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


ST. LOUIS — 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:

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 Corp. (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, and provides payment services to financial institutions and the U.S. government.

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