Mr. WILLCOX. This chart shows a comparison of three indexes which we considered. You will see that the average weekly earnings index is the most conservative of the three. After considerable debate we decided it is the one that should apply at least for the kind of program we were constructing. It was tested by comparing that inflation rate with the average increases in income of families who had gotten mortgages from open over the previous several years; 80 percent of those families did, in fact, have incomes that increased faster than the average weekly earnings index.

This put the trustees of the organization considerably at ease. They felt that they were not going to have trouble with their borrowers being able to make index payments.

Many of the things that Dr. Modigliani has indicated with respect to the problems of taxes and so on were analyzed. We have reached about the same conclusions with respect to them.

In brief, we are absolutely convinced that an index-limited debenture and loan system is possible under present U.S. laws, but it certainly would be more effective and its use more widespread if certain legislative assistance and guidance were provided in the areas of eliminating taxation of adjustments in principal balances, in eliminating the problems of negative amortization versus the usury laws, and in the regulation of mortgage problems. This series of technical problems can be overcome on a small-scale program such as we are working on, on a pilot basis. But if you are going to do it as a national policy, it is going to be a little difficult and legislation would be indicated.

Finally, some of my associates, specifically Mr. Henry B. Schechter of the AFL-CIO, is a strong opponent of indexed debentures and loans.

I think that possibly his views have changed in the last few years, but fundamentally he feels indexation of mortgages is inflationary.

We don't see that at all. We see high interest rates reflecting anticipated inflation and forcing people to make loans to pay for future inflation on a current basis on being forced out of the market. This may be deflationary, because it reduces the production of the housing industry and the amount of loans being made. In terms of the consumer, we think that a program that produces affordable mortgages at perhaps one-third of the mortgage cost per year in the first years, and in future years increases in nominal payments but not in actual real dollars is in the consumer's interest, it is not inflationary.

And if there is no inflation, there is no increase in the monthly payments each year. It is in the consumer's interest to develop and aid this type of indexed mortgage financing.

[The prepared statement of Mr. Willcox, with enclosures, follows:]

Testimony presented to House Banking, Finance and Urban Affairs Committee,
Housing and Community Development Sub-Committee, April 21, 1982

THE INDEX-LINKED SAVINGS AND LOAN SOLUTION TO THE
HOUSING FINANCE CRISIS IN THE UNITED STATES

Roger Willcox, President, Community Cooperative Development Foundation

SUMMARY

Our present housing finance crisis, where new and reconditioned housing is financially beyond the means of even middle income families, can be solved by sensible application of techniques developed more than 20 years ago. The key is use of a index-linked savings and loan system.

The modern form of index-linked savings and loan system was originally created for and by housing cooperatives in Chile some 22 years ago to make available mortgages for middle class Chileans. Variations of it have now spread around the world. The system can be adapted to provide affordable housing for most middle and some moderate income families, without subsidies. It can provide an even better solution for our housing problems than it already does under the economic conditions prevalent in South America. Models already exist for its application in the United States. It can and will be developed even without new legislation, but there are some substantial impediments to its wide-spread use that new legislation could remove.

If properly applied, the system is in the best interest of consumers as well
as the housing and savings and loan industries.
finance to compensate for inflation, it does not
as a whole.

Since it merely adjusts housing add to the problem of inflation

THE INDEXED-LINKED SAVINGS AND LOAN CONCEPT

Indexing of savings and loans can be a simple and straight-forward way of eliminating the inflation problem which has disrupted housing finance in our country since the 1960s. When the rate of inflation was nominal, the private sector mortgage loan interest rates were as low as 4% per annum. Problems caused by inflation are the primary reason for any interest rates above that level. Higher interest rates are the immediate cause of today's housing finance crisis.

As an alternative to high interest rates, compensation for inflation can be
accomplished by periodic adjustment of outstanding principal balances in accord
with an index of inflation. This protects the lender's investment and the
lender is then willing to accept a low and fixed rate of interest.
available on this basis, borrowers can be offered a relatively low, fixed rate
of interest, with periodic adjustment in the outstanding principal balance

With money

of their loans to reflect the real value of the loans after compensating for any inflation or deflation.

THE ORIGINAL INDEXED-LINKED SAVINGS AND LOAN CONCEPT IN CHILE

In the late 1950s, the relatively strong cooperative movement in Chile asked the United States Agency for International Development (AID) for assistance in developing a new savings and loan system in Chile based on the concept of indexing principal balances to offset inflation. Twenty years of continuing inflation in Chile had destroyed the previous savings and loan industry and literally no mortgages were available for housing in that country.

At that time I was President of FCH Services, Inc., the operating arm of the Foundation for Cooperative Housing which had a contract with AID to assist in developing cooperative housing overseas. Our General Counsel, the late David L. Krooth, Esq. who was formerly General Counsel of all the housing agencies, and Arthur Courshon who was then President of the United States Savings and Loan League led our staff in developing a program and draft legislation. The new system was implemented in 1960, with the help of $4 million American dollars from AID.

The Chilean system was based on annual readjustment of the principal balances of mortgage loans in accord with an index of wages established by the Chilean government. A new savings and loan system was established with savers offered 2% interest plus annual readjustment of their savings by the selected index. Mortgage loans, both to single family homeowners and to cooperatives were offered on the basis of a 4% interest rate per annum plus annual readjustment of principal balances, with amortization initially over a 20 year period. There was provision for extension of mortgage terms if inflation as recorded by the index was extraordinarily high resulting in mortgage payments exceeding 25% of mortgagor's gross income. This arrangement was particularly helpful when the program was extended from middle to moderate and even some lower income families. There was no provision for reserves, or even mortgage insurance such as offered by our Federal Housing Administration.

The Chilean experiment was an instant success. I visited Santiago two years later and met with the President of the Chilean Savings and Loan League. His marble office in a former savings and loan institution had one chart on the wall showing a logarithmic curve of investments by savers. He said for the first time in 20 years the general public was investing money in savings instead of in purchases of physical and personal property. Money was pouring in at such a rate that if he had the power, he would have eliminated the interest rate entirely! Savers were much more interested in protecting their principal than they were in the 2% interest rate being offered by the new savings and loan system. His major problem was placing the new volume of money available for mortgages because the underwriting system and staffs in Chile had deteriorated badly over the 20 years during which little mortgage money was available.

With the Chilean success, I personally arranged for extension of the program to Brazil, where within one year after introduction, the system was established and successful. Today, literally all mortgages in Brazil are indexed. AID assisted in the creation of the Brazilian indexed mortgage savings and loan system.

The Inter-American Development Bank asked me to try to get the Argentinian banking and governmental officials to support the development of a similar system in that country. I spent two frustrating months attempting to pursuade them to try

Although

a new system, with my efforts backed up by $25 million in hard American currency available through the Inter-American Bank. My efforts failed and Argentina did not develop an indexed debenture and loan system for several years. continuing drastic inflation had literally wiped out any meaningful mortgage system in Argentina, the financial leaders of that country were not prepared to recognize that indexing was a solution.

Today, the United Nations reports that indexed savings and loan systems are
in effect in a majority of the countries throughout the world. A recent exper-
ience in Great Britain is of particular interest. Over the past few years
Great Britain has developed an indexed savings program which in its latest
form is generating more than half of the national savings. It provides for
annual readjustment of principal and zero interest rate. Copies of materials
regarding this program can be obtained from the British Embassy. An attachment
to my Testimony includes some information on this program, It is apparent
that consumers are so frightened by the losses experienced because of inflation
that they are willing to invest their money in savings certificates that merely
protect them against losses of principal.

SPECIAL CONDITIONS IN THE UNITED STATES

Economic conditions in the United States are much more favorable for the development of a index-linked savings and loan system than in most other countries. The United States economy is huge and diverse and the likelihood of runaway inflation, perhaps 50% or more per year, is remote in this country. This is important, because the record of indexed mortgages in South America indicates that the indexed mortgage system tends to break down when annual inflation is at a rate of 50% or more per year, even when the indexing is based on average wages in the country concerned. The problem seems to be that the sheer size

of the annual adjustments, even when based on wage increases, can be so great that it upsets the budgets of the families who are making the mortgage payments.

The annual rate of inflation in this country, as measured by the comparable wage index (the Average Weekly Earnings of private non-agricultural industry) has been only 7% per annum since 1972. By South American standards, this is a most modest rate of inflation. There is reason to hope that inflation in this country will generally remain below 10% per innum. This would make the concept of indexed savings and loans most attractive.

But it should be noted that even an average inflation of 7% per year, if compensated for by higher interest rates as is now the case in this country, produces mortgage interest rates of 14% to 18% per year. Not very many consumers can afford the prepayment of anticipated inflation or if you will, the "forced savings" inherent in such high annual "interest rates". This problem lies at the heart of the crisis in housing finance in our country today.