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 

I Darlene F. Williams 

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. 

1
 

2
 

Section 2. Historical Survey of the U.S. Housing Finance System 

The historical survey in this section draws from several excellent studies on the topic, in 

particular, Hendershott and Villani (1977), Weicher (1988), Diamond and Lea (1993), and Lea 

(1996). The current analysis attempts to add new information in several fronts. It extends the time 

period covered, especially during the 1990s when a number of information technology (IT) and 

product innovations changed the landscape of the U.S. mortgage industry. It uses real data to 

provide analyses of the outcomes of the U.S. housing finance system (HFS) as it evolved over 

time. Finally, it links the U.S. experience to several emerging mortgage markets. 

Table 1 provides a summary of how the following time segments interacted with three elements 

that shaped the HFS in the United States—institutions, products, and economic shocks. 

• Era of Exploration (Pre-1930s). 

• Era of Institutionalization (1930s to 1960s). 

• Era of Securitization (1970s and 1980s). 

• Era of Automation/Computerization (1990s to Present). 

Era of Exploration (Pre-1930s) 

The first institutional arrangement to finance housing in the United States was “Terminating” 

Building Societies (TBSs), which originated in 1775 in England and played a dominant role in the 

U.S. in the early to mid-19th century. TBSs can be termed a “communal solution” to housing 

finance. A small number of people from a town pooled savings and provided funds to one another 

for constructing houses. More often than not, the members controlled credit and funding risks 

among themselves. A TBS ceased to exist once all members received the loans.1

 Later on, TBSs 

evolved into more formal lending institutions such as “Permanent” Building Societies, Building 

and Loans, and, eventually, savings and loans (S&Ls). 

In this era, the maturity terms for most loans were 6 to 10 years, payments were semiannual with 

no or partial amortization of principal, interest rates were variable, and the maximum loan-tovalue ratio was about 50 percent. The deposit certificates instituted in the 1890s increased the 

inflow of savings into lending institutions, which improved the liquidity of the system. 

1

 In fact, the first mortgage loan made by the first building society, the Oxford Provident, went into default. 

The members negotiated a transfer of the property to another member who eventually repaid the loan (Lea 

1994). 

3
 

Table 1. Evolution of the U.S. Housing Finance System 

Institutions Products Risk/Shocks 

“Era of 

Exploration” 

Pre-1930s 

• “Terminating” Building Societies 

(since 1775) 

• “Permanent” Building Societies 

(1850s) 

• Mortgage companies (1870s) 

• Life insurance companies (active 

in the early 1900s) 

• Nonamortizing; variable rate; 

semiannual payment 

• 6- to11-year loan term and 50 to 

60% maximum LTV 

• MBBs by mortgage companies 

(1870s to 1890s) 

• Deposit/investment certificates 

(1890s) 

• Peer enforcement and deposit-based 

funding 

• Localized risk management (e.g., 50-

mile radius rule) 

• Recession in 1890s led to demise of 

mortgage companies; agency problem 

in pooling 

• Significant growth in 1920s and stock 

market crash in 1929 

“Era of 

Institutionalization” 

1930s to 1960s 

• Creation of HOLC and RFC to 

liquidate bad loans/banks (1933) 

• Creation of FHLBanks (1934) 

and Fannie Mae (1938) to 

increase liquidity 

• Creation of FHA, FDIC, FSLIC, 

and private mortgage insurance 

companies (1934) for credit 

enhancement 

• Privatization of Fannie Mae and 

creation of Ginnie Mae (1968) 

• Fully amortizing loans with 

leveled monthly payments 

• Fixed interest rate and longer 

than 20-year loan term 

• Maximum LTV up to 80% 

• Underwriting guidelines set by 

Fannie Mae (1954) 

• Great Depression (1930s) 

• National Housing Act (1934) and 

Housing Act (1949) 

• Regulation Q (1966) 

• Rising interest rates and inflation 

(1960s) 

Era of Securitization 

1970s to 1980s 

• Creation of Freddie Mac (1970) 

• New investors into the market: 

mutual funds, pensions, foreign 

investors (1980s) 

• S&L Debacle (1980s) and 

creation of RTC (1989) 

• Introduction of ARMs (1981) 

• MBS issuance: first PC by 

Freddie Mac (1971), Ginnie Mae 

tandem plan (1974-76), first 

private MBS by Bank of America 

(1977) 

• First CMO issuance (1984) and a 

big increase in MBS issuance 

(1982–86) 

• Market for interest rate swaps 

(1980s) 

• First and second oil shocks (1970s) 

• Interest rate hike and mismatch of 

asset-liability duration of S&Ls 

(1980s); removal of interest rate 

ceilings (1980s) 

• Oil patch default ramp-up (1980s) 

• FIRREA (1989) and Basle I (1980s) 

Era of Automation/ 

Computerization 

1990s to Current 

• Creation of OFHEO (1992)— 

Minimum and Risk-Based Capital 

Rules for GSEs 

• HUD affordable housing goals for 

GSEs (1992) 

• Globalization of MBS markets 

(ongoing) 

• IT revolution—AUS, mortgage 

score, AVM (since mid-1990s) 

• Refi booms (mid-1990s to early 

2000s) 

• HELOC, second mortgages, and 

other affordable products (1990s 

to current) 

• California default ramp-up (early to 

mid-1990s) 

• Expansion of credit derivatives 

markets (since mid-1990s) 

• House price index-based hedging 

market (currently under study) 

ARM = adjustable rate mortgage; AUS = automated underwriting system; AVM = automated valuation model; CMO = collateralized mortgage obligation; FDIC = 

Federal Deposit Insurance Corporation; FHA = Federal Housing Administration; FHLBanks = Federal Home Loan Banks; FIRREA = Financial Institutions Reform 

Recovery and Enforcement Act; FSLIC = Federal Savings and Loan Corporation; GSE = government-sponsored enterprise; HELOC = home equity line of credit; 

HOLC = Home Owners’ Loan Corporation; HUD = U.S. Department of Housing and Urban Development; IT = information technology; LTV = loan-to-value ratio; 

MBB = mortgage-backed bond; MBS = mortgage-backed security; OFHEO = Office of Federal Housing Enterprise Oversight; PC = participation certificate; RFC = 

Reconstruction Finance Corporation; RTC =Resolution Trust Corporation; S&Ls = Savings and Loans. 

4 
During the 1870s, mortgage banks were formed to lend in the expanding Midwestern and 

Western states. Banks were formed mostly by former agents of insurance companies and other 

financial institutions in the Northeast. Those institutions originated and serviced loans with the 

funds raised by selling mortgage-backed bonds (MBBs), modeled after the practice in France and 

Germany at that time. Under this intermediation process, investors took on the credit risk of bond 

issuers and were compensated through a premium in the interest rate. Through MBBs, investors 

were able to diversify regionally or nationally, which was important to their financial stability. 

Initially, the MBB market grew significantly. Both issuers and buyers of the security benefited 

from scale economies in loan origination, servicing, and funding. During the recession in the 

1890s, however, MBBs defaulted in large numbers. The lax risk screening by the agents 

(mortgage companies) at the time of underwriting (i.e., determining whether and under what 

conditions a loan should be made) caused high defaults during the economic downturn, imposing 

significant costs to the principals (investors). The incident, which exemplifies the classic 

“principal-agent problem,” also resulted in the demise of the mortgage companies, and this 

particular 19th-century experiment of liquidity enhancement ended unsuccessfully. 

Era of Institutionalization (1930s to 1960s) 

As the name the “Roaring Twenties” implies, the booming economy in the 1920s bolstered both 

real estate markets and consumer credit markets, and new players such as insurance companies 

entered the HFS. The Great Depression, however, started by the stock market crash in 1929, 

caused precipitous declines in economic activities.2

 Two outcomes of this economic shock were 

particularly adverse to the HFS: (1) the ramping up of the unemployment rate that caused 

liquidity and solvency problems for a large number of borrowers, leading to nonpayment of 

loans; and (2) the acute deflation that resulted in an almost 50-percent drop in the price level of 

homes. This deflation resulted in insufficient collateral values for bank loans, large-scale bank 

runs, and insolvency for the whole banking system. 

Facing this systemic (economywide) risk, the U.S. federal government implemented four main 

remedies to prop up the HFS. First, the Home Owners’ Loan Corporation (HOLC) and the 

Reconstruction Finance Corporation (RFC) were created to liquidate nonperforming loans in 

bank portfolios and to bail out those lending institutions that were insolvent. Both the HOLC and 

the RFC purchased defaulted housing loans and the stock in bankrupt banks and thrifts (S&Ls 

and mutual savings banks) during the 1930s. Their operation was viewed as a successful response 

to systemic risk, although some early examples of the moral hazard problem (in which at least 

some people are better off defaulting even though they otherwise do not need to) were revealed 

because many borrowers deliberately defaulted on their existing loans to take advantage of the 

HOLC and RFC bailouts. 

Second, the Hoover administration’s (1929 through 1933) remedy was to strengthen the existing 

lending institutions, S&Ls, by creating the Federal Home Loan Banks (FHLBanks) as a special 

liquidity facility for them. The FHLBanks were empowered to charter and regulate federal S&Ls 

and to put restrictions on both the asset and liability sides. That is, S&Ls’ operations were largely 

restricted to making 10- to 12-year home mortgage loans, attracting “small savers” (workers and 

2

 On Black Tuesday, October 29, 1929, American common stocks lost almost 13 percent of their value. 

Later, the Dow Jones Industrial Average lost about 90 percent of its original value at its trough in 1932 and 

did not regain its original value until 1954. 

5
 
middle-income families), and lending only in their local markets (within a 50-mile radius from 

their home offices). 

Third, the Roosevelt administration’s (1933 through 1945) strategy was quite different from that 

of the Hoover administration in that the new administration’s focus was more national than local. 

In particular, three main policies were implemented: (1) The Federal Housing Administration 

(FHA) was created to provide insurance against mortgage defaults for lenders, (2) a new kind of 

loan—the fixed-rate, self-amortizing mortgage with a low downpayment (as low as 20 percent of 

home value) and a longer term maturity (20 or more years)—was introduced, and (3) private 

mortgage associations were authorized as a part of the 1934 National Housing Act, which were 

empowered to issue bonds and buy mortgages from primary market lenders. 

The thrust of these remedies was to broaden the institutional base for mortgage funding by 

encouraging new entrants into the HFS such as commercial banks. Regarding the private 

mortgage associations, none were started until the late 1930s and Fannie Mae (the Federal 

National Mortgage Association) was established as a government-owned agency to provide a 

secondary market for FHA-insured mortgages. This new institution was expected to borrow in 

areas where credit was more available (from mutual savings banks in the Northeast) and to lend 

where capital was in short supply (the Midwest and the West). 

Fourth, two deposit insurance companies—the Federal Deposit Insurance Corporation for 

commercial banks and the Federal Savings and Loan Insurance Corporation (FSLIC) for S&Ls— 

were established, in large part resulting from a political bargain to win support from S&Ls in 

creating the FHA. Viewing the FHA as a new competitor, S&Ls initially objected to its creation. 

The federal deposit insurance was to provide them with a level playing field to compete with the 

banks for funds. FSLIC was created under the Federal Home Loan Bank Board in 1934, which 

also regulated the federal S&Ls. 

The FHA’s operation was successful during the 1940s and 1950s, and it produced two 

demonstrative effects in the industry. First, S&Ls found it profitable to make long-term, selfamortizing mortgage loans without government insurance, resulting in the expansion of the 

market for the “conventional” mortgage instrument. Second, private firms saw a value 

proposition in writing mortgage insurance. Between 1957 and 1973, every state passed an 

enabling statute for private mortgage insurance, ending the FHA’s monopoly in this segment of 

the HFS and leading to a decline in its market share in the 1960s and 1970s. 

Era of Securitization (1970s to 1980s) 

By the mid-1960s, the HFS faced new challenges: rising inflation and interest rates. As shown in 

Figure 1, the inflation cycle hit three peaks between the mid-1960s and the early 1980s, with the 

third one being the most severe and recording almost a 15-percent annualized growth rate in the 

Consumer Price Index. Market observers said the rising price level and interest rates resulted 

from the federal government’s large budget deficits in the 1960s during its involvement in the 

War on Poverty and the Vietnam War; the first and second oil shocks during the 1970s, which 

resulted in the ramping up of energy prices; and the change in monetary policy in the mid- to late 

1970s that adopted money aggregates instead of interest rates as the policy target. 

6
 

-4

0

4

8

12

16

55 60 65 70 75 80 85 90 95 00

-4 

0 

4 

8 

12 

16 

55 60 65 70 75 80 85 90 95 00 

Figure 1: Percent Change in Consumer Price Index (CPI) 

The unanticipated rise in inflation caused several problems for S&Ls. First, they had relied on 

short-term deposits to fund long-term, fixed-rate mortgages. In the face of rising interest rates, 

this “borrow-short-lend-long” operational mode created a squeeze on their profit margin. The 

rapidly rising interest rates drove up the rates paid on their deposits, but they could not earn 

higher returns on mortgages except on new ones. Second, the high interest rates dampened 

housing demand, which had an adverse impact on new mortgage origination volume for S&Ls. 

Third, as investors, S&Ls also experienced a worsening duration mismatch caused by the upward 

shift in interest rates; that is, the effective maturity of existing loans lengthened because 

prepayments slowed down in the rising rate environment. Fourth, money market mutual funds 

(MMMFs) came into existence in the early 1970s, opening up a new investment channel for small 

savers. Rates paid by the MMMFs were not regulated, while a federal rule known as Regulation 

Q limited the rates banks and thrifts could pay on time deposits (their primary source of funds). 

While these new vehicles resulted in a significant drop in deposit inflows to thrifts—called 

“disintermediation”—MMMF assets increased from $3.5 billion in 1977 to $180 billion in 1981, 

more than a 50-fold increase in volume within 4 years. 

The S&Ls’ market share of total nonfarm residential mortgages shrank from 43 percent in 1979 

to 30 percent in 1986, and these adverse market conditions in the early to mid-1980s eventually 

resulted in a large number of bankrupt thrifts, known as the “S&L Debacle,” in the late 1980s. 

The federal government created the Resolution Trust Corporation in 1989 to liquidate the assets 

of the troubled lending institutions. 

The federal government implemented three remedies to bolster the HFS in the event of 

macroeconomic shocks such as those occurring in this era. First, Regulation Q (mentioned above) 

was phased out between 1981 and 1986. The rule had been extended to S&Ls in 1966, imposing 

7
 

interest rate ceilings on their time deposits. Contrary to the original policy intent (enabling S&Ls 

to control their own cost of funds), the ceilings further accelerated the outflow of deposits. 

Second, S&Ls were allowed to issue new products on both the asset side (adjustable rate 

mortgages, or ARMs) and the liability side (money market deposit accounts) to make S&Ls more 

competitive with MMMFs. These allowances came too late because the amount of ARMs, which 

could have alleviated S&Ls’ interest margin squeeze, represented an insignificant part of the 

S&Ls’ portfolio during the period of rapidly rising interest rates. 

Third, the government realigned and beefed up liquidity-enhancing institutions by privatizing 

Fannie Mae in 1968 and allowing it to buy conventional (or not government-insured) mortgages. 

Ginnie Mae was established in lieu of Fannie Mae to securitize government-insured loans (FHA 

and U.S. Department of Veterans Affairs loans). Freddie Mac was created in 1970 as a part of the 

FHLBanks to increase the liquidity for S&Ls. 

The market for mortgage-backed securities (MBSs) was formed in the early 1970s and took off in 

the 1980s. Both Ginnie Mae and Freddie Mac instituted their passthrough security programs in 

the early 1970s: participation certificates by Freddie Mac and the tandem plan by Ginnie Mae. 

Fannie Mae, on the other hand, worked purely as a portfolio lending institution during the 1970s 

and did not issue its first MBS until 1981.3

 Private-label MBSs issued by large commercial banks 

(e.g., Bank of America) also had a meaningful volume starting in the mid-1980s. 

The expansion of MBS issuances stimulated the integration of the mortgage market with capital 

markets and broadened the institutional base for mortgage funding. For example, in 1971, twothirds of Ginnie Mae passthrough securities were sold to S&Ls. In 1979, about half were sold to 

pension funds and trusts. The introduction of multiple-class MBSs, known as the collateralized 

mortgage obligations (CMOs) and real estate mortgage investment conduits (REMICs), further 

accelerated the integration process. These securities created “tranches” with varying levels of 

prepayment risk, which made them better matched to the needs of different investors in terms of 

asset-liability management preferences. The introduction of CMOs and REMICs brought an 

influx of new investors to the HFS, including mutual funds, pensions, life insurance companies, 

and foreign investors. The risk-based capital regulation in 1989 (Basle I) also increased the 

demand for MBSs as it offered banks a capital incentive to invest in them. With lower risk 

weights of 20 percent for Fannie Mae and Freddie Mac MBSs and 50 percent for individual 

residential mortgage whole loans, investors were allowed to increase their leverage by two to five 

fold, which made mortgages a more profitable asset type. 

These decades of high volatility in interest rates and high inflation also led to the introduction of a 

number of hedging instruments (options, futures, etc.) and institutions (futures and options 

exchanges and clearinghouses) that allowed market participants to better manage cashflow risk. 

New mortgage products, such as the price level adjusted mortgage, the shared appreciation 

mortgage, and the graduated payment mortgage, were also introduced to better manage the 

inflation risk or to increase the affordability in lending. These mortgage types did not become 

major parts of the U.S. HFS but may appear again during high inflation and interest rate 

environments. 

3

 Since Fannie Mae was privatized in 1968, its portfolio grew from $15 billion in 1970 to $25 billion in 

1975, $50 billion in 1979, and $78 billion in 1983. By 1981, Fannie Mae’s market value net worth became 

negative with minus $11 billion, which turned positive by 1986 with a net worth of about $1 billion. 

8
 

Era of Automation/Computerization (1990s to Present) 

In the 1990s, breakthroughs in IT such as the Internet and dramatically enhanced data 

transmission bandwidth took place. For the U.S. HFS, the most notable development in IT was 

automated underwriting systems (AUSs). Both Fannie Mae and Freddie Mac implemented 

Desktop Underwriter and LoanProspector AUSs, respectively, and large lenders followed suit by 

developing their own proprietary systems (e.g., CAPES by Countrywide). Since then, the use of 

AUSs in mortgage origination and point-of-sale decisions has exploded. For example, the share 

of Fannie Mae acquisitions processed through its AUS increased from less than 10 percent in 

1997 to about 60 percent in 2002 (Pafenberg 2004). 

AUSs are automated decisionmaking tools that accept or classify loans based on the specific risk 

characteristics of the loan and the borrower, with automated connectivity among funding, 

lending, and servicing organizations. At the core of the system is a mortgage scoring model, a 

statistical technique first used in car loan and credit card markets. It quantifies the level of 

creditworthiness of borrowers based on historical default/delinquency information particular to 

the loan specifications. In addition, most AUSs utilize automated property valuation models to 

streamline or even waive property appraisal requirements in mortgage underwriting, reducing the 

transaction cost to borrowers and lenders. 

AUSs have a large and growing impact on the mortgage industry. The most obvious impact is the 

dramatic reduction in transaction/intermediation costs in originating mortgage loans, which, in 

turn, reduces entry barriers for new competitors to participate in the mortgage origination 

industry. The cost of information on the risk profile of the borrower, the loan, and the collateral 

becomes much cheaper; underwriting decisions that accept or classify the loan for documentation 

requirements or interest rate charges are made much faster (reduced from weeks to minutes); and 

the amount of training required for underwriting and secondary marketing staff in 

lending/servicing organizations is significantly lower. Regarding training, AUSs essentially 

replaced the selling and servicing guides published by Fannie Mae and Freddie Mac, documents 

containing more than a thousand pages of detailed instructions on eligibility and business 

processes for new and existing loan products. In the AUS world, these lengthy provisions are 

automatically checked by the computer system. 

Second, AUSs make the assessment of credit risk more scientific, largely because of the scoring 

technique described earlier. In this model-based world, so-called “compensating risk factors” can 

be assessed and used more easily and accurately in underwriting loans and developing new 

products. Some key risk drivers (e.g., borrower credit history, level of downpayment, payment-toincome ratios) can be examined in aggregate based on their risk weights that measure each 

factor’s contribution to default/delinquency risk; hence, the overall risk for a given loan product 

can be examined more soundly during the underwriting and pricing stages. Because AUSs 

typically approve the highest quality loans and refer weaker quality loans to human underwriting, 

loans processed through AUSs on average perform better than their counterparts that are 

processed through manual (i.e., judgmental) underwriting. 

Third, AUSs have been contributing to further specialization in mortgage origination and in 

servicing, as key market participants achieve economies of scale in various intermediation steps. 

For example, the volume of loans originated by mortgage brokers has increased since the 

implementation of AUSs because the cost of interfacing with the borrower and making the 

underwriting decision has been equalized for large and small lenders with the use of the AUSs. 

Many large lenders now focus more on servicing with specialized AUS and IT solutions both in 

streamlining its administrative tasks (e.g., disbursing tax and insurance payments, reporting to 

9
 

investor and borrower, etc.) as well as in managing stressed loans (deciding which loans present 

the greatest risk of default and then focusing on them first). 

The challenge to this automation is the potential increase in fraudulent loan applications, either 

via identity thefts or incorrect/invalid documentation on employment, wealth, income, or 

collateral. This issue is getting more attention by industry participants, and online identification 

and authentification tools are being developed and gradually implemented in the systems. 

10
 

Section 3. Assessing the Emerged U.S. Model 

Recap of New Intermediation Models 

Like any financial intermediation, the purpose of mortgage intermediation is to link a large 

number of borrowers and investors/savers efficiently. From the historical survey in section 2, a 

simple schematic representation of the mortgage intermediation process is shown in Figure 2. 

Figure 2. A Schematic View of the Mortgage Intermediation Process 

Borrowers Intermediaries 

(Origination & 

Servicing) 

Liquidity Enhancers 

(Secondary Market 

Conduits) 

Savers/ 

Investors 

Default Deposit 

Insurance Insurance 

Given this framework, at least five different institutional arrangements (models) have emerged 

from the U.S. experience: 

1.	 Informal/communal intermediary (e.g., the Terminating Building Society). 

2.	 Local intermediary without special funding (savings and loans [S&Ls] before the 1930s). 

3.	 Local intermediary with special funding/insurance (S&L, Federal Home Loan Bank 

[FHLBank], Federal Savings and Loan Insurance Corporation [FSLIC], private mortgage 

insurance [PMI]). 

4.	 Regional/national intermediary with special funding/insurance (commercial/mortgage banks, 

Federal Housing Administration [FHA], Fannie Mae/Freddie Mac, Ginnie Mae, Federal 

Deposit Insurance Corporation [FDIC]). 

5.	 The U.S. housing finance system (HFS) today (the consolidated model). 

In the United States today, a combined model prevails in that most institutions and products 

created during the 1930s still exist. These institutions take various forms and exert their 

influences in market outcomes. Figure 2 also shows that multiple players in each area compete 

with one another (except for deposit insurance, for which the FSLIC has been merged into the 

FDIC). The government-sponsored enterprises (GSEs, including Fannie Mae, Freddie Mac, and 

FHLBanks) and private-label mortgage-backed security (MBS) issuers all compete to provide 

liquidity enhancement. FHA, PMI, GSEs, and other secondary market conduits compete for 

11
 

default insurance. Many institutions compete for deposits, mortgage origination, and servicing. 

This consolidated model delivers a number of beneficial outcomes as discussed below. 

Results Delivered From the Consolidated Model 

An important result of the consolidated model is the amount of liquidity injected into the HFS 

during the past two decades. Figure 3 shows that mortgage debt outstanding (MDO) in the United 

States increased from $1.5 trillion in 1980 to more than $7 trillion in 2001, recording a 480-

percent total growth rate and an almost 20-percent average annual growth rate during the period. 

The level of securitization also increased dramatically: less than 10 percent of MDO was 

securitized in 1980, whereas more than 45 percent of MDO was securitized in 2001. 

1000 

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60 

70 

80 82 84 86 88 90 92 94 96 98 00 

MDO (Billion US $, Left Y-Axis) 

%MBS to MDO (Right Y-Axis) 

Figure 3: Mortgage Debt Outstanding (MDO) and %MBS to MDO 

12
 

To discuss subsequent effects of this dramatic increase in liquidity, Cho (2002) provides the 

following analytical framework for mortgage spreads: 

(1) MortgageSpread = ExpectedInflation + RiskPremia(cf, d, l) + IntermediationCost 

where: 

MortgageSpread represents the difference between the mortgage interest rate (for a 

representative mortgage loan) and the risk-free rate (or yield on the a government bond with a 

comparable duration) at a given point in time; 

ExpectedInflation measures the risk of currency devaluation over the life of the loan in the 

country where the loan is issued; 

RiskPremia are financial charges to compensate for three types of risk—market risk (f, the 

upside and downside interest rate risks), credit risk (d), and liquidity risk (l); and 

IntermediationCost represents average operational expenses in originating, servicing, and 

funding mortgage loans. 

Figure 4 shows the mortgage spread over corporate bond rates over time. The spread provides an 

indicator of the efficiency of the HFS, as it shows the relative cost of mortgages to investors 

compared to corporate bonds. 4 

Before the 1960s, the spread was fairly high consistently. The upheavals of the early 1980s 

brought the spread to its historically highest levels, but since the mid-1960s the spread otherwise 

became lower, implying that some of the premiums intrinsic to mortgage lending decreased. The 

first contributing factor to this change is the reduction in the liquidity risk premium in mortgage 

lending.5

 Both MBSs and the debentures issued by Fannie Mae and Freddie Mac are now traded 

among the most liquid securities in fixed income markets around the world. This contrasts with 

4

 The series combines three data series: (1) annual data between 1895 and 1952 on the difference between 

mortgage rates in New York and yields on long-term corporate bonds (from Grebler et al. 1956), (2) 

monthly data between 1955 and 1971 on the difference between the national average effective mortgage 

rate and yield on 20-year AA utility bonds (from Hendershott and Villani 1977), and (3) monthly data 

between 1971 and 2004 on the spread between the rates on 30-year fixed-rate mortgages and AAA 

corporate bonds. 5

 Liquidity risk reflects a perceived marketability risk that is specific to an institution and/or a security. If a 

security is homogeneous, frequently traded, and large in volume outstanding (e.g., U.S. Treasury debt and 

top-rated Fannie Mae agency notes), then its liquidity risk is close to zero. Otherwise, issuers can incur a 

significant cost or delay to sell the securities, especially when securities are new to the market. 

13
 

the situation in the 1970s when Ginnie Mae had to pay about 60 basis points over Treasury as a 

liquidity risk premium for their Tandem MBS Program (Black, Garbade, and Silber 1981). 

The second factor contributing to the spread reduction in the 1990s is the increased efficiency in 

mortgage intermediation. This efficiency was promoted by specialization (i.e., companies 

specializing in funding, origination, or servicing) as well as the automated underwriting system 

(AUS) technology implemented from the mid-1990s. As shown in Figure 5, the average fees and 

points charged in originating 30-year fixed-rate mortgages in the United States have been lowered 

from more than 2 percent in the early 1990s to about 1.3 percent of the loans’ amount in the early 

2000s. 

14
 

Pe

rcentage Point 

Figure 4: Spread between Real Estate Lending and Corporate Bond 

543210 

-1 

Year-Month 

15

1895

1898

1902

1905

1909

1912

1916

1919

1923

1926

1930

1933

1937

1940

1944

1947

1951

1954

1958

1961

1965

1968

1971M7 1972M9

1973M11 1975M1 1976M3 1977M5 1978M7 1979M9

1980M11 1982M1 1983M3 1984M5 1985M7 1986M9

1987M11 1989M1 1990M3 
0.8 

1.2 

1.6 

2.0 

2.4 

2.8 

1990 1992 1994 1996 1998 2000 2002 

Figure 5: Average Fees and Points (30-year FRM) 

The remaining spread between mortgages and corporate debt in Figure 4 during the 1990s 

generally reflects the premium for prepayment risk (downside interest rate risk or reinvestment 

risk), which is unique to mortgage loans and securities and does not exist in the case of corporate 

bonds.6

 As expected, the peaks of the spread in most recent years roughly coincide with the 

periods of mortgage refinancing booms (in 1993, in 1999, and again in 2003). The gap in the 

spread before the 1990s, on the other hand, reflects add-on costs from less liquid funding methods 

and a less efficient intermediation process. 

Other benefits of the consolidated model are also relevant. First, the mortgage market cycle 

became more independent of the inflation cycle since the early 1980s. As shown in Figure 6, the 

two mortgage market cycles during the 1970s (shown by the annualized changes in MDO) moved 

with the changes in inflation (the Consumer Price Index [CPI]) with about a 1-year time lag. In 

the later years, after the introduction of securitization and other innovations, the MDO changes 

show virtually no correlation with CPI changes. 

6 When market interest rates go below a borrower’s mortgage interest rate, the borrower has an incentive to 

repay the existing loan by obtaining a new one at the lower market interest rate. This situation poses a risk 

to investors because they have to reinvest the principal received from the paid-off loan at the now lower 

interest rates. 

16
 
-4 

0 

4 

8 

12 

16 

55 60 65 70 75 80 85 90 95 00 

MDO Growth (%, Annual) CPI Growth (%, Annual) 

Figure 6: MDO and CPI Growth 

Second, the home ownership rate in the United States increased 4 percentage points between 

1995 and 2004 (65 to 69 percent), after the stagnant period from 1986 to 1994 when the rate 

hovered around 64 percent. This increase in the ownership rate almost perfectly correlates with 

the rise in MDO during the same time period, which never occurred in prior periods (see Figure 

7). Although the interest rate decrease from 1986 to 1994 is more significant in size than the 

interest rate decrease from 1995 to 2004, an increase in the homeownership rate is only observed 

during the latter time period. Although a more formal analysis would be beneficial, it is possible 

that the increased liquidity along with AUS technology and various affordable lending products 

reduced the financing barriers for consumers and helped push the ownership rate upward. Quercia 

et al. (2003). offer some evidence based on household level microdata that affordable lending 

products, particularly low downpayment loans, are likely to increase the propensity to own for 

underserved populations by 27 percent for young households, 21 percent for African Americans, 

and 15 percent for central-city residents. 

17
 

0 

2 

4 

6 

8 

10 

12 

14 

16 

62 

63 

64 

65 

66 

67 

68 

69 

70 

65 70 75 80 85 90 95 00 

Ownership Rate (%, Right Y-Axis) 

Annualized Change in MDO (%, Left Y-Axis) 

Figure 7: MDO Growth and Home Ownership Rate 

18
 

Section 4. Lessons Learned and To Be Leveraged 

Lesson 1. The Evolution Entails the Sequence of Shock-Response-Innovation 

The U.S. experience shows that government policies responding to economic shocks led to a 

number of innovations and market expansions. Examples of this sequence include the following: 

•	 Following the Federal Housing Administration (FHA) example, savings and loans 

(S&Ls) and other market participants accepted long-term fixed-rate mortgages as a 

standard mortgage product (often termed as “plain vanilla” or conforming loan product), 

which greatly helped the creation of the mortgage-backed security market in later years. 

•	 Development of private mortgage insurance after observing the government insurance 

programs of FHA and the Department of Veterans Affairs.7 

•	 Establishment of the mortgage passthrough market in the 1970s and 1980s; mortgage 

default risks were guaranteed and, hence, filtered out, by secondary market conduits. 

•	 Issuance of collateralized mortgage obligations and real estate mortgage investment 

conduits in the 1980s made the cashflow risks embedded in mortgages more tradable 

commodities. 

The sequence can also be termed a “learning-by-doing process” because private-market 

participants initially observed whether certain new government-sponsored products could succeed 

in the marketplace and then embraced them once a value proposition for being in the business 

became more clear. The outcome, as discussed in section 3, was the expansion of the mortgage 

market and more extensive services to consumers by the system. 

Lesson 2. Risk Matters and Must Be Managed 

The evolution shows that the risk caused by unanticipated economic shocks is a real threat to the 

health of the whole housing finance system. Several points are worth making in that vein. First, in 

managing mortgage risks, diversifiable risks must be discerned from systemic (nondiversifiable) 

risks. Examples of systemic risks include the recession in the 1890s, the Great Depression in the 

1930s, and the inflation shock and high interest rates in the 1970s and 1980s. Mortgage investors 

and insurers need to manage these risks to survive them. Such economic shocks can be used to 

test the internal policies and supervisory limits imposed on managing such risk. 

Examples of diversifiable risk include regional default cycles in different time periods. For 

example, the collapse of the Florida land boom in the 1920s resulted in 40 percent of the state’s 

S&Ls becoming insolvent, while the industry prospered nationwide. More recent examples 

include the regional recession in Southern California in the early 1990s caused by cuts in U.S. 

defense spending and the downturn in Ohio and other Midwestern states caused by recession in 

the manufacturing sector during the past several years. The observed foreclosure rates from 

California and Ohio reflect those downturns specific only to the local economies (see Figure 8).8 

7

 The Fannie Mae Charter Act of 1954, which required third-party mortgage insurance for high-loan-tovalue ratio loans, also caused the private mortgage insurance market to expand. 8

 For both mortgage and nonmortgage debts, the Black-Scholes-Merton family of default models explains 

borrower nonpayment as the passage of the value of the underlying collateral asset (home price for a 

mortgage or the value of total assets for a corporate debt) going below the value of the liability. Under this 

theory, two factors influence the likelihood of that passage—the initial cushion (i.e., the distance of the 

asset value from the threshold at the bond/loan origination date and the volatility of the asset value 

thereafter (Duffie and Singleton 2003, Deng et al. 2000, Kau et al. 1995). 

19
 
Figure 8: Conventional Mortgage Foreclosures (%) - California and Ohio 

0.00% 

0.20% 

0.40% 

0.60% 

0.80% 

1.00% 

1.20% 

1.40% 

1.60% 

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 

California Ohio 

For diversifiable risks, the national lending/funding institutions generally have an advantage. The 

default cycles driven by the local economy can be diversified by having national or largegeographical area diversified portfolios. For nondiversifiable risks, the market and interest rate 

risks have been more manageable through various hedging tools introduced since the early 1980s. 

Credit derivative products (credit swaps, credit-link notes, etc.) have been on the rise in recent 

years, making it more feasible to control nationwide mortgage credit risk. 

Lesson 3. Incentives Matter, Too 

In general, private-sector participants will jump into a new venture only if they see a positive 

value proposition by doing so (that is, in equation (1), the left-hand side should exceed the sum of 

all the right-hand-side terms). The high uncertainties associated with new products (e.g., the 30-

year fixed-rate mortgage or mortgage default insurance) usually discourage private-sector 

initiation of such ventures. As the U.S. history shows, the government played a significant role in 

introducing and nurturing such products. 

The principal-agent problem in mortgage intermediation generates another incentive issue. 

Although the unbundling and automation of origination, funding, and servicing processes 

increases operational efficiency, they can also raise potential principal-agent problems such as 

moral hazard in data and document verification, adverse selection of good-quality loans (by 

originators) instead of passing them along to secondary market outlets, and outright fraud. As 

revealed in the mortgage-backed bond experiment in the late 1800s, this principal-agent risk can 

be toxic, leading to the demise of a certain type of intermediary, and calls for a proper due 

diligence by both public and private institutions. 

20
 

Lesson 4. Multiple Options Are Available To Achieve a Given Policy Objective 

The U.S. experience demonstrates that different options can be used to achieve a given public 

policy objective. In particular, the following list provides alternatives that arose in the U.S. 

experience and can be considered by other countries. 

Wholesale Funding • Mortgage securitization with explicit government guarantee (Ginnie Mae) 

• Mortgage securitization with implicit government guarantee (GSEs, with 

lines of credit with the U.S. Treasury) 

• Mortgage securitization with no government guarantee (private-label MBS 

issuers) 

• Corporate bonds issued by special facilities (GSEs) 

• Corporate bonds issued by secondary market conduits 

• Corporate bonds issued by primary market lenders 

Affordable Lending • More affordable but high-risk lending products (e.g., high-loan-to-valueratio loans, reduced documentation loans, home equity line of credit, and 

second mortgages) 

• Products targeting specific population groups (e.g., reverse-annuity 

mortgages for house-rich/cash-poor senior citizens) 

• Housing goals and loan-size limits for GSEs 

• Lending through community organizations 

• Education and counseling 

Risk Sharing and Management • Private mortgage insurance (PMI) 

• Government default insurance (FHA and VA) 

• Deposit insurance (FDIC) 

• Preclosing commitments 

• Interest rate derivatives 

• Credit derivatives, recourse, and make-wholes 

• Prepayment-tranched CMOs 

• Credit-tranched REMICs 

• Post-purchase document reviews 

Ensuring Safety and Soundness • Minimum and risk-based capital requirements 

• Financial disclosures 

• Onsite/offsite examinations by regulators and auditors 

• Ex-post bailouts (Reconstruction Finance Corporation, Home Owners’ 

Loan Corporation, Resolution Trust Corporation) 

Technology Solutions • AUS, automated valuation model, and related IT systems 

• Online connectivity and data transmission 

• Data repositories (for borrower credit and loan performance) 

• Data mining tools 

AUS = automated underwriting system; CMO = collateralized mortgage obligation; FDIC = Federal Deposit Insurance 

Corporation; FHA = Federal Housing Administration; GSEs = government-sponsored enterprises; IT = information 

technology; MBS = mortgage-backed security; PMI = private mortgage insurance; REMIC = real estate mortgage investment 

conduit; VA = U.S. Department of Veterans Affairs. 

In the context of enhancing the HFS in other countries, this list offers a menu from which 

possible options could be selected and customized to best achieve the particular policy goals, 

given various economic and institutional conditions specific to that country. 

21
 

22
 

Section 5. Experience of Emerging Mortgage Markets 

Emerging mortgage markets in other countries generally face challenges in three public policy 

areas: (1) wholesale funding, (2) risk sharing and management, and (3) affordable lending 

products. The experiences of Mexico, Korea, South Africa, and Poland are useful in discussing 

these challenges. 

Wholesale Funding 

South Africa and Korea issued mortgage-backed securities (MBSs) during the 1990s. The MBS 

markets in both countries are stalled, however, since their first issuance. In South Africa, where 

the first securitization was done in 1989, virtually no activity in the market was recorded between 

1991 and 1999. Then several MBS transactions occurred in the 2000s. In Korea, on the other 

hand, MBSs were issued nine times with the total amount of $2.8 billion between 1999 and 2003 

by Korea Mortgage Corporation (KoMoCo) and seven times more totaling $3.1 billion by the 

newly created Korea Housing Finance Corporation (KHFC), but the total MBS volume 

outstanding is very small compared to the asset-backed security (ABS) market, which developed 

immediately after the financial crisis in 1997 to securitize nonperforming bank loans (the MBSs 

outstanding are only 2.5 percent of that of ABSs as of 2002). 

These countries’ cases exemplify the difficulties faced by many other emerging economies in 

developing a successful MBS market. Saayman and Styger (2003) make the following key points 

based on survey data with investors and structured finance specialists in South Africa: 

o	 	 The South African government, unlike the U.S. government, was generally not 

favorable and conducive to MBS issuance and left the market to demand/supply 

factors. 

o	 	 The Securitization Notice of 1992 in South Africa had a bias against MBSs; 

mortgages carry a 50-percent risk weight in determining the capital holding of banks, 

while MBSs carry a 100-percent risk weight. 

o	 	 Limited trust in rating agencies and the credit ratings they assigned to securities, 

together with the reliance on each investor’s assessment of the credit quality of the 

securities, contributed to the slow growth in demand. 

o	 	 The lack of default and delinquency data as well as systems access to the appropriate 

data added to the difficulty of rating, structuring, and assessing the transaction. 

o	 	 Historically high interest rates were not conducive to the development of a debt 

market, but they have led to the development of a strong equity market, causing the 

investment community in South Africa to be an equity-investment community. 

o	 	 There is a lack of a corporate bond market and the lack of depth in the secondary 

bond market. 

o	 Large banks do not currently face any liquidity constraints. 

o	 The general public has the perception that an organization will securitize only when it 

is in trouble. 

In short, two important preconditions for flourishing MBS markets need to be met: (1) favorable 

government policies for securitization such as the implicit and explicit guarantees that the U.S. 

government provides and (2) a strong demand for and supply of liquid mortgage-backed 

securities (Saayman and Styger 2003). 

23
 
In the case of Korea, the government supports securitization, as evidenced by the creation in 2004 

of the wholly government-owned secondary market conduit, the Korean Housing Finance 

Corporation. The problem, however, lies on the demand side. After the Asian financial crisis of 

1997, there was an increased supply of capital in the market, which raised the liquidity in 

consumer lending. In 1997, 22 percent of bank lending was for housing, credit cards, and other 

consumer loans; this share ramped up to 47 percent in 2002 as lending institutions avoided what 

they perceived to be high-risk corporate lending. (Yoo 2003) Therefore, the current issue for 

Korea is the development of standard loan products—both a “Korean conforming loan” to make 

the wholesale funding more feasible in the future and affordable loan products to include more 

households in the intermediation system. 

MBS financing may be sound and efficient, but it is not the only method of wholesale funding to 

increase liquidity. As shown in the list above, liquidity enhancement in the United States has been 

achieved through several different methods, including the issuance of debentures by those 

institutions that have good market acceptability. This bond financing is likely to be a more 

feasible, and even a comparable, way to achieve the funding efficiency in many emerging 

markets. Unlike in the United States, not all critical market infrastructures are currently in place 

in most emerging markets. These include institutional factors such as foreclosure laws, 

accounting rules, capital markets that include a deep bond market for long-maturity securities and 

a complete spectrum of hedging instruments, well-functioning and healthy banking systems, and 

stable macroeconomic and housing market conditions and policy tools to ensure the stability of 

the financial markets. In the context of many developing countries, property rights and 

enforceable liens on residential land and structures are particularly critical in establishing a wellfunctioning and efficient housing finance system. 

Wholesale funding also faces product-related hurdles. For example, both Mexico and Poland rely 

heavily on dual-indexed mortgages to protect both lenders (from high interest rates, caused by 

high inflation) and borrowers (from income shock).9 Because the payment is tied to two separate 

indexes, the cashflows and effective returns of such a product are exposed to additional 

uncertainties. Another product-related hurdle is the interest rate subsidies that are prevalent in 

many countries. These product-driven hurdles, in the forms of added complexity and subsidized 

rate setting, also make wholesale funding and a more market-based housing finance system (HFS) 

less feasible. 

Risk Sharing and Management 

Information technology innovations such as automated underwriting systems, automated 

valuation models, and fraud detection tools are relatively more transferable to other countries, 

compared to establishing certain markets or changing legal or accounting systems. The challenge, 

however, is in the quality and quantity of data. Saayman and Styger (2003) report that robust data 

on consumer credit and loan performance are simply not available in many countries. This 

shortage of data creates a critical problem in importing the best-practice risk management tools. 

Sharing information across lending institutions and establishing data repositories are important 

prerequisites in building quantitative risk models. Governments can play an important role in 

mitigating this limitation. The lack of effective default risk assessment tools (because of the lack 

of consumer credit data, for example) limits the extent to which loan-to-value (LTV) ratios can be 

9

 The dual-indexed mortgage is an adjustable rate mortgage built around two variable indexes: (1) the 

interest due on the remaining loan balance moves with shifts in market interest rates and (2) the borrower’s 

monthly payment fluctuates with wage changes. 

24
 
increased. High LTV ratios are an effective solution to affordable lending and the expansion of 

the HFS to more borrowers. 

Affordable Lending Products 

U.S. experience demonstrates that increased funding through MBSs and other means combined 

with sound risk-sharing arrangements among various intermediaries lead to more affordable 

lending. This is evidenced by the steady increase in the homeownership rate and various lending 

products targeting low-income and other consumer cohorts. Several challenges caused by 

peculiarities of market conditions in other countries, however, make it difficult to directly 

replicate such affordable products. 

As mentioned earlier, lack of consumer credit data makes high LTVs impractical from a credit 

risk standpoint. In addition, the high real estate price relative to household income in many 

countries means a high mortgage payment burden. For example, the home price-to-income ratio 

in Poland (the average home value divided by the average annual household income) ranges 

between 8 and 11, depending on the specific location. This ratio is much higher than the 

comparable ratio of about 3 in the United States and the ratio of 6.2 in 2003 and 5.5 in 2004 in 

Korea. See Table 2 for selected market conditions of different countries. 

Affordable loan products in the United States are low-downpayment mortgages. When the 

collateral values are too high, however, the monthly mortgage payment becomes more 

burdensome to typical households, given other constant lending terms. To remedy this payment 

affordability problem, Korean lenders have issued various interest-only loan products in large 

quantity with 3- to 5-year maturities. Unfortunately, such products pose the risk of 

nonamortization (or lack of equity building). These mortgages are very similar to the typical 

products developed in the U.S. market during the Era of Exploration. 

The coexistence of formal and informal intermediation systems also characterizes many emerging 

markets. With informal arrangements, funding can come from various sources, such as direct 

family members, more distant relatives, and friends (similar to Terminating Building Societies in 

the early U.S. experience), and even landlords (as in the case of Chonsei contracts in Korea).10 

Regardless of the source, the informal arrangement tends to be inefficient and likely has a limited 

impact in raising affordability. Those who are able to lend may not be able to relate to those who 

need to borrow. Relying on informal financing arrangements also poses an equity issue in that a 

key determinant of access to housing is luck of birth, with advantage and disadvantage passing 

down generationally (Stephens 2000). Therefore, in determining public policy goals in those 

countries, the design of loan products that can attract the population that currently relies on 

informal financial arrangements will be an important factor.11 

Other policies instituted in the United States induce lending and funding institutions to better 

serve underserved population groups (e.g., the housing goals for government-sponsored 

enterprises [GSEs], Community Reinvestment Act requirements, and the loan limits for Federal 

10 The Chonsei market in Korea is extensive. Under the Chonsei contract, the tenant puts a large lump sum 

deposit (about 50 to 60 percent of property value) in lieu of periodic rent payments and the landlord returns 

the same amount of money at the expiration of the contract. Under this arrangement, the landlord can invest 

money for higher returns than bank deposits or in other business ventures, while tenants can keep their 

savings intact until they accumulate enough money for a home purchase. 11 In the context of Korea, Cho (2002) suggests parameters of such a “conforming” loan product: 50 to 60 

percent maximum loan-to-value ratio, 10- to 15-year loan term, funded by a wholesale intermediary with a 

loan limit. 

25
 
Housing Administration insurance and GSE mortgage purchases). In addition, the U.S. 

experience also shows the importance of public-private partnerships. The collaboration among 

large intermediaries, community organizations, and state and local housing agencies can extend to 

the identification of specific local and national target groups, the design of new products suited to 

their needs, and the availability of counseling and training services. 

Some policies outside the owner-occupied housing market can also offer indirect boosts for some 

target households, such as multifamily (or apartment) financing to promote a sound private rental 

market, contract savings and other means to equip certain households to become homeowners, 

and construction loans for affordable housing units. Designing specific loan products to serve 

target population groups in a particular country and applying some of the experience from the 

United States warrant further research. 

26
 

Table 2. Relevant Markets—A Five-Country Comparison 

United States Mexico Korea South Africa Poland 

Housing/ 

Land 

Market 

• 69% owners 

in 2001 

• HP-to-income 

ratio: 3 

• Freer supply 

of land for 

urban 

development 

• 55% owned • 54% owned* 

• HP-to-income ratio: 

4.2 to 6.2 

• Restrictive land 

conversion and use 

regulations 

• Policy shift being 

pursued from subsidyonly low-income 

housing service to 

more market/financeoriented service 

• 72% owned 

• HP-to-income ratio: 8 

to 11 

• Weak private rental 

market 

Mortgage 

Market— 

Primary 

• 53% MDO to 

GDP 

• 15- to 30-year 

loan term 

• 79% average 

LTV 

• 33% income 

ratio 

• Mortgage 

interest 

deduction 

• 12% MDO to 

GDP ratio 

(1996) 

• DIM and PLAM 

are very 

prevalent 

mortgage 

instruments 

• Private 

mortgage 

insurance by 

SHF being 

pursued 

• 11% MDO to GDP 

in 1997; 13% in 

2001; 21.8% in 

2004 

• 81% for less than 

10-year loan term 

• 60% average LTV; 

70% maximum LTV 

• 40% income ratio 

• Interest deduction 

w/ the maximum of 

$ 10,000 

• 3- to 5-year bullet 

loans (70%) 

• No liquidity constraints 

for large banks 

• Lack of default/ 

delinquency data as a 

hurdle for market 

making 

• CRA and other policy 

initiatives to serve 

underserved 

population groups 

• Heavy interest rate 

subsidy for target 

population groups 

• DIM introduced in 

1994 

• 40–60% average 

LTV; 70–80% 

maximum LTC 

• Following German 

model: contract 

savings, Pfandbriefe 

Mortgage 

Market— 

Secondary 

• First MBS 

issued in 1971 

by Freddie 

Mac 

• $1.9 trillion 

total MBS 

• Growing ABS 

markets 

• No serious 

legal issue in 

MBS 

transaction 

• Credit 

derivatives 

increasing 

• Private and 

public pension 

funds 

dominating 

(67% by 

INFOVIDAT 

and 7% by 

FOVISTE) 

• Public housing 

fund, FOVI 

having 20% 

market share 

• Inadequate 

enforcement of 

liens and titles 

• First MBS issued in 

1999 by KoMoCo 

• Nine MBS 

issuances until 

2003 and seven 

more issuance in 

2004 

• Large ABS market, 

& housing bond 

market 

• Various legal 

constraints in MBS 

transaction 

• First ABS issuance in 

1989, but no 

securitization activity 

between 1991 and 

1999 

• 100% risk weight for 

MBSs and 50% for 

mortgages 

• Equity (vs. debt) 

investment community 

in general 

• National Housing 

Fund–cofinance 

rental construction 

ABS = asset-backed security; CRA = Community Reinvestment Act; DIM = dual-indexed mortgage; GDP = gross domestic product; HP = home price; 

LTV = loan-to-value ratio; MBS = mortgage-backed security; MDO = mortgage debt outstanding; PLAM = price-level adjusted mortgage; SHF = Sociedad 

Hipotecaria Federal. 

27
 

28
 

Section 6. Summary and Next Steps 

The main goal of this paper is to survey the evolution of the U.S. housing finance system (HFS) 

and to document the best practices observed from the process to provide insight for enhancing 

other countries’ HFSs. We hope the lessons discussed here can help make other countries’ 

intermediation processes more efficient and can help facilitate homeownership for more 

households in those markets. Some of the lessons examined have already occurred in different 

parts of the world (e.g., the foreign investors for U.S. mortgage-backed securities and debt that 

supports housing and the ongoing integration of funding markets across European countries after 

the advent and spread of the European Union) (European Mortgage Federation 2003). 

Table 3 summarizes some major requisites for an efficient HFS, based on the U.S. experience, 

and points out some indicators or evidence that would signify the particular requisite is in place. 

Advanced HFS mechanisms are feasible only if certain institutional or process infrastructures are 

in place. For example, MBSs need standardized mortgage products that generate continuous 

sufficient cashflows, are originated based on sound underwriting rules, and are collateralized by 

complete ownership of the houses. The “basics” involve elements necessary for effective 

underwriting. Capital supply to housing is enhanced if requisites such as sound financial 

institutions are in place. Automated underwriting systems and economies of scale that result from 

specialization are among the conditions that help reduce borrowers’ transaction costs. In addition, 

clear and enforceable property rights can be promoted by developing a title insurance market. 

The role of government in enhancing the efficiency and stability of the HFS in a particular 

country is an important and complex policy issue to consider. In the context of the U.S. system, 

the market for mortgage securitization was created and has been expanding since the early 1970s, 

with the federal government being a key market maker. The creation of Ginnie Mae and Freddie 

Mac, the privatization of Fannie Mae, the favorable risk weight for MBSs, and the creation of the 

Office of Federal Housing Enterprise Oversight all contributed to the very efficient and extensive 

mortgage funding market in the United States today. Nonetheless, debates still continue regarding 

the optimal public-sector involvement in the mortgage market (e.g., the further privatization of 

government-sponsored enterprises [GSEs] and the need for new regulator(s) for the GSEs). In the 

United States, the Federal Housing Administration program takes on some financial risks to make 

housing finance accessible by more households. Thorough analyses and extensive operational 

experiences are necessary to keep such risks manageable. Emerging countries, in their risk 

management analyses, may find government insurance programs somewhat too risky in the 

beginning and may wish to consider instead devoting attention to creating a more solid legal and 

regulatory framework and to improving basic financial practices, such as credit reporting 

standards, in order to attract greater private sector interest and involvement in mortgage finance 

and insurance. 

Policy goals vary widely among different countries. For example, the prioritization may be very 

different among reforming the banking system, formalizing informal sectors, compiling consumer 

credit data, introducing a long-term fixed-rate mortgage, or any combination of these initiatives 

and other targets. At the same time, the stage of development for the various requisites within and 

outside the HFS also differs among countries. Thus, policy goals and constraints in achieving 

those goals will determine what roles the government needs to play in a particular country. 

Instead of embracing a certain policy direction (e.g., mortgage securitization) simply because it 

delivered positive outcomes in other countries, it is advisable to start establishing market makers 

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and required functionalities. As this paper summarizes, other countries can assess and leverage a 

menu of options drawn from the evolution of the U.S. HFS to pursue their countries’ respective 

public policy goals. An alternative that may work better in a given country would depend on its 

specific culture, market, and institutional environments. 

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Table 3. Requisites and Indicators of an Efficient Housing Finance System— 
 


Reflections on the U.S. Experience 
 


The Basics Indicators/Evidence 

• Housing collateral 

o Clear and enforceable property rights o Land and property title/title insurance 

o Active unconstrained market (e.g., 

elastic supply of serviced land) 

o Accessible market sales data/home price-to-income 

ratio 

o Methods to limit frauds (in valuation or 

condition) 

o Appraisal regulation and sanctions 

• Borrower willingness and ability to pay 

o Valid credit history o Consumer credit repositories/credit 

bureaus/consumer reports 

o Valid employment and earnings data o Verifiable wage statements, tax returns, and 

employment 

o Valid wealth estimates o Verifiable brokerage, savings statements 

• Stable macroeconomic conditions o Trends of inflation, interest rates, and other 

macroeconomic factors 

Capital Supply 

• Standardized mortgage products o Market trading in those products 

• Supportive legal and regulatory environment o Specialized government charters and guarantees, 

supportive capital requirements, active government 

lending programs 

• Competitive lenders o Financially sound lenders and investors, with 

trustworthy financial reporting; Different mortgage 

terms offered by different lenders 

• Competitive insurers o Title, hazard, liability and mortgage insurance 

available 

• Financial instruments o MBSs, derivatives, hedging vehicles for interest 

rate and credit risk/rating agencies/benchmark 

interest rates 

• Favorable investor base for fixed income 

securities 

o Pension funds, insurance companies, mutual funds 

Low Transaction Costs 

• Reasonable taxation on housing sales and on 

mortgage transactions 

o No extraordinary taxes 

• Economies of scale o Specialized, high-volume originators and servicers 

• Automated underwriting o Large volume processed by AUSs 

AUS = automated underwriting system; HFS = housing finance system; MBSs = mortgage-backed securities. 

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Glossary 

ABS—asset-backed security. 
 


ARM—adjustable rate mortgage. 
 


AUS—automated underwriting system. A computerized method for underwriting mortgages. 
 


automated valuation model—An information technology tool that provides automated estimates 
 


of house values. 
 


CMO—collateralized mortgage obligation. A multiple-class mortgage-backed security. 
 


conventional mortgage—A nongovernment, private-sector mortgage. 
 


disintermediation—The outflow of deposits when deposit rates are below market rates. 
 


DU—Desktop Underwriter. Fannie Mae’s automated underwriting system. 
 


duration—A measure of the effective maturity of mortgage cashflows. 
 


Fannie Mae—Federal National Mortgage Association. The largest secondary mortgage market 
 


company in the United States. Fannie Mae was chartered in 1938 by Congress. 
 


FDIC—Federal Deposit Insurance Corporation. An independent agency of the federal 
 


government that insures deposits at banks and Savings and Loan institutions. 
 


FHA—Federal Housing Administration. Part of the Department of Housing and Urban 
 


Development’s Office of Housing. As the largest insurer of home mortgages in the world, 
 


provides government insurance for primarily affordable mortgages.
 


FHLBanks—Federal Home Loan Banks. Twelve independent but cooperative banks (part of the 
 


FHLBank System) that provide liquidity to thrifts. 
 


Freddie Mac—Federal Home Loan Mortgage Corporation. A secondary mortgage market 
 


company that was chartered in 1970 by Congress. 
 


FSLIC—Federal Savings and Loan Insurance Corporation. A corporation formed by Congress to 
 


insure the deposits of federally chartered savings and loans institutions. It was abolished in 1989 
 


and replaced by the Resolution Trust Corporation. 
 


Ginnie Mae—Government National Mortgage Corporation. An entity established by Congress in 

1968 to provide insurance for mortgage-backed securities backed by federally insured or 

guaranteed loans, mainly those insured by the Federal Housing Administration or guaranteed by 

the U.S. Department of Veterans Affairs. 

GSE—government-sponsored enterprise. A privately held company created by Congress to 

reduce the cost of capital for certain borrowing sectors of the economy. Examples of GSEs 

include Fannie Mae, Freddie Mac, and the Federal Home Loan Banks. 

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HELOC—home equity line of credit. A mortgage loan, usually in a subordinate position, that 

enables the borrower to obtain cash drawn against the equity of his or her home, up to a 

predetermined amount. 

HFS—housing finance system. A collective term for institutions and the environment for funding, 

originating, and servicing mortgages. 

HOLC—Home Owners’ Loan Corporation. A former U.S. government agency established in 

1933 to grant long-term mortgage loans to homeowners facing the loss of their property. The 

HOLC ceased its lending activities in 1936. 

IT—information technology. The application of computer hardware, communications, and 

software technology to the management, processing, and dissemination of information. 

LoanProspector—Freddie Mac’s automated underwriting system. 

LTV—loan-to-value [ratio]. The amount of mortgage loan borrowed divided by the market value 

of the house used as collateral. LTV is the complement of the percentage of downpayment paid in 

purchasing a house. 

MBB—mortgage-backed bond. 

MBS—mortgage-backed security. 

MDO—mortgage debt outstanding. 

MMMF—money market mutual fund. An open-end mutual fund that invests only in money 

markets. These funds invest in short-term (1 day to 1 year) debt obligations such as Treasury 

bills, certificates of deposit, and commercial paper. 

PMI—private mortgage insurance. A mortgage insurance policy without government backing. 

principal-agent problem—A situation in which agents (e.g., mortgage originators) may have 

different incentives than the principals (e.g., mortgage investors), resulting in losses for the 

principals. 

Regulation Q—A U.S. government regulation, now phased out, of the Federal Reserve system 

that established a ceiling on interest rates on time deposits. 

REMIC—real estate mortgage investment conduit. A self-contained, multiple-class mortgagebacked security. 

reverse-annuity mortgage—An arrangement in which a homeowner borrows against the equity in 

his or her home and receives regular monthly tax-free payments from the lender. 

RFC—Reconstruction Finance Corporation. A former U.S. government agency that made 

emergency loans to banks and railroads in danger of defaulting during the Great Depression. 

S&L—Savings and Loan. Originally, an institution that specialized in home mortgages. 

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specialization—The propensity of an organization, institution, or company to perform a certain 

function. In the housing finance system, entities tend to specialize in funding, originating, and/or 

servicing mortgages. 

systemic risk—Risk that affects an entire financial market or system and not just specific 

participants. It is not possible to avoid systemic risk through diversification. 

TBS—Terminating Building Society. A community of people who pooled their savings and made 

loans to each other for constructing houses. 

thrifts—A term referring to lending institutions such as savings and loan associations, credit 

unions, and mutual savings banks. 

underwriting—The process of determining whether and under what conditions a mortgage should 

be made. 

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