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  • I'm going to start by talking a little bit about the history

  • of mortgage lending.

  • And then, I want to talk more recently about how we do

  • commercial real estate finance, and then, residential

  • real estate finance.

  • And then, if I have time, I'm going to try to get into

  • discussing --

  • [SIDE CONVERSATION]

  • PROFESSOR ROBERT SHILLER: So when we talk about real estate

  • finance, it's really about financial contracts that

  • involve real estate, and that particularly use real estate

  • as collateral.

  • So, it's a very complicated history.

  • But I'd like to put things in a long-term perspective.

  • I want to start with the word mortgage.

  • It actually goes back to Latin.

  • Mortuus vadium.

  • And that means in Latin, death pledge.

  • And then, in the Middle Ages in France, they substituted

  • the French word for vadium.

  • And that's [CIRCLES GAGE ON BLACKBOARD].

  • I don't know how to pronounce it.

  • That means pledge in French.

  • And I don't know why they called them death pledges.

  • That doesn't seem to involve death to me.

  • But in the long history of these

  • institutions, it became important.

  • The Oxford English Dictionary says the word mortgage entered

  • the English language in 1283.

  • So, we've got a long history here.

  • Actually, I can take it back further than 1283.

  • I was inspired by the research of Yale historian Valerie

  • Hansen, who has been reading old documents related to the

  • silk trade.

  • And her documents are based on a trove of old documents from

  • the Tang Dynasty in China, between the 7th and 10th

  • centuries, which reflect loans that were

  • made to finance trade.

  • So, you had people going back and forth from the Middle East

  • to China with silk, and other items, and they needed

  • financing for the trade.

  • So, she reads these old documents in Chinese.

  • And I was looking over her work a little bit to see

  • whether they had mortgages.

  • She says that in China, it didn't seem, at least if I'm

  • getting her generalities right, they didn't seem to

  • mortgage property, at least in these documents.

  • But she says that among these documents are some --

  • they weren't all in Chinese, because they were trading

  • between China and many other countries.

  • So, she found some in the Sogdian language.

  • She reads all these languages.

  • It's an ancient language of what's modern day Iran.

  • And it's a dead language.

  • It died out in the ninth century.

  • But she finds some Sogdian documents

  • that look like mortgages.

  • So, some people borrowed money for their silk trade, and they

  • would mortgage their property, or their slaves.

  • You could mortgage slaves.

  • It's an awful thought.

  • And then the contracts would additionally say that you were

  • obligated to maintain the property or the slaves.

  • I guess that meant feed your slaves.

  • Keep them healthy.

  • Those were mortgages from over 1,000 years ago.

  • So, it's a very old institution.

  • But I think it formed its modern form more recently.

  • And it became a well-known term for the general public

  • maybe in the late 18th century.

  • I was trying to confirm that.

  • I'm interested in history, just out of a passion for

  • understanding origins of things.

  • So, I looked up mortgage on ProQuest to find, what were

  • they talking about.

  • And I found an article in the Hartford Courant, dated 1778.

  • Actually, it wasn't an article, it was an ad that

  • someone took out.

  • And I think it's kind of revealing of what the mortgage

  • market looked like in 1778.

  • We here in Connecticut, have -- did you know this? --

  • the oldest newspaper in America.

  • That's the Hartford Courant.

  • So, a man by the name of Elisha Cornwell took out an ad

  • in the Hartford Courant in 1778.

  • And he explains in the ad, that he sold his farm, and,

  • instead of taking the money right up front, he'd mortgaged

  • the farm, so that he sold it for GBP 800 to another farmer.

  • And the farmer was promising to pay him.

  • And if he didn't pay him, he should get back the farm.

  • The farmer subsequently mortgaged the same

  • farm for GBP 880.

  • So he's made GBP 80 profit.

  • Which would all be fine and good, except he still hadn't

  • paid back the first mortgage.

  • And then the guy mortgaged it again for GBP 1,000.

  • And Mr. Cornwell is protesting: "Hey, you didn't

  • pay me for the farm in the first place, so you

  • don't own the farm.

  • How are you mortgaging it multiple times? " So he said,

  • "I thought I better put an ad in the newspaper, so that any

  • subsequent victims of this farmer, would be warned." So,

  • that's the end of the ad.

  • He said, "this is my farm because he didn't pay me."

  • But this shows how undeveloped mortgage

  • institutions were in 1778.

  • Because he had to put an ad in the newspaper to explain that.

  • The problem was that nobody had any systematic way of

  • representing title.

  • The farmer, who supposedly bought it from Mr. Cornwell

  • really didn't, and nobody would know that.

  • You know, he could fool people.

  • I think that's partly why you didn't see so many mortgages

  • in those days.

  • Because the law wasn't clear.

  • The institutions were not clear about property.

  • And so, you couldn't really do a mortgage business, if you

  • couldn't find out whether the guy mortgaging the farm really

  • owned it or not.

  • And so, it wasn't until the late 19th century that

  • government started to get rights to property

  • sufficiently advanced that we could develop a big national

  • or international market in mortgages.

  • So, an important step is in Germany, in 1872, or Prussia,

  • the government created a Grundbuch law that created a

  • system for Prussia that established in a central book,

  • who owns what exactly.

  • That was in 1872.

  • And in 1897, they made it a national German institution.

  • Still, the United States did not have a

  • Grundbuch at the time.

  • It developed throughout the 20th century in different

  • countries of the world, that property rights would be clear

  • enough that one could do a mortgage lending business.

  • So that's, why I think mortgage lending has really

  • taken off in the 20th century.

  • Hernando de Soto was a Peruvian economist. He wrote a

  • book a few years ago called Mystery of Capital.

  • And it's about the developing world.

  • He argued in that book that property rights, the problems

  • that we just heard about from the Hartford Courant are still

  • very big and alive around the world today.

  • That you can't easily establish who owns what in

  • many or most countries of the world.

  • So, that's a problem.

  • That's why we don't see mortgage

  • finance developing there.

  • You can't make a loan.

  • You know, if you go to some small town in some less

  • developed country, you can ask around, "who owns this

  • property?" And they'll tell you, "that's been in the such

  • and such family for a long time." But if you want solid

  • knowledge of that, if you're going to base financial

  • transactions on it, you can't base it just on hearsay.

  • Someone else might have a different opinion.

  • So even today, in many countries of the world, the

  • laws are not developed well enough.

  • We don't have property rights established well enough.

  • And we have laws that might inhibit mortgages.

  • For example, in many countries, if you give a

  • mortgage on a property, in other words, if you lend on a

  • property, and the person doesn't pay, you're supposed

  • to be able to seize the property, right?

  • But if the court system doesn't function well, or if

  • it's kind of left leaning and supporting the rights of the

  • person living in the home, you might not be able to get it.

  • Or it might take you 10 years to get the guy

  • thrown out of the house.

  • Now, it seems cruel to throw someone out of a house, who

  • doesn't pay on their mortgage, but you have to think of the

  • other side of it.

  • If we don't throw them out of the house, no one's going to

  • make a mortgage.

  • You have to be able to get the house.

  • Right?

  • That's the idea of the mortage.

  • The guy doesn't pay, the lender gets the house.

  • And so, I think there's a general process of

  • development, improving the definition of property rights,

  • and improving the ability of lenders to get the property if

  • it fails, which accounts for the advance of mortgage

  • lending in the 20th and 21st century.

  • So, that's my long history of mortgage lending.

  • But I want to get into some specific institutions.

  • I said, I would start with commercial real estate and

  • then I'll move to single-family homes or

  • residential real estate.

  • I will to talk now mostly about the United States.

  • There's just too many countries to think about.

  • One thing about finance is that it tends to develop a

  • sort of tradition, and a sort of standard contract.

  • It's encouraged by laws and regulators.

  • You have to do the same sort of contract that other people

  • are doing in your country.

  • And I think the standardization is kind of a

  • limitation.

  • We can't be creative in financing, because the public

  • and the regulators will not be receptive to new things.

  • Let me talk about some of the institutions in finance in the

  • United States.

  • It's natural to start with commercial real estate.

  • So, you see a lot of buildings.

  • My question is, how are they owned?

  • I don't know whether you think about this.

  • Who owns these buildings?

  • In much of the 20th century and still today, they tend to

  • be owned as partnerships.

  • Real estate partnerships, which is different from a

  • corporation.

  • In a corporation --

  • we talked about that yesterday [correction: last class]--

  • you might sell shares on the stock exchange if it's public.

  • And it's defined as a legal person.

  • And it has limited liability, so that all the shareholders

  • don't have to worry about being sued as a result.

  • But a partnership is different.

  • And most real estate, that's not part of a larger business,

  • is owned in a partnership, rather than a corporation.

  • And the reason is that they're taxed more favorably.

  • Corporations have to pay a corporate profits tax.

  • They're double-taxed.

  • You as an individual pay an income tax, and your

  • corporation pays a corporate income tax, or corporate

  • profits tax.

  • So, you're taxed twice.

  • If you incorporate yourself, or you set up some friends to

  • do business in a corporation, you get taxed twice.

  • So, you don't like that, and obviously you

  • try to avoid that.

  • The way to avoid it is not to have a corporation, but a

  • partnership.

  • The law allows you to form

  • partnerships to own a building.

  • So, you're building like 360 State Street.

  • It's a new building that just went up in New Haven.

  • You know this building?

  • The biggest construction.

  • Does anyone know who owns it?

  • It's probably a partnership.

  • I haven't investigated that.

  • Or it's called a Direct Participation Program.

  • So, the partnership is an investment that is offered

  • only to accredited investors.

  • It's not generally available to the general public.

  • And what is an accredited investor?

  • The Securities and Exchange Commission takes it upon

  • itself to define, who are accredited investors that

  • don't need the protections of the SEC.

  • Basically, accredited investors are wealthy people.

  • And it's defined in the SEC laws who is accredited.

  • You have to have at least $1 million, or minimum income.

  • And so, if you are an accredited investor, you can

  • invest in a DPP.

  • And then, the income of the property flows through to you

  • as your personal income.

  • It's not corporate income, so it's taxed only once.