When Mortgages Made Sense

When Stanley Greenstein graduated from college, he dreamed of working in the advertising industry. But Madison Avenue wouldn't hire him. So the Bronx native placed a "Situations Wanted" ad in The New York Times. A mortgage company called, and in 1952 Greenstein took a job helping people borrow money to buy homes. Now, a few months shy of 80 years old, he still works full-time financing real-estate deals.

After a career that has spanned nearly enough time to repay back-to-back thirty-year mortgages, Greenstein has seen a lot of change. And with the mortgage industry facing a new crisis as subprime mortgages default and foreclosure rates climb, that gives him a unique perspective on today's troubles—and the reforms that might help avert future problems.

In fact, many things Greenstein did as standard practice when he processed loans are likely to become more common. Today the Federal Reserve is announcing lending reforms that will, among other things, put an end to mortgages made without verifying the borrower's income and require lenders to ensure that a borrower will be able to afford the payment on an adjustable-rate mortgage after it resets, instead of simply qualifying him at the introductory "teaser" rate. The Fed's proposal will also likely limit lenders' ability to use prepayment penalties to discourage refinancing, call for better disclosures on the true costs of the home payment (including property taxes and insurance) and require better disclosures on mortgage brokers' fees. The new rules could go into effect next year.

In a way, such reforms are a return to a simpler time. When Greenstein began processing mortgage applications in the 1950s, many of the homes his clients were buying—which looked much like those in nearby Levittown, America's original postwar subdivision—cost less than $20,000. "We did literally thousands of them," he says.

The mortgages he was writing were themselves a response to the last great mortgage-industry crisis. Before the 1930s, many home loans lasted only five years, with borrowers required to make a large "balloon" payment at the end of the term. Homeowners with these loans faced big trouble during the Great Depression, so lending practices changed. Longer-term mortgages (usually 20, 25 or 30 years) became standard, and balloon payments became the exception rather than the norm. There were other changes beyond the term of the loan. Most important, the government stepped in, creating the Federal Housing Administration to provide guarantees to lenders that loans would be repaid. For Americans who had served in the military, the Veterans Administration offered their own loan programs.

During the 1950s and 1960s, Greenstein put borrowers almost exclusively into these FHA and VA loans. They carried a fixed-rate of interest—usually 4 or 4.5 percent. Every borrower underwent a thorough credit check (a laborious process in the days before computers and lightning-fast online approvals). Like all lenders, Greenstein relied on strict ratios to determine how much money someone could afford to borrow. A person's mortgage payment (including taxes and property insurance) couldn't exceed 28 percent of his monthly income. When you added together the family's car loan and the mortgage payment, the total should be below 36 percent of income. "It wasn't set in stone at 28/36; you could make judgment calls," he says, but most borrowers were held to those limits. What about credit card payments? That was rarely an issue, since credit cards didn't start catching on until the late 1950s. "It used to be a very simple business," Greenstein says.

But over the years things became more complicated. Greenstein recalls reacting skeptically when adjustable rate mortgages first became popular in the 1970s, and he tried to encourage people to behave conservatively with them. For instance, when qualifying a borrower for an ARM, he didn't just look at their ability to pay the mortgage at the introductory rate; he also tested how their finances would hold up as the rate began to increase. When his children became old enough to buy their own homes, he encouraged them to obtain fixed-rate mortgages.

He recalls in the 1970s, when financial innovators first began "securitizing" loans to resell them to investors. That step was one example of how the overall mission of the industry seemed to change. "Now it's no longer about providing financing for someone to buy a home," he says. "It's about providing a vehicle for return-on-capital."

And he recalls how, by the late 1990s, the whole idea of "underwriting" a loan—doing the due diligence required to make sure a buyer's income can support the payment and that the house is worth what they're paying—began to crumble. "All of this was obliterated during the so-called boom, when they were financing purchases just on a signature, with no credit check," he says.

Now, as the pain caused by that laxity has spread, where do we go from here? Greenstein says loan modifications—whether done on a case-by-case basis or via the standards recently set out by the Bush administration—are the logical starting point. He also wonders if we'll hear more about steps to help people who have invested in securitized mortgages, which are now suffering losses.

He hopes the lending process will move back toward stricter underwriting, to a time when people wouldn't be issued a mortgage that would consume 40 percent of their income. The Fed's reforms will help, but Greenstein says he'd also like to see the loan documents borrowers sign become more comprehensible. Lately some consumer advocates have talked about reforms that would make mortgage disclosures just easy to understand as the nutritional labels the FDA requires to be put on food. However, Greenstein says those disclosures aren't necessarily a panacea. "I read those boxes in the grocery story all the time, and I don't understand them. Carbohydrates, sodium, transfat—I wouldn't want to go with that disclosure," he says.

Greenstein points to another moral in those nutrition labels: they're based on the fallacy that Americans eat food in the standard serving sizes nutritionists use. Anyone who has ever compared a "normal" portion of pasta, cereal or French fries against the nutritional standards knows Americans tend to go overboard. So too with mortgages. That's why better disclosures aren't the only element of the mortgage system that should be reexamined in the months ahead. Perhaps we also need to be looking at whether old-timers like Greenstein and their 28/36 ratios had the right idea—and whether the "serving sizes" on America's mortgages should be a bit more slender than they became during the boom.