CHAPTER 2
A BRIEF HISTORY
OF HOUSING FINANCE

To move forward in housing finance,
we must first examine
how we got to the present.

AS WE CONSIDER the sustainability of housing while we move into the future, we must include financial sustainability in the discussion. In many ways, the current housing market suffers when home values go down. Having a housing finance system dependent on continuously increasing home values isn’t sustainable as populations of low-income people in need of quality housing grow. The subprime mortgage crisis was a symptom of the problems inherent in this system. Reduced home values and increasing adjustable interest rates have caused millions of foreclosures. In the second quarter of 2010, 11 million American homeowners were “underwater” (they owe more on their homes than they’re worth), according to real estate analytics firm CoreLogic.1 Rather than suggesting that home values need to go back up, these effects are symptoms of a bigger problem: a system that’s dependent on ever-increasing home values most Americans can’t afford. If we look with a broader lens, we can see that it would be better for almost everyone if housing prices were to go down. Reduced home prices would allow more people to afford homes. It would bring more tax revenue to cities. It would reduce the amount of our incomes we must dedicate to housing, freeing up resources that could go toward higher-quality food and health care.

  History of Housing

With any endeavor, as we look toward the future, it’s best to first examine the past. Before we can understand the current housing finance system, we need to understand how it came to be.

Government and industry leaders have manipulated American land and housing pricing since the nation’s founding. In the very early years, distribution of government lands was chaotic and arbitrary. Boundaries, marked off by footsteps from geographic landmarks, were a common source of disputes. The Land Ordinance of 1785 formalized border markings by astronomical points and broke townships into 640-acre land parcels. Potential homesteaders were minimally required to purchase an entire 640-acre block of land at $1 an acre, just over $8,000 today, expensive during a time when housing finance didn’t exist. By 1800, minimum lot size was halved to 320 acres, land prices rose to $1.25 an acre, and homeowners could pay in four installments, according to the National Archive,2 but forces were still working against low-income citizens who hoped to obtain land. In the South, large-scale farmers became wealthier as crop prices increased, and they bought up large swaths of land at the expense of low-income Americans. The already-settled Northeast held few opportunities, so potential landowners looked toward the growing West. Before the 1846 to 1848 war with Mexico, settlers in the West demanded preemption — the ability to settle first and pay later, one of the earliest forms of American credit. After the war, growing numbers of immigrants pressured the government to increase the affordability of unsettled property through homesteading legislation, but corporate interest opposed it; in the North, factory owners feared that cheap land would draw away its low-wage immigrant labor force. In the South, wealthy farmers feared rapid Western settlement would include large numbers of small farmers who would oppose slavery. According to the National Archives, three times — in 1852, 1854 and 1859 — the House of Representatives passed homestead legislation, but on each occasion, the Senate defeated the measure. In 1860, a homestead bill providing Federal land grants to Western settlers was passed by Congress only to be vetoed by President Buchanan. Finally, in 1862 the Homestead Act passed — in large part because the South’s secession took the slavery issue out of the equation.

The Homestead Act allowed any citizen who had never borne arms against the US government to attain ownership rights to 160 acres of land by filling out an application, living on the property for five years, building a structure 12-by-14 feet or larger and growing crops. Initially, meeting the requirements was more difficult than it sounded. With no form of mass transportation or outposts for supplies, travels westward through the American wilderness were extremely difficult. Once settlers arrived at settlements on the Plains, the lack of large trees made finding building materials difficult (and it’s why many Plains settlers built sod houses). Winds, blizzards and insects made growing crops difficult; limited crops made raising livestock difficult. As a result, many homeowners couldn’t stay in one place long enough to make the five-year requirement of the Homestead Act. When the Railroad Act of 1869 passed, relief came to settlements in the form of a nationwide railroad, providing transportation and access to resources. Pioneering flourished. By 1934, over 1.6 million homestead applications were processed, and more than 270 million acres — 10 percent of all US lands—passed into the hands of individuals, according to the National Archives. The Homestead Act wasn’t repealed until passage of the Federal Land Policy and Management Act of 1976.

As homesteaders settled the West in the late 1800s and early 1900s, immigrants and others in urban areas were renting apartments or tenements. In growing American urban centers, the need to provide housing for rapidly increasing immigrant populations demanded the construction of thousands of tenement buildings, which allowed property owners to earn a second income renting out low-income housing. These units generally included a street-level store topped by four to six stories that housed four tenements each. For many years, tenements did not have plumbing, and usually several families lived together. In 1890, a studied tenement block housed 4,000 persons in 600 apartments. In 1865, New York City had about 15,000 tenements. In 1900, the city boasted more than 80,000 tenements and 3.4 million residents.³

Throughout this period, mortgages existed, but borrowers often had to pay around 50 percent down on five-year loans.4 While handmade housing continued to be accessible outside urban areas, a variety of forces made purchasing and financing a home created by professional companies more appealing. A more specialized economy gave individuals and families higher incomes and less time and desire to do traditionally homemade, handmade activities such as sewing clothes, building furniture, baking bread and building homes. As the Industrial Revolution took a greater hold, the idea that something was not homemade gained a glamorous appeal. The novelty of factory-made items made them intriguing. Industrialization made its way into the do-it-yourself mindset of early 1900s Americans via hybrid house kits. Sears, Roebuck and Co. famously offered a DIY house kit by catalog, selling more than 100,000 homes from 1908 to 1940.5 The kits contained more than 30,000 parts and the building instructions for around $2,500.

In the early 1900s, extremely poor housing conditions led to the formation of three organizations tasked with the creation and enforcement of building codes: the Building Officials and Code Administrators (BOCA), serving the eastern and Midwestern states; the International Conference of Building Officials, serving the western states; and the Standard Building Code Congress International (SBCCI), serving the South,6 but city slums still offered extremely poor housing conditions. Government officials did little to provide decent inner-city housing to the ever-increasing numbers of low-income urban dwellers. “By contrast,” writes Anthony J. Badger in The New Deal: The Depression Years, 1933–1940, “governments in both Britain and Germany in the 1920s had built a million homes and the Netherlands housed one-fifth of their population in government-owned housing.”⁷

  Moving Toward Modern Housing

The groundwork for much of modern home financing was laid with the New Deal, legislation passed in 1934 by Franklin Roosevelt in response to the Great Depression. The New Deal aimed for economic recovery, reform of economic policies and relief for the nation’s jobless.

As the effects of the Great Depression set in nationwide, homelessness began rising dramatically. Hundreds of thousands of homes and farms were foreclosed or in danger of foreclosure. From 1929 to 1933, foreclosure rates rose steadily, peaking at 1,000 a day in March 1933.8 As rural farmers lost homes, they came to the cities in search of work. Roosevelt’s administration hoped to rein in foreclosures and provide low-income housing, and the New Deal enacted three major housing-related programs to work toward those goals.

Home Owners’ Loan Corporation

The Home Owners’ Loan Corporation (HOLC) was tasked with putting a halt to foreclosures and reversing ever-increasing foreclosure rates. The HOLC used capital funds to purchase and refinance risky mortgages, aiding more than a million homeowners from 1933 to 1935. The HOLC made mortgages more manageable by extending loan periods from then-standard 5-year mortgages to 20- and 25-year loans. In 1935, the HOLC ceased lending, as was mandated in the Home Owners’ Loan Corporation Act that created it. By most accounts, it was a successful program, refinancing one of every five mortgaged homes at the time, and lending about $3.5 billion over its lifetime. In addition to mortgage refinancing, its services included debt counseling, budget planning and family meetings. One major criticism of the program is that its policies encouraged racial segregation.

Federal Housing Administration

The Federal Housing Administration (FHA) was established under the National Housing Act of 1934 to insure loans for the construction and purchase of homes. In the 1920s, construction of about 900,000 new homes started each year; in contrast, in 1933, the construction industry started on only 93,000 new homes. By insuring private lenders, the government provided the confidence that lenders needed to offer more individuals the opportunity to build or buy a home. “FHA support encouraged lenders to reduce the down payments they required, lengthen the repayment period, and lower the interest rates they charged,” Badger writes.9 Over the next 40 years, the percentage of American homeowners rose by almost a third.

Greenbelt Programme

The New Deal administration made efforts to create government-built low-income housing communities, though none met with great success. The Greenbelt Programme was designed to put the jobless to work building towns just outside major cities. The communities would offer low-income housing and relieve growing pressure on crowded inner cities. Led by the head of the government’s Resettlement Administration, collectivist economist Rex Tug-well, the communities were planned to include democratic decision-making on the part of residents. Many problems plagued the program, however. Its usefulness was reduced by poor site selection near fairly well-functioning urban centers rather than the most blighted. High costs associated with building quality housing quickly made rent too high for city slum-dwellers. Several other programs were launched to attempt to provide high-quality, low-income urban dwellings, but conservative opposition kept successes to a minimum. Attempts at creating government-funded urban housing dropped off until 1949. A post-World War II housing shortage yielded Congressional approval for 810,000 units of public housing, but lack of enthusiasm from both voters and government representatives meant only about 357,000 were actually built. Badger writes:

Low-cost housing, therefore, never attained public legitimacy and met only a small part of the poor’s housing needs. Instead, public housing, in contrast to European countries, served further to isolate and stigmatize the poor, creating the end result that New Deal welfare policies had expressly set out to prevent.¹⁰

In 1938, the government founded and sponsored mortgage giant Fannie Mae (the Federal National Mortgage Association), tasked with improving accessibility to loans, encouraging lenders to increase availability of mortgage funds and provide liquidity in the mortgage market. Fannie Mae works with lenders to provide mortgage funds. It does not lend directly to homeowners, but purchases mortgages from lenders, holding them in a portfolio and providing lenders with liquid assets to fund more mortgages. The company also issues mortgage-backed securities (MBSs) in exchange for pools of mortgages from lenders. With $2 trillion worth of business, Fannie Mae is the nation’s largest provider of mortgages, the second-largest corporation and one of the world’s largest financial services corporations. Upon its founding as a government entity, Fannie Mae was only authorized to purchase FHA-insured mortgages.

In the late 1960s, housing went through another set of updates and alterations. Poor residential living conditions and lack of affordable housing led to the addition of the Department of Housing and Urban Development (HUD), passed by Lyndon B. Johnson in 1965 with the mission of creating strong, inclusive communities and affordable housing for more Americans. In 1968, Fannie Mae became a private shareholder-owned company. In 1970, it was authorized to purchase conventional mortgages. Also in 1970, Congress chartered Freddie Mac to help secure low-income mortgages by purchasing and financing mortgages.

In 1977, the Community Reinvestment Act (CRA) was designed to help fight discriminatory lending habits known as redlining. The federal law requires banks and savings and loan associations to offer credit throughout their entire market area. Its purpose is to provide credit, including homeownership opportunities and small-business loans, to underserved populations. Under the law, banking institutions are evaluated to see if they’ve met community needs and are issued a CRA-compliance rating. Bank CRA records are taken into account when the government considers an institution’s application for deposit facilities, including mergers and acquisitions. The CRA has been controversial since its inception, and, as we’ll discuss more in the next chapter, the controversy has increased since the subprime mortgage crisis.

  The Cost of Housing

A commonly accepted general rule today is that we should spend approximately 30 percent of our household income on housing. But why do we accept this figure? What could we do with the extra income we would save if our housing required 20 percent of our income — or 10?

The 30 percent estimate hasn’t always been the norm. The number has evolved over time since its founding, based on the US National Housing Act, a Great Depression-inspired public housing program passed in 1937 as a way to provide affordable housing to the nation’s lowest-income families. Initial rent limits stated that renters couldn’t qualify as “in need” if they earned more than six times the cost of the rent.11 In 1940, the standards were altered, requiring that rents be capped at 20 percent of household income. In 1969, the standard was raised to 25 percent, and in 1981, it was increased again to 30 percent. Over time, spending greater proportions of our income on our homes has become more acceptable. In fact, we frequently spend more than 30 percent of our incomes on housing. The 2006 American Community Survey12 found that 46 percent of residents nationwide pay 30 percent or more of their income on housing costs. Thirty-seven percent of owners with mortgages and 16 percent of owners without mortgages spend 30 percent or more of their income on housing costs. The census bureau refers to “30 percent or more of income spent on housing costs” as “housing-cost burden.” Families on the lowest rungs of the economy suffer most from expensive housing. While some high-income households may choose to spend more than 30 percent of their incomes on lavish housing and still have plenty of available income, for low-income families, spending more than 30 percent of income on housing cuts into expendable income for quality food and health and child care.

Building homes using the vast supply of used building materials lowers housing costs for the individuals building that home. As several examples in this book show, we can create low- and no-debt homes using almost entirely salvaged materials. If we could institutionalize the reuse of this supply stock, it could have a wider economic effect. Building more homes that cost less to create will reduce the price of overall housing. Though conventionally seen as bad for the real estate market, an overall reduction in the price of homes would mean people would have more disposable income to invest in quality education, health care, nutritious food and home improvements and to reinvest in the economy.