Historical evolution of residential lending structures and the rise of financial innovation

Residential lending structures have evolved considerably over the past two centuries (Chava & Rani, 2023; Kannan, 2022; Sriram, 2022). It is commonly said that knowledge of the past will allow for informed decisions for the future. In the context of this essay, an understanding of the historical evolution of residential finance is of central importance since it serves as a basis for the current housing market and related mortgage financing. In addition, this understanding allows researchers to properly diagnose problems of the present, formulate hypotheses about likely future trajectories of housing finance toward existing trends of financial innovation, and assess the feasibility of various paths of change. We aim to highlight historical events, socio-economic conditions, and technological advancements that proved to be pivotal in the development of residential lending practices in the U.S. that are now increasingly being adopted worldwide. Throughout this chapter, we focus on the economic trends of the 20th century experienced in the U.S., as it was the most pivotal period in the development and massive diffusion of residential lending, which remained a predominantly regional affair until then. The landmarks of this modern innovation are progressive real estate market securitization, which relates to the quick appraisal and amortization through secondary market financing, as well as the subsequent evolution of those processes into the mortgage-backed security and its technical counterpart, the CMO. It is impossible to consider residential lending on the basis of economic determinism alone, as such economic innovation was influenced by (and in turn influenced) social and technological factors. Therefore, we will step out of the economic approach to psychoanalyze the turn of the 20th century, as technological advancements had given rise to the multimillion-dollar real estate industry, but housing prices remained impervious to those advances. Government intervention, in its infancy in the perhaps too generous savings and loan concept, is also noted.

1.1.1. Overview of Key Themes and Objectives

This chapter examines the historical evolution of the financial structure of housing in society. We aim to understand the way residential lending has evolved over time, as well as the socio-political motives behind these transformations. This paper will shed light on the major socio-political events in history that have led to changes in the way individuals finance their homes, as well as the laws and regulations that have allowed for these financing methods. Importantly, the reader will develop a rich understanding of the various financial innovations that have occurred from antiquity to today. In every period of history, in response to pressing socio-political dynamics, residential lenders adapted the products they were offering or were willing to take on more risk. Each of these ideas then set off its own innovation boomlet.

The story of residential financing is actually a series of changes in the way we think about and build homes and the tools that allow us to finance their creation and purchase. Taken as a whole, our hope is that this paper will provide a lens with which to engage this story, while also highlighting that the growth and change in financial systems have been anything but straightforward and naturally evolving. Many of the changes in residential lending have been mandated by regulation; others were sparked by social and political changes. Another set was driven by more basic demand-driven functions: people wanted to build more homes, so a different, more solidly grounded finance method was devised. And some are adaptive following a financial product innovation: as people used the product, it began to redefine the nature of how we did business, and so a new financial system adapted. Together, these three themes in this introductory overview will help weave the story of home financing throughout history together.