Foreclosed: High-Risk Lending, Deregulation, and the Undermining of America’s Mortgage Market (review)

Dan Immergluck has written a broad and accessible account of mortgage finance in the United States, from the activities of the building-and-loan societies of the nineteenth century to the “Hope Now” initiative of the Bush Administration in the summer of 2008. His book is coherent and cohesive and is well worth reading by citizens who would like to have a deeper understanding of the current mortgage mess. It is also a rewarding read for many academics and social scientists—nonspecialists who may have followed recent events in the housing market but who would like to have a more thorough grounding in its causes and antecedents.

Immergluck reviews the growth of the building-and-loan (B&L) societies in the 1890s and their subsequent fortunes. He compares the more generous mortgage terms of the B&Ls (ten- or eleven-year loan terms with loan-to-value ratios, LTVs, of 60 percent) with commercial banks and mortgage corporations (three- to eight-year terms at 50 percent LTV) and hints at alliances between “reformers” of urban housing conditions and these more aggressive lending institutions.

The collapse of the economy in 1929 led to a calamity in the housing market, as credit dried up and many homeowners were unable to roll over their short-term mortgages, while others lost their jobs and were unable to meet existing repayment obligations. The Home Owners’ Loan Corporation, established by the Roosevelt Administration in 1933, converted one in eight U.S. mortgages to a long-term fixed-rate contract by 1935, and it established the charter for federal savings and loan institutions (S&Ls). The Federal Housing Administration, established a year later, codified the long-term fixed-rate low-LTV mortgage as a product offered by the Federal government.

These two developments, federal charters for lending institutions and the standardization of insured mortgage products (insured through mutual finance at practically no cost to taxpayers) hastened the conversion of what had been exclusively local markets to a national market—a standardized mortgage contract required national underwriting standards, national appraisal standards, national norms. The modern mortgage market was born.

Despite these advances, it is estimated that as late as the 1970s, about half of the mortgages in the United States originated under the “James Stewart” model of mortgage finance—local banks and thrift institutions mobilized the savings of local households and originated mortgages for those nearby customers. After origination, these same institutions retained the debt and serviced it, collecting payments and guarding against delinquencies.

Immergluck recounts the history of the regulatory structure of mortgage markets and how they changed during the 1980s and the 1990s as the mortgage market morphed into a national set of institutions. He attributes the growth of the national market in large part to the relaxation of oversight and rules enforced by the federal government. But of at least equal importance were the substantial economies and efficiencies facilitated by the rapid development of large national markets for mortgages in the 1980s and 1990s. The functions of providing mortgages could be undertaken by specialists—in mortgage origination, in underwriting, and in lending. The investment function could be mediated by institutions that specialized in bundling mortgages into securities—Freddie Mac, Fannie Mae, and various private securitizers. Mortgage securities could be efficiently sold to individuals and institutional investors, and the securities could be repackaged to meet the risk preferences of different investors.

Functional specialization yielded the efficiencies in the division of labor described in the eighteenth-century pin factory of Adam Smith.

Immergluck’s treatise does a good job of describing the agency problems that arose from this new market structure. Firms specializing in mortgage originators had weaker incentives to weed out bad credit risks than did firms that originated mortgages and kept these investments in their portfolios. Specialists in mortgage lending had weaker incentives for diligence than did other lenders who kept the...