Real estate.

• Author: Hendershott, Patric H.
• Position: Housing finance system in the 1980s

In the 1980s there were enormous changes in the housing finance system that affected both the home-ownership rate and real house prices. In addition, housing's historic sensitivity to changes in nominal interest rates seems to have been dampened substantially. This, with the integration of national capital markets--which has reduced the ability of monetary policy to alter U.S. interest rates relative to world rates--probably brought about a significant reduction in the potency of monetary policy.

But the altered housing financing system is hardly the only factor that changed homeownership, household formation, and real house prices in the 1980s. The real costs of owning and renting housing depend on real interest rates and tax laws relating to investment in housing, and both have undergone major changes in the 1980s. (1) Moreover, household formation, homeownership, and real house prices also depend on real wages, an important determinant of the effective demands for privacy and housing.

While housing comprises over 80 percent of noncorporate real estate in the United States, the other nearly 20 percent also has undergone major changes in the 1980s. This report briefly addresses that topic, too.

Mortgage Market Changes and Housing

During the 1960s and 1970s, the U.S. government closely regulated the system of financing single-family housing in four ways. First, federally chartered depository institutions were prohibited from originating adjustable-rate mortgages (ARMs), so virtually all home-buyers were granted fixed-rate mortgages (FRMs). Second, portfolio restrictions and tax inducements led nonbank depository institutions (S&Ls and mutual savings banks) to supply two-thirds of all funds to the home mortgage market (commercial banks and the Federal National Mortgage Association--FNMA, or Fannie Mae--supplied most of the rest) and caused home mortgage rates to be roughly one-half percentage point below fair market rates during the 1970s. (2) Third, because depository institutions were funding their long-term investments (FRMs) with short-term deposits, deposit rate ceilings were introduced so that significant increases in interest rates would not cause large cash flow losses for the institutions. Fourth, because the capital market could not compete with "cheap" deposit money, few conventional mortgages were pooled into passthrough securities.

Prohibitions against ARMs, portfolio restrictions, tax inducements, and deposit rate ceilings all were lifted in the 1980s. Not surprisingly, the housing finance system changed dramatically. (3) A national primary market for ARMs developed (between early 1982 and 1989, two-fifths of all new conventional home mortgages had adjustable rates). FRMs (both whole loans and passthroughs) held by S&Ls declined by 15 to 20 percent. Moreover, the fraction of conventional FRM originations that were pooled into passthroughs rose from less than 5 percent before 1982 to over 50 percent after 1985 and to over two-thirds in 1989.

In the last dozen years, the S&L industry has been decimated. The sharp and sustained rise in interest...