977, the first private label residential mortgage-backed bond was issued by Bank of America.

Congress later passed the Tax Reform Act in 1986 which included the Real Estate Mortgage Investment Conduit provisions (REMIC) that enabled greater flexibility in structuring the mortgage back security investment vehicles. This is the relief that financial institutions and banks were looking for to start transferring out mortgage lending risks. The appeal of being able to group similar mortgages together and move them “off-balance sheet” allowed lenders to reduce risk and make more money, while at the same greatly increasing funding available to meet consumer demand for housing.

Canada’s equivalent government supported program called National Housing Association mortgage-backed securities, started in 1987. This program allowed investors to earn interest from investing in a large group of mortgages and eliminated repayment and credit risk through a government guarantee. Starting in 2001, loans could also be sold into the Canada Housing Trust which provided an additional benefit to investors of eliminating the negative impact on returns from of any early mortgage repayments by smoothing out the interest rate investors would receive.

In total, mortgages funded by the National Housing Association (NHA) mortgage-backed securities program amounts to 34% of residential mortgages. This is up significantly from the early 2000s where NHA mortgage securitization were approximately 10% of the total mortgage market. In the U.S., government agency mortgage backed securities account for 46% of the total mortgage market and private securitization accounts for 14%.

The chart below shows how much the private market originated mortgage volume grew, which was also when sub-prime loans rife with moral hazard became popular. This was the time when the market got out of control and the worst loans were made. After 2003 is when the lending practices of originators became more focused on getting money out the door on easy terms over providing the right loan size to each borrower. This was done because these mortgage companies could immediately sell off the loans, eliminating all the risk for themselves. And, sub-prime adjustable rate loans generated the most profit because they had the highest rates.

From 1970 to 1983, the U.S. Federal Mortgage agencies grew in market share to 31.1% from 8.3% and homeownership participation grew to 65.6%. What is interesting to note is that as of 2016, the U,S, is now at just over 65% homeownership participation. Any innovation or new efforts to create financing options for home-purchasers since 1983 have now had a sum total impact of nothing. Canada has also experienced no growth in the homeownership participation rate for those less than 44 years of age since the census results in 1976.

In 2012, banks in Canada were required to follow the new “B-20” guidelines which, among other things, put more emphasis on the borrower’s income and ability to repay the debt than simply the collateral value of the real estate itself. While these guidelines are good in making sure household debt doesn’t grow beyond the means to repay it, income levels at the median are not growing as quickly as home values have. In order to provide homeownership choices, it seems that now more than ever the banks are not going to be able to provide all of the solutions by themselves.

The past two decades have seen increases in income inequality that may well be exacerbated by the current financial system for mortgage loans and by some of the issues surrounding housing-related government policies. Securitization has definitely helped to improve funding for homeownership but in the last 10 years we have tested and found the limits of securitization for helping to sustainably grow homeownership. In order to move beyond where we now find ourselves, we will have to do something new, something more or something different. Singapore has achieved more that 90%+ homeownership participation without massive waves of foreclosures. Has Singapore figured out something we in North America still don’t understand? What can the future hold and where will the next advances in homeownership come from? The final part in this series will provide some insight and ideas for the future of mortgages.

For more information go to adamgant.com or read other posts on LinkedIn or @adamgant

*Mortgage Markets World Wide - Blackwell Publishing
*Housing Finance Systems A Comparative Study - Croom Helm Ltd Publishing
http://www.mhpbooks.com/books/debt/
http://www.bankofcanada.ca/about/history/
*Mortgage Banking in the United States, 1870–1940 Research Institute for Housing America.
*The Historical Origins of America’s Mortgage Laws, Research Institute for Housing America.
http://whoswholegal.com/news/features/article/31673/securitisation-brief-history-road-ahead

#mortgage #securitization #homeownership #home #bank #lending #loan #home-financing

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A History of the Home Mortgage Part #2 - The Early to Mid 1900’s
In the prior edition of this history on the home mortgage series, we discussed the heavy handed nature of lenders in medieval times and the advancement of mortgage laws to protect borrower’s equity. Throughout history and leading up to the early 1900’s, the...

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A History of the Home Mortgage Part #2 - The Early to Mid 1900’s

In the prior edition of this history on the home mortgage series, we discussed the heavy handed nature of lenders in medieval times and the advancement of mortgage laws to protect borrower’s equity. Throughout history and leading up to the early 1900’s, the mortgage markets were very different then what we know today. Home mortgage loans were provided by life insurance companies, trust companies, or in many cases, smaller individual lenders or mortgage companies.

For those of us who have seen the movie “Its A Wonderful Life”, we can fondly remember the scene where they discuss how money deposited at the bank is not actually sitting in the bank’s vaults but has been used to make loans and is now sitting in peoples’ homes. But, in the US and Canada before the creation of the central banks and government sponsored housing loan insurance organizations, banks were not significant players in the mortgage markets. The reason for this was simple, if a bank could have a surprise wave of customer withdrawals in a short amount of time and needed to call on loans to gather cash for covering the depositors’ requests, mortgages against real estate could not be collected fast enough to meet liquidity demands. For insurance companies and mortgage companies, daily access to cash was not as big of a concern because none of their customers would come and demand their money back on a given day of the week.

The creation of the central bank, the guarantee on deposits later provided by governments following the great depression, and the creation of home loan insurance organizations were the three big changes the banks needed to finally get into mortgage lending.

1. Central banks allowed the individual banks to co-operate together more easily to manage each of their own liquidity needs. In effect, if one bank needed cash on a given day of the week to meet depositors’ withdrawal requests, it could borrow the money overnight from another bank. This took pressure off the bank and allowed for less liquid loans to be made.

2. A government guarantee on deposits reduced the probability and magnitude of a potential bank run. This also made it more comfortable for a bank to lend on longer term mortgage loans.

3. And most important of the three for housing, with the creation of home loan insurance organizations the banks could mitigate loan loss risk if borrowers defaulted or the value of homes went down below outstanding mortgage balances.

From the 1940’s onwards, the banks began to dominate the mortgage markets and ultimately became the leading lenders. Additional local chartered lenders began operating much the same way, called Credit Unions in Canada or Savings and Loan Co-operatives in the US. These smaller regional players filled geographical gaps or provided loans to borrowers where the larger banks could not.

Part 1 of this series started by describing how individual direct lenders were the only source of mortgage loans prior to the 19th century, followed by outlining how mortgage companies expanded late in the 1800s. This second part to the series covers the portion of history when the banks became active with the invention of central banks and housing loan insurance organizations.

Part 3 of this series will cover the next big evolution in housing finance which occurred with the introduction of mortgage securitization and mortgage banking. Starting in the 1970’s, the wide spread adoption of national mortgage agencies like the Government National Mortgage Association - GNMA (Ginnie Mae), the Federal National Mortgage Association - FNMA (Fanny Mae), and the Federal Home Loan Mortgage Corporation - FHLMC (Freddie Mac) helped mortgage banking to become a new home financing force.

The chart below shows a progression of housing finance systems starting with simple direct individual lenders, evolving through corporate intermediaries like mortgage companies, followed by the entrance of the banks, and finally to the creation of mortgage banking and the securitization model.

What is interesting to see, now looking back on these stages of the mortgage market evolution, is the increase in homeownership with each successive development.

By 1930 home ownership reached 47.8%. Before dropping to 43.6% after the great depression the homeownership rate then rose up to just over 60% by 1970 as a result of the banks becoming the leading lenders.

In the 3rd part of this series we will look at how much the addition of securitization increased home ownership, personal debt levels, and the quality of housing.


*Mortgage Markets World Wide - Blackwell Publishing
*Housing Finance Systems A Comparative Study - Croom Helm Ltd Publishing
http://www.mhpbooks.com/books/debt/
http://www.bankofcanada.ca/about/history/
*Mortgage Banking in the United States, 1870–1940 Research Institute for Housing America.
*The Historical Origins of America’s Mortgage Laws, Research Institute for Housing America.
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