Back to the Future: The 20% Solution

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Wednesday, May 2, 2012

What lessons can the U.S. learn from housing programs, policies, or regulatory frameworks in other countries? Are there specific tools in use (e.g., covered bonds, full recourse loans, prepayment penalties, etc.) that we should consider adopting or using on a larger scale?

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Around the turn of the last century in 1900, homeownership in America was 36.5 percent, consisting primarily of the family farm. American homeownership steadily increased to 46% in 1930 before dropping to 41.1% following the Great Depression. As a result of the Great Depression, banks failed and many Americans lost the family farm. The New Deal created the Federal Housing Administration (FHA) and Fannie Mae to insure home loans and create a secondary market for mortgages. By 1960, homeownership had jumped to 61%. Ownership peaked near 70% in 2005. In 1900, less than one-third of homes were mortgaged. In 1940, less than half of homeowners had any mortgage on their property. By 1960, the majority of homes were mortgaged. The traditional mortgage required a 20% down payment, providing a buffer for the lender, the Savings & Loan, and thus insuring a steady supply of capital. This system worked for a century.

In 1977, Congress passed The Community Redevelopment Act. Enacted to ban the process of “red-lining” poor neighborhoods, the intent of Congress was to make housing a right and not a privilege reserved for the wealthy. When people lacked a down payment, Congress encouraged Fannie Mae to provide 5%, 3%, 1% and finally zero down payment loans. When people had poor credit, Congress allowed the secondary market to purchase “no-docs” loans. Sub-prime mortgages, purchased and insured by the federal government, caused home prices to skyrocket as new, unprepared buyers flooded the market. The rest is history.

Canada did not follow us down this ruinous path. In fact, few other nations made housing a right as our Congress did. They did not experience the spike in prices or a bubble and consequently did not suffer as we did. American needs to return to homeownership as a privilege, not a right. A privilege earned by saving a traditional down payment and accepting a conventional mortgage. Homeownership requires skin in the game that comes from a substantial down payment. We would do well be ending the failed practice of 3% down payments, low introductory teaser rates, and negative amortizing loans.

Robert J. Cristiano, PhD is the Real Estate Professional in Residence at Chapman University; a Senior Fellow at The Pacific Research Institute; and President of L88 Investments LLC.


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