The Great Collapse Part 2: Mortgages in a Nutshell

Hey, Hey Kids! Back for more? Yay! Hold on to your hats, because here's mortgages in a nutshell and the role they played in all this fun...

A mortgage, as we mentioned and you know if you're not currently brain-dead, is when you borrow money to buy a house. Houses cost a lot. So, unless you're rich, you have to borrow a lot. Generally, when people lend you a lot of money, they want to be extra sure their getting their money back.

Actually, this is a truism about lending money more generally (and will come up again later on in this wonderful story of The Great Collapse. I made that up, by the way, but you should use it. Really. It'll catch on.). When you lend money to someone, you're going to want to know how likely they are to pay it back. The more sure you are that they'll pay it back, the lower the interest rate you will charge them.

Anyhoo, way back in history, like 30 or 40 years ago or more, mortgages were sold by banks. And banks were heavily, heavily regulated. Many of these regulations kept banks from getting too large or doing too much competing with each other. The result of this was that most mortgages were sold to you by your local bank.

Having a small, local bank be your mortgage bank made that world different in a number of ways: for one thing, the banker was likely to know you personally. This had benefits and negatives. A benefit was that he wouldn't have to dig deep into your finances (well, lots of your finances were probably at his fingertips anyway as your one-and-only banker) for him to be confident that you were a worthy person to lend to. He knew you, so it was much more like lending to a friend. On the other hand, maybe he doesn't like you. Maybe he doesn't like you because you're black or a woman or beat him at golf too often. He doesn't have to loan to you even if you're otherwise a great risk.

The other thing about a small, local bank giving out mortgages is that it is small. That means it has limited funds to lend out. Often, in these primitive days, that bank would end up "servicing" the loan as well.

"Servicing" a loan is not the same thing as a prostitute "servicing" a client, though that distinction is often lost on those unfortunate enough to be foreclosed on. No, servicing a loan means you own the loan, you're the one getting the payments, it's effectively your money that was lent.

When a small bank keeps a loan on the books (services it) this can be a fairly significant amount of money for the bank. This severely limits the number of loans they can make.

The government saw this and saw that they wanted to promote home ownership. Why did they want to promote home ownership? Lots of reasons. Owning land is a part of the American Dream and has been a huge part of our national mythos since the very beginning. (Think of the indentured servants spending years as virtual slaves on the chance of getting their own farm someday.) Also, it's believed, with some evidence I think, that home-ownership is good for communities. People who own their living space tend to be more invested in their community: they'll be on local councils, they'll make sure the neighborhood is taken care of, in short, they care in a way that renters, on average, may not.

So. Wanting to increase home-ownership and seeing the limitations of the small-banking system in existence, the government created a new thing to fix the problem. The new thing eventually became Fannie Mae.

I was going to go on but this post is getting a bit long-winded. So I'll stop here and make the next part all about Fannie... sort of like a British porn-film, in a way.