Evolution of the U.S. Housing Finance System

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Evolution of the U.S. Housing Finance System

Transcript Of Evolution of the U.S. Housing Finance System

The contents of this report are the views of the contractor and do not necessarily reflect the views or policies of the U.S. Department of Housing and Urban Development or the U.S. Government.

Foreword

The housing finance system of the United States is a marvel in its size, scope, and efficiency. A strong American tradition of private ownership in conjunction with America's modem day housing finance system has produced high quality housing for virtually all Americans and has over time increased the homeownership rate to the current 69 percent. The social and economic implications of these statistics are significant, e.g., household wealth in the United States is closely linked to housing assets. Thus, housing finance is of central importance to two critical sectors of the national economy: one obvious, the housing industry, and the other, less obvious, the larger financial system of the United States.

Americans use the system daily and seem to take it for granted, whether taking out a first-time mortgage or re-financing it. It is assumed that the necessary mortgage capital will always be available on reasonably convenient tkrms. Few realize the complex underpinnings in histoy, law, and regulation that allow this capital to be so available, or appreciate the key role of the private sector in making the system so responsive to borrowers' needs.

How the housing finance system came into its present state and how it functions are perennial questions of many delegations from other governments that visit HUD each year for briefings on American experience in housing policies and programs. For this reason, the Office of Policy Development and Research, through its Office of International Affairs, has long been interested in a study that would explain the growth of this financial network over time.

Hence, this study, "Evolution of the U.S. Housing Finance System: A Historical Survey and Lessons for Emerging Mortgage Market," was commissioned, primarily for an international audience. It identifies those pivotal events in the development of the housing finance market, such as the creation of the Federal Housing Administration (FHA) in 1934, that helped to structure the current system, and it highlights lessons from the U.S. experience that may assist policy reform efforts in the development of emerging mortgage markets.

I think that all those working on ways to improve housing opportunities, whether here or

abroad, will find this study both enlightening and useful.

A

Darlene F. Williams

I

Assistant Secretary for

Policy Development and Research

Contents
Section 1. Introduction...............................................................................................................1 Section 2. Historical Survey of the U.S. Housing Finance System ...........................................3 Section 3. Assessing the Emerged U.S. Model........................................................................11 Section 4. Lessons Learned and To Be Leveraged ..................................................................19 Section 5. Experience of Emerging Mortgage Markets ...........................................................23 Section 6. Summary and Next Steps........................................................................................29 References................................................................................................................................33 Glossary ...................................................................................................................................35

Section 1. Introduction
In the past 180 years, the U.S. housing finance system (HFS) has evolved from an informal/communal institutional arrangement to one of the most well-functioning and extensive financial intermediation systems in the world. This evolution did not develop in a linear fashion in that policy changes were made in response to economic shocks and that innovations such as mortgage products, mortgage-related securities, specialized institutions, and risk management tools appeared discretely over time in government policies. This study seeks to provide a critical survey of this evolutionary process focusing on milestone events and the shaping of key functions of the U.S. HFS over time. It also aims to infer lessons from the U.S. experience for assisting emerging mortgage market systems. Four particular countries representing diverse market and institutional conditions are selected for contrast with the U.S. HFS: Mexico, Korea, South Africa, and Poland.
The generic term “HFS” refers to a financial service delivery system in which various intermediaries compete in performing three main functions: funding, lending, and servicing. In any country, the system is inherently complex because public policy goals, such as promoting home ownership for target population groups, work with, and often through, the for-profit private-sector participants. The performance of the HFS influences, and is also influenced by, the level of performance of related markets—housing, bond, and derivative markets in particular. Therefore, it should be noted that the efficient HFS in the United States today, which delivers affordable loans, competitive mortgage securities to investors, and sound risk control practices, is the result of a long evolutionary process of the partnership between public and private participants. The U.S. HFS likely will continue to evolve, both in public-sector responses to economic shocks and through innovations that profit-motivated participants develop to gain competitive edges.
In the 1990s, one particular aspect of the U.S. HFS—mortgage securitization—came into fashion worldwide. Since the early 1990s, 24 countries in 6 continents have issued some forms of mortgage-backed securities (MBSs) (Diamond 2000). Despite the spread of the MBS, only a few countries—mostly those in Western Europe—have experienced success and are expanding their MBS markets. The growth of the U.S. MBS market during the past two decades stemmed at least partially from the critical enabling ingredients that were in place, both within the system (e.g., risk-sharing arrangements, deposit insurance, and conforming loan products) and outside the system (stable macroeconomic conditions, depth in the corporate and government bond markets, and a sound banking system). These infrastructures are not in place in many other countries. We discuss some of the key requirements for an efficient HFS in a later section of this paper. One recommendation for improving emerging overseas markets—an “a la carte” approach to system reform—involves identifying specific areas that need to change and choosing from a menu of options observed in the United States to achieve the defined policy goals as they are deemed feasible given the specific country’s political, economic, and institutional environments. The three areas that are discussed in the context of the four countries selected for comparison with the U.S. HFS are (1) wholesale funding, (2) risk management and sharing, and (3) affordable lending products.
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