Rising property values can entice mortgage lenders and the availability of credit for real estate investments can fuel further property appreciation. This has often caused problems. However, the absence of mortgage financing is at least equally problematic as it deprives property owners, or prospective owners, of the chance to undertake improvements to property and this holds back economic growth. Chile was an economy deprived of mortgage financing until economic booms that originated faraway in the United States and Australia proved stimulating for economic development in Chile too. The result of this expansion was the establishment of a mortgage bank with some peculiar characteristics, the Caja de Crédito Hipotecario.
Chile at Midcentury
Positioned where it was in relation to the wealthiest, most populous, or most well-connected parts of the world, Chile was a rather remote country in the first half of the 19th century. However, by midcentury, this was changing rapidly, largely because of mineral finds both in Chile and abroad. The gold rush in California in 1849 and in Australia two years later brought about a major economic boom in Chile. One of the effects was busier ship traffic as more vessels travelled around South America. The number of ships arriving in Chilean ports grew from 1,397 in 1848 to 2,351 by 1851. Valparaíso in particular became a busier port in these years.
The gold finds also benefited the Chilean farms producing wheat sent to California and Australia. Chile had already had an export demand for wheat but now the product found buyers farther away than the more traditional final destination of Peru. Demand for wheat grew and so did the incomes of Chilean landowners. Overall exports to California ballooned from about 250,000 pesos in 1848 to 1.8 million pesos in 1849 and 2.4 million pesos the following year. After these exports dipped in 1853, Australian demand picked up, bringing export revenues from these two buyers together to nearly 3 million pesos in 1855, though by this point it was Australia accounting for almost all of the foreign demand.
Besides this export demand, local wheat consumption was rising as the population grew. Mining communities in northern Chile were buying wheat from farmers further south. With demand for their products rising and these products fetching higher prices, productive rural land in Chile was appreciating. Landowners were keen to increase output to capitalize on the favorable conditions.
There was a serious impediment though. Landowners were limited by a lack of credit which in turn constrained possible improvements to irrigation which were the primary means of increasing output. Despite the value and the profits of their landholdings, there were few sources of credit for landowners in Chile, in part because laws made securing loans by real estate unreliable.
Thus, there were hardly any institutional lenders in Chile. Compared to North America and Europe, this part of the world was behind in bank formation. Some money was lent to landowners by Valparaíso merchants but this was generally only in limited amounts advanced against the value of future harvests. The security of the land itself was going unleveraged.
A bank was authorized by Chile’s government in 1849 but on the condition that it could not issue paper banknotes, a limitation which caused the bank’s charter to go more-or-less unused. This bank, the Banco de Chile de Arcos y Cia, wound itself down in 1850. Despite a traditional phobia for paper money, informed opinion was generally becoming more favorable towards the idea of banks and their attendant financial innovations, namely the introduction of new instruments like paper banknotes. The business community was coming to the view that a scarce money supply and lack of credit were debilitating. The amount of metal coin circulating was more-or-less fixed but the economy was growing; how could this be resolved?
Caja de Crédito Hipotecario
Progress came with another attempt at creating a bank. Legislation authorizing the creation of a state-owned mortgage bank, introduced by the Minister of the Interior, Antonio Varas de la Barra, was passed on August 29, 1855. The resulting bank, the Caja de Crédito Hipotecario, was established that December and made its first loans in early-January 1856. Philip L. Brock, professor at the University of Washington, has written extensively on this bank and is responsible for much of the English language writing about it. The bank was state-owned and governed by a Board of Governors composed of political appointees; the Caja de Crédito Hipotecario was the first state-owned mortgage bank in the world.
Its approval would be followed a few months later by that of Chile’s first private commercial bank, the Banco de Valparaíso de Depósitos i Descuentos. The creation of other private mortgage banks was also authorized by the law creating the Caja de Crédito Hipotecario, through the others were all smaller and began operation a bit later. Across the world, bank formation has often come in waves and the story in mid-19th century Chile does not end here. In 1859, a bank would be approved, the Banco de Chile, which was given the right to issue paper banknotes and in 1860, the right to issue banknotes was expanded to other private banks.
Returning to the Caja de Crédito Hipotecario, it was charged with making long-term amortizing mortgage loans to landowners. These loans would be made at a rate of 8% and extended in amounts up to 50% of the property value securing the loan as measured in tax assessments or other approved valuations. The loans would amortize their principal at a rate of 2% per year.
Chilean mortgage law was reformed in 1854 to resolve issues with mortgage lending. The reforms created a new type of mortgage, the hipoteca especial, which could take priority over other types of mortgages on a property. Property registries were also established to make information on mortgages and property sales public. This made it safer to lend against real estate.
Letras de Crédito
The Caja de Crédito Hipotecario had a very curious means of funding its lending activity. Rather than by deposits or banknotes, the bank would fund its lending by issuing bonds, or letras de crédito, backed by mortgages. More interesting still, the bond was issued to the landowner to fund the loan and it was the landowner who was responsible for selling the bond for cash, raising the money they needed. Later, in addition to making payments in cash, landowners could reacquire the bonds in the secondary market to make payment on their loans, since the bonds were accepted as cash towards the repayment of principal. This would be advantageous to borrowers when the bonds traded at a discount, such as if interest rates had risen.
In a sense, the Caja de Crédito Hipotecario was as much a securitization vehicle as it was a bank. It would collect interest from the landowner and pay interest to the bondholders but did not lend for its own account. For this payment collecting service, it received a fee of 0.5% per year from the borrower. On top of the 2% amortization and 8% interest, the total debt service cost of the loans came to 10.5% but was still advantageous to the borrowers. As for the bank, it also collected interest from the borrowers six months before paying these amounts to bondholders giving the bank a float which it could invest at interest for six months and thus provided another source of income.
Because the loans were funded by bonds, the bank did not need to fund its loans with reinvested profits or other sources of equity capital. Instead of reinvesting them or distributing them to the government, profits of the Caja de Crédito Hipotecario would be accumulated in a reserve fund. This sum grew from nothing at inception to a little over 2% of the volume of bonds outstanding by 1861.
The Caja de Crédito Hipotecario issued nearly two million pesos in bonds in its first year of operation, 1856. This fell to just over one million pesos the following year and under 500,000 pesos in 1858. Originations were likely higher in 1856 because of pent-up demand as landowners sought to use the newly available bank financing to replace more expensive loans sourced privately from merchants. Still, the total volume of letras de crédito outstanding rose to over five million pesos by the early 1860s.
Mortgage Crisis of 1860-62
Conditions that encouraged the formation of the bank did not last very long though. In 1857, there was a financial panic in the United States and financing dried up in other parts of the world too. Also, both California and Australia became self sufficient in wheat despite their large population growth. The silver mining industry in northern Chile was also experiencing lower output. Making all this worse, there were delays in the construction of a new railway between Santiago in the interior and the port city of Valparaíso.
In the preceding years, some of the new mortgage financing went towards construction of mansions or to support the lifestyles of the landowners, rather than improvements to farms. Combine this with agricultural exports that fell sharply in 1860 and rising global interest rates (the Bank of England’s bank rate rose as high as 8% in early 1861) and the result was that by 1861, one-fifth of all mortgages were in arrears.
Liquidations of rural land surged. By the end of the decade, 10% of the Caja’s portfolio was foreclosed on. The reserve fund of the bank was reduced to zero and it suspended operations altogether for a few months in 1862. With its reserves depleted, a loan was obtained from the government to continue bondholder payments. Understandably, the market price of the letras de crédito fell. They got as low as 75% of face value. No doubt unhelpful, the liquidation of a Chilean insurance company named El Porvenir de las Familias put one million pesos in mortgage bonds on the market.
As in most financial panics, credit contracted. For several years in the 1860s, just about 200,000 pesos in mortgages were originated annually by the Caja de Crédito Hipotecario. Far larger amounts were being repaid than were being lent out in new loans. Thus, the volume of letras de crédito outstanding would not return to their 1861-62 levels for another twelve years.
A July 19, 1862 article in El Mercurio summed up the situation. It explained that “the abuse of credit having been one of the causes of the crisis, the granting of credit has naturally been restricted as much as it was expanded before. We have passed from one extreme to the other”. The liquidations and reduced originations by the Caja de Crédito Hipotecario meant that the volume of letras de crédito outstanding fell from 5.6 million pesos in 1862 to 3.7 million in 1869. Thankfully, liquidations peaked in 1862 at nine loans, falling to about two or three per year between 1867-69. While it is not straightforward to date the end of the depression, the situation had clearly improved by 1869.
Lesson
Some land bubbles are difficult to rationalize because they are fundamentally, and sometimes entirely, irrational occurrences. Marketing and undue optimism coupled with huge amounts of credit fuel these bubbles. However, the 1860s mortgage crisis in Chile seems more forgivable. The credit extended may have been inappropriately used by many but Chile was in need of mortgage credit nonetheless. The causes of the upswing and downswing of the cycle were also to a large extent external or dependent on the vagaries of mineral finds which are perhaps impossible to offset or avoid. In any case, the subsequent development of the country justifies the financial experiments of the 1850s and 1860s even if the occasional crisis can prompt some second guessing.
More from the Tontine Coffee-House
Read about the Crédit Foncier, a French mortgage bank that inspired the creation of the Caja de Crédito Hipotecario, and land bubbles in Melbourne and Florida. Consider subscribing to this blog’s newsletter or checking out book recommendations, which include many of the sources often referenced in my posts.
Further Reading
1. Brock, Philip. “The California Gold Rush and the Creation of Chile’s National Mortgage Bank: The Caja De Crédito Hipotecario.” HAAL: Historia Agraria De América Latina, vol. 3, no. 2, Nov. 2022, pp. 1–29.
2. Brock, Philip L. “Mortgage Lending and Banking Crises in Nineteenth-Century Chile.”, Sept. 2016.
3. Rodríguez, Agustín Llona. “Chilean Monetary History, 1860–1925 an Overview.” Revista De Historia Económica / Journal of Iberian and Latin American Economic History, vol. 15, no. 1, Mar. 1997, pp. 125–57.
4. Subercaseaux, Guillermo. Monetary and Banking Policy of Chile. Oxford, Clarendon Press, 1922.
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