This week at Strong Towns we are going to focus on the findings of a report published by Regional Plan Association. The report identifies a very narrow set of federal housing rules that were adopted during the Great Depression. These rules came about for logical reasons but, played out over subsequent generations, have created incredible distortions in the U.S. housing market. If you're frustrated about the lack of choice in housing, distorted pricing, issues of affordability, gentrification and blight, you're going to want to pay attention this week. We're going to explain the financing element that shapes the DNA of your community.

The National Housing Act of 1934 was passed during the depths of the Great Depression. The act created the Federal Housing Administration (FHA), an organization that sought to stabilize housing prices. Before the FHA, home financing was primarily handled by local banks. To limit risk, those local banks (which were investing the savings of other community members) kept mortgage terms short -- three to five years -- and required really high down payments in order to maintain a safe loan to value ratio. When housing prices fell, banks refused to offer refinancing without additional capital -- which many did not have -- and lots of homeowners were driven into foreclosure. An excess supply of repossessed houses along with a lack of people able to make huge down payments only accelerated the decline.

As part of the New Deal, the FHA offered insurance to local banks which allowed them to issue mortgages with less money down and longer payment terms. The immediate effect of this was to increase home ownership rates. In 1940, the US home ownership rate was 44%. By 1950, that had climbed to 55%. The FHA today is still a major insurer of home mortgages.

In order to limit risk, the FHA placed some reasonable-sounding limitations on what they (more precisely: we, as taxpayers) were willing to insure. While some practices, such as redlining, were later made illegal (although it still remains a problem), others continue to be in force. For example, a home being mortgaged may not have more than 25% of the floor area used for commercial purposes. That means the family business, the one that was built up over generations, where there is a building with the business on the first floor and the home on the second, is too risky to insure. A local bank is on their own for that kind of thing. The new suburban house out on the edge of town, however, meets the guidelines perfectly and can easily attain federal backing.

Another rule concerns the amount of income that can be derived from a commercial use. Let's say you live in the quintessential city building -- a first floor retail store and a second story home -- and the mortgage for it would be $1,000 per month. Let's say the business, which has been there for decades, pays $1,000 a month in rent and has never been late for a rent payment. Seems like not much risk. However, to limit their exposure to commercial volatility, the FHA would only allow the home owner to claim $150 of that rent as income towards the mortgage. They would need to show, within income to debt ratios, that they had other sources of income to cover the payment.

The end result of this is pretty simple to grasp. One kind of dwelling was suddenly easy to finance at very generous terms. Other kinds of dwellings suddenly became less competitive as they were not easy to finance and the terms were far more onerous. When one approach is made easy and the other is made difficult, the outcome is not surprising.