EMERGENCY HOME FINANCING MONDAY, FEBRUARY 9, 1970 HOUSE OF REPRESENTATIVES, COMMITTEE OF BANKING AND CURRENCY, The committee met, pursuant to recess, at 10:05 a.m., in room 2128, Rayburn House Office Building, Hon. Wright Patman, (chairman), presiding. Present: Representatives Patman, Barrett, Sullivan, Ashley, Gonzalez, Hanna, Gettys, Galifianakis, Bevill, Griffin, Chappell, Widnall, Blackburn, Brown, Williams, and Heckler. Chairman PATMAN. The committee will please come to order. The final phase of the House Banking and Currency Committee's emergency housing hearing will begin this morning with testimony from the members of the President's Council of Economic Advisers. With us this morning are Dr. Paul W. McCracken, Dr. Hendrik S. Houthakker, and Dr. Herbert Stein. Did I pronounce Houthakker all right? Dr. HOUTHAKKER. Yes, you did. Chairman PATMAN. Welcome to the hearing, gentlemen. I am sure the committee members, as they seek ways of developing additional sources of mortgage funds at reasonable rates, will take special interest in the remarks you gentlemen make this morning. Especially so since Dr. McCracken made some news yesterday when he said the administration is moving into a more active role in the area of monetary policy. Your comments yesterday, Dr. McCracken, are being interpreted as a planned attempt to extend the administration's influence to achieve policy changes by the Federal Reserve Board. Your position is somewhat in contrast to the one described for himself by Dr. Arthur Burns, new Chairman of the Federal Reserve Board, when he appeared before the committee Saturday. Dr. Burns made it clear that he cherished the independence of the Federal Reserve Board and intended to maintain it, but that is not necessarily inconsistent with your statement because Dr. Burns said at the time, too, that he would be very glad to seriously consider any proposed structural change in the Federal Reserve System. But let me say, Dr. McCracken, that you have my best wishes for success. Let me also say that the committee has a legislative item before it that I am sure will help to strengthen the position of future administrations in terms of efforts made to influence the Federal Reserve Board. As you know, Doctor, H.R. 11 is designed to reorganize the Federal Reserve Board from the point of view of making it more responsive to the policies of both the administration and Congress. Since you have already indicated you desire the same thing, I am sure you will want to put the administration's support solidly behind the measure. Dr. McCracken, you may commence your testimony. And I believe you are testifying for the Council. And after you have finished, we will interrogate you. Dr. MCCRACKEN. Fine. Chairman PATMAN. Thank you, sir. You may proceed as you wish. Mr. WILLIAMS. Will the chairman yield, please? Chairman PATMAN. Yes. Mr. WILLIAMS. What other witnesses do you have scheduled to appear before us this morning? Chairman PATMAN. Just these gentlemen. You see, we had another witness but we had to agree to a change in accordance with the wishes Mr. WILLIAMS. I thought even after the change, Mr. Chairman, that we were supposed to have before us this morning the President of FNMA. Chairman PATMAN. No, that is not correct. Mr. WILLIAMS. When is he appearing? Chairman PATMAN. The President of the Federal Home Loan Bank Board is scheduled for the 20th. Mr. WILLIAMS. Thank you, Mr. Chairman. STATEMENT OF HON. PAUL W. McCRACKEN, CHAIRMAN, COUNCIL Dr. MCCRACKEN. Thank you, Mr. Chairman. I would like to submit my prepared statement, if I may, and then we shall be glad to entertain any questions which you may have. Chairman PATMAN. All right, sir. You may file your remarks at this point in the record. Dr. MCCRACKEN. All right. Chairman PATMAN. And then comment any way you desire. (The prepared statement of Dr. McCracken, follows:) PREPARED STATEMENT OF HON. PAUL W. MCCRACKEN, CHAIRMAN OF ECONOMIC ADVISERS Mr. Chairman. The Council of Economic Advisers appreciates this opportunity to discuss with the committee the economic aspect of the housing situation as we see it. The Council is not, of course, the body to express administration views on particular legislation that this committee may have before it, or to propose any other legislation the Administration may wish to lay before your committee for dealing with the housing problem. The Secretary of Housing and Urban Development and perhaps others will discuss these matters. We shall confine ourselves to an economic analysis of this problem. During the period of the inflation, which began in 1965, the volume of housing construction has been highly irregular. The annual rate (seasonally adjusted) of conventional starts fell from a high of 1.5 million in the final quarter of 1965 to 900,000 a year later. Starts then began an irregular rise which, with some setbacks, brought them to a 1.7 million rate by the first quarter of 1969. Starts have. of course, moved downward throughout 1969, declining 24 percent from the first quarter to the final quarter of the year. This was a severe reduction (though short of the 39 percent decline in 1966), and some further downward movement seems to be a real prospect. This wide variation in the rate of housing activity has been harmful to the contractors and workers engaged in the industry. Moreover, it has discouraged the rationalization of the industry and improvement of technology which is necessary if future housing demands are to be met at reasonable cost. And it is causing a shortfall in the supply of housing. The net of these variations has been construction of an average of 1.4 million conventional houses a year in the four years 1966 through 1969. Even when mobile homes are added, the total is below the number required for a growing population with high incomes. The result has been a deficiency in our supply of housing. Indeed, vacancy rates have moved downward steadily since about 1965. The causes of this performance of the housing industry are fairly well known and need only be summarized here. 1. The difficulties of the industry are only partly financial. It is an important fact that residential construction costs rose somewhat more than prices generally during the past four years. Since 1965 the price level generally for the private sector rose 14 percent, while the cost of residential structures rose 20 percent. This obviously has limited the ability of people to buy houses. Major factors in the construction cost increase have been obstacles to expansion of the skilled labor supply, and as a result high wage increases in 1969 that were far out of line with settlements in industry generally and with productivity trends in the construction industry. It should not be assumed, therefore, that merely increasing housing funds will enable production to expand to desired levels. 2. In the years following the return to reasonably full employment in 1965 growing Federal budget deficits were an increasing drain on capital markets, reducing the supply of funds for private investment, including housing, and driving up interest rates. While the flow of funds to residential mortgages accounted for 30 percent of total funds raised in the credit markets from 1960 to 1965, this figure dropped to an average of about 20 percent for the years 1966 to 1969. When the budget position was finally changed to one of surplus after 1968, other forces set in motion during the deficit period continued to push interest rates up. 3. The rising deficits and the generally expansive policies of 1965-1968 generated an inflationary boom which greatly increased business demands for credit. An important and persistent aspect of this was the creation of inflationary expectations which increased the nominal interest rates lenders and savers insisted upon receiving and also the nominal interest rates that borrowers were willing to pay. 4. Twice in the past four years a restriction of monetary growth was imposed upon a strongly inflationary environment. In each case this caused a sharp rise of interest rates. In 1966 the rise was temporary, as the general effects of the monetary contraction also reduced the demand for credit. That is the result naturally to be expected, although it has not yet appeared after the 1969 monetary restriction. 5. Housing construction is, of course, especially sensitive to rising interest rates and the availability of funds in the credit markets. This occurs for several reasons. The demand for additional housing is to some extent postponable. It is also due to a number of other factors, including the nature of the mortgage instrument and the policies of the chief lending institutions. Legal ceilings on the interest rates that may be paid on mortgages or on savings that flow into mortgages have played a significant role. As market rates rose above mortgage ceilings, mortgages became less attractive to many investing institutions. And ceilings on the rates that thrift institutions could pay to their savers, however, needed in the short run to preserve some equilibrium between yields on their mortgage portfolios and rates these institutions paid to savers, placed these thrift institutions in a less effective position to compete for funds. Moreover, during an inflation fixed-interest investments, including mortgages, become less attractive for the investment of savings. The administration in 1969 took numerous steps to moderate the decline in residential construction resulting from these forces that had been building up during earlier years. Its general anti-inflationary fiscal policy was, of course, basic, but a number of more specific steps were taken. Revision of Federal procurement and forest management policies contributed to a reduction of lumber and plywood prices. A sharp cutback in direct Federal construction and an appeal for reduction in State and local construction reduced competition with house building in the construction industry for the resources available. Huge amounts of money were put into residential mortgages through Federally sponsored agencies. FNMA committed $5.7 billion to the home mortgage market in 1969, and the FHLBB System advanced $5.5 billion to member savings and loan associations to improve their liquidity position and to provide funds that would enable them to continue mortgage lending. Not all of this was a net addition to mortgage finance. Some unknown proportion of the funds that flowed into mortgages through FNMA and the Federal Home Loan Banks would have gone into mortgages anyway, directly or indirectly. Nevertheless, there was undoubtedly some net addition, and this helps to explain why housing construction was better maintained in 1969 than in 1966. Looking ahead to 1970 the administration's goal, as stated in the President's Economic Report, is to "permit residential construction to revive and begin a rise toward the path of housebuilding required by our growing number of families needing homes and apartments." A critical part of a combination of policies to achieve that is the moderate budget surplus projected for fiscal 1970 and 1971. It is hard to conceive of anything that would so certainly block the revival of housing as the return of budget deficits, forcing the Federal Government into the capital markets again as a net borrower. Indeed, the outlook for housing in 1970 and 1971 would be much brighter today if a larger surplus were in prospect. The tax reductions going into effect this year, which substantially exceed the Administration's recommendations, have now made that impossible. Indeed. only with Herculean efforts to hold down expenditures was it possible to project the small surplus for fiscal 1971. We believe that the budget surplus, combined with the moderation of monetary restraint which should become possible, and a continued high rate of support for the mortgage market by FNMA and FHLBB projected in the budget, should provide the financial conditions for a revival of housing starts during fiscal 1971. Particular attention should be paid to the volume of new and rehabilitated housing for low- and moderate-income families to be assisted through the Federal budget. The budget finances commitments for 451,000 of such subsidized housing units in fiscal 1970 and 545,000 in fiscal 1971, both figures being far above any previous ones. This does not mean, of course, that the financial problem of housing in the near term is resolved. Even the revival we expect is not assured, and a still larger volume of construction than is now realistic to expect would be desirable. Therefore, ways of improving the near-term housing outlook must continuously be sought. The problem, however, is not an easy one. What is required is not only to put more money into housing but also to take some money out of something else. Ours is still a fully employed economy. If we put more money into housing without taking demand away elsewhere, we only intensify the inflation, raise interest rates further, and probably hurt rather than help housing. Moreover, we have reached a stage where creating new arrangements to borrow money and put it into some part of the housing market serves mainly to divert monev from other parts of the housing market, without much net addition to housing finance. Also, when we look around and ask where the additional resources and money for more housing should be found, an answer that would command general agreement does not immediately appear. We are not saying that nothing can be done. We are only saying that nothing significantly can be done without facing up to the problem of deciding where resources and money are to be diverted from, and how this is to be done. For the longer run there are both more possibilities and further difficulties There is no doubt that as we pass beyond the present inflationary pressure the supply of funds for housing will increase. However, we shall have a backlog of unmet needs for houses and a high rate of family formation. The annual demand for housing will be larger than ever before. The National Housing and Urban Development Act of 1968 set as a goal the construction and rehabilitation of 2 million houses in the decade ending in 1978. No mechanism was provided for achieving that goal, and the goal itself will have to be reviewed in the light of estimates of costs and other changing conditions. Nonetheless, the goal suggest that a major problem lies ahead, a problem with which the Federal Government must be deeply concerned. Our studies have made clear that satisfaction of the nation's housing needs will require expansion of the supply of skilled construction labor at a vigorous rate. At the President's direction the Departments of Labor, and HEW are both moving to achieve this. A great increase in productivity in housing construction is also urgently needed. Nothing would contribute more to the achievement of our national housing objectives than more rapid technological development in the industry, a better productivity performance, and cost movements that are more in line with those for the economy generally. The Department of HUD is now vigorously promoting this advancement, by its Operation Breakthrough and in other ways. The Secretary of HUD will undoubtedly testify about this when he appears before this Committee later in the month. On the financial side there will be two requirements. One is that the total supply of saving available to finance private borrowing be adequate to meet both the need for housing and the need for a rate of business investment that will keep productivity and the economy growing at a satisfactory rate. The magnitudes involved here are difficult to measure, or even to define, but the Government cannot escape evaluating this matter. The second requirement is that housing be able to acquire its needed share of the total savings on terms that will encourage construction and purchase of the houses. With respect to the first requirement, our present estimate is that private saving would almost certainly be inadequate to finance the rate of housing construction that has been described as the housing goal, the business capital requirements of our growing population and economy, and a Federal deficit. There is even some question about the adequacy of private saving to finance the housing and other capital formation that will be undertaken in the years ahead if the budget is merely balanced. If this is indeed the case, attention will have to be given to the possibility of running substantial Federal budget surpluses as a way of supplementing private saving. Unless an adequate total supply of saving is generated, diversion of sufficient funds to housing would be difficult to achieve and would then come at the sacrifice of investment needed to maintain the rising trend of productivity and real incomes. Even if the total supply of saving is adequate, the proportion going into housing is not assured. Certain obvious and essentially costless steps would help. For example, the development of the mortgage-backed security and bond should improve the terms on which housing is able to reach certain sources of capital, such as pension funds. Resolving the problem of interest rate ceilings should improve the ability of residential mortgages to compete for savings. There is some evidence, for example, that States with low interest rate ceilings have had a particularly unsatisfactory housing record in the last year. Experimentation with new mortgage forms, such as the variable rate mortgage, might reveal instruments that would tap new credit sources. Some provisions of the Tax Reform Act of 1969 will reduce tax advantages formerly obtained by other forms of investment and thus assist the flow of funds into housing. While only crude calculations can now be made, it looks as if residential mortgages would need to absorb close to 30 percent of the funds raised in the credit markets during the 1970's, if housing is to trace out a path that would meet the goal of 26 million units. While this is about the same as the figure that prevailed during the first half of the 1960's, it is substantially above the roughly 20 percent average for the years 1966 to 1969. We must, therefore, face the possibility that, unless we are willing to tax ourselves to create a substantial budget surplus to supplement private savings, funds would not be available to meet our apparent housing requirements or goals on terms that would induce construction of the target volume of housing. This would probably not mean inability to meet whatever goal is set for low- and moderate-income housing. Subsidy devices are already available which could attract into low- and moderate-income housing a large volume of resources. The consequence would be to squeeze further the supply of funds for housing not now considered eligible for subsidy. The question would then be whether to provide a subsidy, or some equivalent device, to channel funds into houses for people who do not fall into the category of low or even moderate incomes. If this question arises, it would have to be considered in the light of other competing claims on the Federal budget and the national output. As we examine the economics of our housing problem, three conclusions seem to be justified. First, the provision of a needed and adequate supply of housing for a growing population with rising real incomes should be within the capability |