Does the Great Depression Hold the Answers for the Current Mortgage Distress?

ST. LOUIS, May 2 /PRNewswire/ -- While the nation's current level of
mortgage distress seems reminiscent of the Great Depression, a closer
examination reveals the underlying causes are far from similar, according to
an economic analysis from the Federal Reserve Bank of St. Louis.
David C. Wheelock, an economist with the St. Louis Fed, wrote the analysis
for the May/June issue of Review, the Reserve Bank's bi-monthly journal of
economic and business issues. The publication is also available online at the
St. Louis Fed's Web site: http://research.stlouisfed.org/publications/review.
Since the peak of U.S. housing prices in 2005, the housing market has
undergone a rapid fall while mortgage delinquencies and foreclosures have
risen sharply. Many analysts predict house prices will continue to fall and
mortgage delinquency and foreclosure rates will remain high until 2009 or
beyond.
One of the proposals to stem the tide of loan defaults and foreclosures
includes creating a new federal corporation to purchase distressed mortgages
from investors and convert them to 30-year fixed-rate mortgages. "The type of
agency being suggested," said Wheelock, "would closely mimic one from the
Great Depression called the Home Owners' Loan Corporation."
Wheelock's analysis revealed that a period of intense housing construction
preceded the Great Depression. Although this growth period came to an end
shortly after housing prices reached their peak in 1925, outstanding home
mortgage debt continued to increase.
Well into the Great Depression, falling household incomes and property
values fueled high levels of loan delinquencies and foreclosures. Many of the
home loans during this period lasted no more than five years and many
homeowners made little or no payment toward the principal. Falling incomes
made it increasingly difficult for borrowers to make loan payments or to
refinance outstanding loans as they came due. "At its worst, in 1933, around
1,000 home loans were foreclosed every day," said Wheelock.
In addition to programs aimed at providing affordable housing, the federal
government took several steps to alleviate distress in the mortgage markets.
During the 1930s, five major agencies were created to provide liquidity for
home lenders, reduce the number of home loan foreclosures, and reform the
mortgage market -- among them the Home Owners' Loan Corporation (HOLC).
Created in 1933, the HOLC was authorized for a period of three years to
purchase and refinance delinquent home mortgages, including mortgages on
properties that had recently been foreclosed. The agency was permitted to
issue up to $2 billion of bonds to purchase mortgages on one-to-four-family
properties that were in default or that had resulted in foreclosure during the
previous 24 months. "It is difficult to determine the extent to which the HOLC
contributed to the rebound in the housing market," said Wheelock.
"Nevertheless, in helping to clear a million delinquent loans from the books
of private lenders, the HOLC undoubtedly contributed to the continuation of
private mortgage lending."
Recently, many parallels have been made between the current distresses in
the U.S. home mortgage market and the experiences of the Great Depression.
Like the recent episode, the increase in mortgage defaults during the
Depression coincided with a sharp decline in housing prices after a period of
rapid gains. Also like the recent experience, mortgage defaults during the
Depression were more prevalent on mortgages with unconventional terms, such as
short-term, non-amortizing loans. Lastly, mortgage underwriting standards
prior to both periods appear to have deteriorated.
But regardless of the similarities, Wheelock said the underlying causes of
the mortgage loan distresses are dissimilar. "Unlike the situation now," he
said, "During the 1930s the main causes were a sharply contracting economy and
falling price level. Today's mortgage distress was mainly caused by
questionable mortgage practices on the part of some borrowers and lenders.
Borrowers took loans that they could not afford, and lenders were granting
those risky loans."
Because the actions that brought us to this point are very different from
the 1930s, Wheelock concluded that, "The federal response to mortgage distress
during the Great Depression can provide insights into how the government might
respond to the current wave of defaults, but the lessons from the operations
of the HOLC are somewhat limited. History is useful not only for pointing out
similarities with past experience, but also differences."
With branches in Little Rock, Louisville and Memphis, the Federal Reserve
Bank of St. Louis serves the Eighth Federal Reserve District, which includes
all of Arkansas, eastern Missouri, southern Indiana, southern Illinois,
western Kentucky, western Tennessee and northern Mississippi. The St. Louis
Fed is one of 12 regional Reserve banks that, along with the Board of
Governors in Washington, D.C., comprise the Federal Reserve System. As the
nation's central bank, the Federal Reserve System formulates U.S. monetary
policy, regulates state-chartered member banks and bank holding companies,
provides payment services to financial institutions and the U.S. government,
and promotes community development and financial education.
SOURCE Federal Reserve Bank of St. Louis

Adriene L. Mathes, +1-314-444-7471, mobile, +1-314-852-5968,
adriene.l.mathes@stls.frb.org