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Abstract of: Adam Gordon, The Creation of Homeownership: How New Deal Changes in Banking Regulation Simultaneously Made Homeownership Accessible to Whites and out of Reach for Blacks, 115 Yale Law Journal 186-224, 188-190 (October 2005)
From 1920 to 1960, the rate of owner occupancy in the American housing market rose from 46% to 62%. These numbers, however, explain only a small part of the significance of the federal government's New Deal intervention in the housing market. The creation of the Federal Housing Administration (FHA) to insure lenders against the risk of default on single-family mortgages fundamentally transformed what it meant to own a house in America. Prior to the 1930s, owner-occupied housing was a good held primarily for reasons of consumption--not investment--and usually acquired late in life. Through New Deal reforms, homeownership became the primary mechanism that middle-class Americans use to build assets. Today, 60% of the total assets of middle-class Americans are held in owner-occupied homes.
Transforming America's housing market required a legal revolution, one that previous commentators have not fully explained. In order to make homeownership affordable to most Americans over the majority of their working lives, lenders had to accept far lower down payments than they ever had before--saving up for the pre-New Deal standard of one-third or more of the value of the home could take many years. And they had to allow homebuyers to spread out loan payments over far longer terms than they had before--the prior practice of making a mortgage to a homebuyer for only five to seven years made it impossible for most people to ever fully own their homes. State and federal banking law prohibited lenders from lowering down payment requirements and lengthening terms, and for good reason. Such changes would pose genuine threats to lenders' "safety and soundness" because they would expose lenders to greater risks of default.
Despite the risk involved, the FHA decided that it would insure low-down-payment, long-term mortgages in order to promote homeownership. Once the FHA had made that decision, it needed to change dozens of federal and state laws to make those mortgages legal. It had a very good argument for doing so: The increased rate of default on such loans would not threaten lenders' safety and soundness because the FHA, as an insurer, would take over payments in case of default. This Note illuminates for the first time how the FHA convinced all federal bank regulators and all forty-eight state legislatures to make exceptions to safety-and-soundness regulations for loans that it insured.
I argue that these policies, while logical and benign on the surface, in fact produced devastating results for African-Americans. As historian Kenneth Jackson and others have described, the FHA's core insurance program, section 203(b), systematically discriminated against African-Americans. The FHA produced underwriting guidelines based on an economically and historically flawed understanding of a "natural" progression of neighborhood racial change from all-white (with high property values) to all-black (with low property values). These guidelines rated a neighborhood's suitability for insurance based on racial composition, encouraged or mandated racial covenants as a condition for insurance, and discouraged integrated neighborhoods.
Commentators such as Paul Boudreaux and Robert Ellickson have downplayed the importance of the FHA's racial discrimination, instead arguing that personal preferences have driven racial segregation. Underlying their skepticism of the FHA's importance is the reasonable question: "If substantial numbers of African-Americans would have taken out insured mortgages, why didn't businesses develop to serve that market?" This Note answers that question for the first time. Congress and state legislatures granted exemptions to bank safety-and-soundness regulations only for FHA-insured mortgages--not for mortgages insured by the private sector. Thus, if the FHA would not insure a particular borrower, that borrower could not get a low-down-payment, long-term mortgage from any source. The FHA's discretionary guidelines effectively became binding law, giving whites a generation's head start on accumulating wealth through homeownership, a fact reflected in concrete data from the census and land records. This reality suggests that government policy fostered segregated housing patterns to a greater degree than many commentators have previously thought.
I argue that the integration of section 203(b) forty years ago through an Executive Order by President Kennedy did not sufficiently remedy the pervasive system of FHA discrimination against African-Americans. Simply making FHA-insured loans available to blacks did not compensate for the dramatic advantage that whites had enjoyed for decades in the homebuying market, an advantage that may explain why the median white household has ten times as much wealth as the median black household today. In addition, the end of discrimination in the FHA program failed to eliminate the view of neighborhood racial transition and composition that the FHA's insurance guidelines cemented in the American mind: that whites could prosper only by living separately from blacks, and that blacks moving into a neighborhood signified imminent price decline. The past acceptance of these empirically faulty characterizations as official federal policy may help account for why American metropolitan areas remain highly segregated by race.
I end this Note by briefly considering potential remedies to housing segregation and racial disparities in wealth that others have proposed. I do not explicitly endorse these remedies or exhaustively describe their constitutional implications. Because this Note fully explains for the first time the regulatory base that girded the FHA's discretionary administrative actions, I simply wish to suggest areas in which my research may help build a stronger case for action to remedy past discrimination and ongoing inequalities.
Much of my data and examples derive from Connecticut records, particularly those covering New Haven. However, the patterns I describe could be seen in any metropolitan area, and I cite national data and statutes from all states to show that Connecticut's experience mirrored those of other states.