Trouble Began When Lenders Couldn't Fund Their Own Loans
Last year, I unwisely committed to writing an article on mortgage insurance for an international encyclopedia. When all too soon it became time to deliver, I realized that the encyclopedia was looking for both a global and historical perspective, neither of which I had.
I remedied my ignorance about programs in other countries by mining articles written by Roger Blood, who has consulted on mortgage insurance programs abroad and is an expert's expert on the subject.
While mortgage insurance began in the U.S., programs now exist in some 34 countries, according to Blood's count. In 14 countries, the insurance is public; in eight, it is private; in seven (including the U.S.), there are both public and private programs; in four, insurance is offered by a mixed public/private entity; and in one, it is offered by a nonprofit.
The historical perspective I needed came from the Aldrich Report, published in 1934 by a commission appointed by the governor of New York state to examine the practices of title and mortgage guaranty corporations chartered by the state. Mortgage guaranty, as it was then called, was an integral part of the operations of these firms.
The firms in this industry mostly began as title insurers, but gradually they moved into mortgage banking. They originated loans, holding them if necessary but selling them if possible.
Mortgage insurance evolved primarily as a device to facilitate sales. Insurance was attached to mortgages that were sold, and to certificates issued against mortgages that the firms owned. The certificates were sold to the public, and were typically collateralized by mortgages that could not be sold directly. Loans were all interest-only, so the insurance was a guarantee of the interest on the due date, and return of principal at some future date.
Until the Great Depression, these firms were tremendously profitable. They collected loan origination fees, title insurance fees, and retained the spread between the rate on the mortgages they owned and the rate paid certificate holders. In 1930, there were 50 of them in New York, plus a few scattered around in other states. But by the end of 1933, all had ceased operations. The 16 largest New York firms had $1.8 billion of guarantees outstanding on Dec. 31, 1933, but only $721 million of the mortgages securing those guarantees was not in default.
In an attempt to fill the void and encourage shellshocked lenders to make mortgage loans, the federal government in 1934 created the Federal Housing Administration. At the outset, FHA hardly made a dent because lenders did not trust it. Fannie Mae was chartered in 1938 to buy FHA mortgages -- to demonstrate that they were safe. …