Mortgage Finance (The 1970s): Inflation, Stagflation, and Disintermediation

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A bank holds a loan in its asset portfolio and funds it with low-cost deposits (also known as “portfolio” or “spread” lending). Holding loans in portfolio and funding them with low-cost deposits, works as long as interest rates were stable, and there was a readily available supply of deposits. This model broke down in the 1970s when market interest rates soared in response to rapid increases in both wholesale and consumer prices.

The seeds of inflation were sown in the previous decade (the 1960s), arguably when the U.S. government expanded its role in the economy tremendously. Simultaneously, the U.S. government carried out an expensive war in Southeast Asia, launched several ‘Great Society’ programs designed to promote upward mobility among disenfranchised Americans, and eventually landed a manned spacecraft on the moon. These initiatives provided a sizeable economic stimulus to an economy already undergoing rapid expansion.

The Johnson and Nixon administrations failed to raise taxes by nearly enough to pay for all of these ambitious undertakings. The government was forced to issue increasingly large amounts of debt, which in turn crowded out private investment, or, at the very least, raised the rates at which the private sector could borrow. Compounding the issues of over stimulus and the…