mortgage loans were made for only three years -- 7/12/16

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Today's selection from -- Debtor Nation by Louis Hyman. During the first three years of the Great Depression, loans outstanding collapsed by an astonishing 20 percent (as compared to 3 percent in the Great Recession of 2008). It was that collapse that turned a panic into a grueling, long-term depression with almost 25 percent unemployment. One of the chief culprits of the loan collapse was the three-to-five-year mortgage. There were no 20 to 30 year mortgages, and most borrowers were at the mercy of their lenders to renew their loans every three to five years. After the Crash of 1929, that stopped happening. In the wake of that collapse, the federal government invented a new type of mortgage -- the 20 year, amortizing mortgage:

"During the freewheeling years of the 1920s, capital may have seemed to flow too freely, but the easy credit was not limited to consumer goods. During this period, mutual savings banks and building and loan societies lent huge sums to the growing urban population as well. But these home mortgages were not what we today consider traditional mortgages. Bal­loon mortgages dominated urban lending. In these 'balloon notes,' the principal was paid back in whole or in part at the end of the loan term and whatever difference remained had to be refinanced. The average length of a mortgage was three to five years, and was not amortized. Amortized loans -- that is, loans where the borrower pays down both the principal of the loan as well as the interest on the loan every month so that the payments are roughly equal -- existed, but during the boom years, interest-only loans meant home buyers could borrow more money. Bor­rowers hoped to pay it off quickly, or to sell and reap a profit. Most bor­rowers, however, rolled over the mortgage every few years. The bank, if it chose to, could renew the mortgage and keep the borrower in a state of what the later chairman of the Federal Home Loan Bank Board, John Fahey, called 'more or less permanent indebtedness.' ...

"In 1924, the McFad­den Act allowed commercial banks to write mortgages for only five years -- up from one year in 1916. State banks had only 16 percent of their assets in mortgages and this accounted for 95 percent of all com­mercial bank ownership of mortgage loans. Home mortgages were dominated by small lending institutions.

"When the short-term mortgages came due after the stock market crash, investors, recognizing an increasing risk, refused to renew borrowers' loans. Nervous investors and prudent banks everywhere increasingly withdrew their capital from the mortgage market, making it more expen­sive and difficult for borrowers to renew their mortgages. Many smaller banks funded their mortgages by issuing bonds, called participation cer­tificates, to local investors. As investors refused to reinvest in these bonds, banks had no choice but to refuse to refinance balloon mortgage holders. Available mortgage funds dropped precipitously in 1929. For borrow­ers, when a single lender chooses not ... to renew, it is inconvenient; when all lenders choose not to renew for structural reasons, it is a calam­ity. Borrowers unable to pay off the principal on their balloon mortgages faced foreclosures. Foreclosures during the Depression resulted as much from the drop in home owner's income as from the withdrawal of short­-term mortgage funds from the market, making refinance impossible. By 1933 the mortgage market was effectively dead, and with it the housing industry.

"Without mortgages, the housing industry collapsed. Housing invest­ment fell from $68 billion in 1929 to $17.6 billion in 1932. By 1934, the construction industry, as a whole, was one-tenth the size it had been in the late 1920s.Wage earners from a third of the families on relief were employed in construction. Indirectly, the collapse of the housing indus­try hit other sectors of the economy as well. Construction also had tre­mendous linkages to other sectors of the economy to a much greater ex­tent than most industries. Ten percent of American factories manufactured building materials for construction. Twenty percent of freight cars car­ried those materials across the country. Unskilled labor carried mate­rial. Skilled labor put it together. Metal and wood of all shapes and types were needed for almost any project. Muscle and machine were needed alike. Clearly, restoring the economy turned on restoring the construction industry. What was less certain was how to bring about new construc­tion. New Deal policymakers focused on the housing industry in their efforts to restart the economy because it had fallen so hard and so fast. ...

"In 1932 and 1933, lenders foreclosed on half a million homes."