We do not advocate Federal contributions to FNMA. (In fact, this bill nowhere calls for any contribution by the Federal Treasury or for any additional guarantees by the Federal Government.)

(3) Revision of FNMA structure

The third important change effected by title I is to authorize the President of the United States, by and with the consent of the Senate, to appoint the President of FNMA, who shall serve as chief executive officer of the Association and as Chairman of its Board of Directors, and to authorize similar appointment of two other full-time directors. The terms of the President and other members of the Board of Directors are to be 6 years on a staggered basis. While still remaining within the framework of the Housing and Home Finance Agency, such a Board would give to FNMA a standing and dignity consistent with the importance of the function of this agency. This is not presently provided by the status of FNMA as a unit of the Office of the Administrator with the FNMA President chosen by the Administrator-as if he were a staff employee and with its Board composed of part-time directors who have their main employment and responsibility in other parts of the HHFA or elsewhere within the Government.

The Federal National Mortgage Association has been and is fortunate in the type of sound administration which it has enjoyed during the tenure of Stanley Baughman as President. We hope and trust Mr. Baughman continues in office for many years to come. Nevertheless it is not healthy for the policies and operation of such an important organization to depend upon one man. We therefore have advocated a Board of three with staggered terms to minimize changes in basic policies and in administration which result from changing personnel.

The bill also establishes an Advisory Council to provide a responsible forum for exchange of ideas between FNMA and the home finance and homebuilding industries. The Council would consist of 12 members to be appointed by the President of FNMA for terms not exceeding years. In order to assure that the position will be somewhat more than merely honorary, it is provided that the Council shall meet at least once every 4 months and that its meetings shall be held in various cities so that the members of the Council-and FNMA officials can keep informed of the differing conditions of the mortgage market in various parts of the country from time to time.

Title II provides for establishment of Federal mortgage investment companies. These would be local privately owned organizations with capital of at least $1 million and would be chartered and supervised by FNMA. In effect, such companies would be local privately owned "little Fannie Mae's." They would be authorized to raise money for investment in mortgages by selling their securities up to 20 times their capital and surplus but not to exceed the outstanding principal amount of FHA or VA loans held by the investment company. This title is patterned very closely on old title III of the National Housing Act which was the original statutory basis for FNMA, prior to its reorganization in 1954. That title was repealed before any mortgage associations, other than FNMA, were formed. It is felt that the legislation was sound in theory; that there is now available private capital to form such investment companies; and that they could perform a very worthwhile function in providing a means for investment in mortgages by local capital, such as State and local pension and retirement funds, labor union funds, and other investment capital reluctant or unable to invest directly in mortgages.

All aspects of the operations of such investment companies would be supervised by FNMA. All moneys would be required to be invested in mortgages, in obligations of the United States or of FNMA, in operating facilities, or kept in cash, with the proviso that each company must maintain such reserves as FNMA shall prescribe. The companies could invest in conventional mortgages but only to the extent of capital and surplus; borrowed funds must be backed by FHA or VA loans.

Title III provides for miscellaneous statutory changes including important tax treatment and SEC changes.

National mortgage associations originally contemplated by title III of the National Housing Act were given complete tax exemption including tax exemption on securities issued by them. The pending bills (S. 3541 and H.R. 12216), however, in keeping with Government policy since 1941 do not attempt to provide tax exemption to securities issued by these companies but provides tax treatment comparable to that provided to mutual funds. Under this the company could

avail itself of "conduit' tax treatment by paying out to its stockholders 90 percent of its taxable income. In addition it is provided that such companies can take as a deduction reserves for losses up to 10 percent of taxable income.

Finally, the bill would free securities issued by these companies from certain provisions of the Securities Act of 1933, the Trust Indenture Act of 1939, and the Investment Company Act of 1940, having in mind that such companies are adequately supervised and their issues of debentures passed upon by FNMA. We urge serious consideration by Congress of these bills (S. 3541 and H.R. 12216). We believe the provisions of title I will substantially improve the existing functions and organization of FNMA. We believe further that the Federal mortgage investment companies provided by title II may eventually permit FNMA to discontinue its mortgage purchasing operations and-through the use of the new lending function provided by title I of this bill-convert itself into a credit reservoir for mortgage investment companies and other lending institutions. In any event, the bill has been drawn in such fashion as to avoid the necessity for any additional Federal funds or credit to be invested in the mortgage market. In our opinion it provides maximum assistance in stabilizing the mortgage market at minimum cost without increasing the Federal Government's responsibility in mortgage financing.

We strongly commend it to the consideration of the Congress. A section-bysection analysis is attached for your convenience.

SECTION-BY-SECTION ANALYSIS OF S. 3541 AND H.R. 12216

TITLE I

Section 101 effects an amendment to provide general authority for the proposed new FNMA lending operations-loans of up to 12 months to be secured by mortgages that are expressly provided for in section 106 of the bill.

Section 102 removes from FNMA's charter the present provision which recites that common stock shall, arbitrarily, be retirable at par value. The substitute language states that FNMA may "purchase, and may retire, hold, or sell" its common stock. This substitute language provides need flexibility under which outstanding capitalization could be reduced whenever circumstances permit a major contraction of the portfolio of mortgages; in such circumstances there would be, of course, a reduction of the income that is available for dividend payments on outstanding stock.

Section 103 establishes a ceiling of one-half of 1 percent on the nonrefundable amount to be paid by borrowers toward FNMA capital.

Section 104 provides that those who make nonrefundable payments, including borrowers, shall be entitled to receive shares of FNMA common stock, subject to any appropriate adjustments if the association should determine that portions of any such payments are to be credited to surplus.

Section 105 is an amendment which provides that plans for the transfer of the FNMA secondary market operations to the owners of the outstanding common stock (after the retirement of all preferred stock) should be transmitted, for legislative action, by the President of the association rather than by the Housing and Home Finance Administrator.

Section 106 sets forth in full the proposed new FNMA lending operations. FNMA is granted authority in its secondary market operations to make loans secured by FHA or VA mortgages, in amounts not to exceed 90 percent of the unpaid principal balances of the mortgages deposited with FNMA as security. Such loans shall bear interest at a rate established from time to time by FNMA and shall be for not more than 12 months. The volume of such operations and all details, within the statutory authority, are to be determined by the Board of Directors of the Association with the express statutory precaution that such lending activities should be conducted in such fashion as to prevent excessive use and to be fully self-supporting.

Section 107 would amend existing law to permit FNMA to borrow 15 times the amount of its capital and surplus. The present limit is 10 times the capital and surplus.

Section 108 repeals the existing prohibition against the purchase by FNMA, under its secondary market operations, of participations in mortgages.

Section 109 authorizes FNMA to take into account as a part of its assets the notes which will evidence the loans that are made on the security of mortgages.

55869-60-32

Section 110 makes provision for a full-time three-man Board of Directors, and also provides (in subsec. (e)) for "The Advisory Council, Federal National Mortgage Association." The President of FNMA and other members would constitute the Board and are to be appointed by the President of the United States with the advice and consent of the Senate. Their terms of office shall be 6 years, on a staggered basis. The basic rates of compensation of the President and Board members are set forth in the terms of the Federal Executive Pay Act of 1956.

There is established the Advisory Council of the Federal National Mortgage Association to be appointed by FNMA's President after selection by its Board of Directors, and to consist of 12 members to serve for terms not exceeding 2 years. Members of the Council shall fairly represent the homebuilding, mortgage banking, real estate, and general financing interests, and the geographic divisions of the nation. The Council must meet at least once every 4 months and, insofar as feasible, its meetings shall be held in various cities. Section 111 places the authority to appoint employees in the President of the Association. Under existing law this authority is in the Housing and Home Finance Administrator in his capacity as Chairman of the Board.

Section 112 amends existing law to state affirmatively that the Association is a mixed-ownership corporation, and to correct obsolete provisions to the contrary in the Government Corporation Control Act.

TITLE II

Section 201 designates this title as the Federal Mortgage Investment Act. Section 202 authorizes the Board of Directors of FNMA to charter and to regulate, examine, and supervise Federal mortgage investment companies. The Board is authorized to levy fees and charges for its services, to provide funds for its expenses; to appoint a Secretary of Incorporations to serve as chief administrative officer for this title; and to empower him to carry out such duties as it may determine necessary. FNMA may make available its personnel and facilities and may make advances for purposes of this title, all on a reimbursable basis.

Section 203 gives the usual general corporate powers to Federal mortgage investment companies chartered under this title.

Section 204 provides that not less than five natural persons may apply for a charter under this title by submitting proposed articles of incorporation stating the proposed name of the company; its proposed place of business; its capitalization (not less than $1 million); the names and residences of subscribers and the number of shares to be held by each; and such other information as the Board may require.

Section 205 authorizes the Board to issue a certificate of incorporation to an applicant Federal mortgage investment company if it determines the company to be lawfully entitled thereto under this title. No company shall transact any business until chartered; and no certificate of incorporation shall be issued until at least 25 percent of the company's capital stock has been subscribed to and paid for in cash, Government securities, or first mortgages.

Section 206 authorizes a chartered Federal mortgage investment company to originate, purchase, service, sell, borrow on, and otherwise deal in mortgages insured by FHA or insured or guaranteed by VA, or (within the limitation provided in section 207 that borrowed funds may not be used for that purpose) conventional loans not exceeding 75 percent of value, subject to rules and regulations of the Board. Such companies are also given powers sufficient to carry out their stated purposes, such as to make payments to FNMA; to borrow money; to deal with any property acquired by them; to adopt and use a corporate seal; to adopt, amend, and repeal bylaws; and generally to enter into any transaction and to execute any instruments and do any and all things necessary or incidental to the conduct of its affairs.

Section 207 authorizes a Federal mortgage investment company to issue its securities up to 20 times its paid-up capital and surplus, but in no event to exceed the unpaid principal balances of FHA and VA loans held by it, plus its cash and the value of its investments in obligations of or guaranteed by the United States, or of FNMA. Except with the approval of the Board, a company is forbidden to issue any securities until the full amount of subscriptions to its capital stock are paid in full.

Section 208. Moneys not invested in mortgages or in operating facilities approved by the Board are to be kept in cash or invested in obligations of or guar

anteed by the United States, or of FNMA, provided that a minimum reserve shall be accumulated as the Board shall prescribe by regulation.

Section 209 exempts such companies from State or local taxation, except that their real or personal property is subject to tax as other such property is taxed. Section 210 permits voluntary liquidation by any solvent Federal mortgage investment company by a two-thirds vote of its stockholders, subject to regulations of and supervision by the Board.

Section 211 gives the Board power to wind up the affairs of any such company found to be violating this title or any rule or regulation promulgated thereunder, on which conducts its business in an unsafe and unbusinesslike manner. If the capital of any such company is substantially impaired and not restored after 30 days' notice, the Board is required to order liquidation of the company. Section 212 authorizes the Board to prescribe rules and regulations for operations of companies under this title; makes each company subject to examination at the direction of the Board; and requires each company to report to the Board as required by it.

Section 213 contains the usual provision forbidding any company not incorporated under this title using the words "Federal Mortgage Investment Company", or any combination thereof, as a part of its name, and prescribes a fine of $100 or imprisonment up to 30 days, or both, for each day during which any such violation occurs. Companies under this title are exempted from section 709, title 18, of the United States Code, which forbids a private corporation (which these would be) using the word "Federal" in its title.

TITLE III

Section 304 (a) amends section 1242 of the 1954 Internal Revenue Code to make clear a stockholder owning stock in a Federal mortgage investment company properly chartered under the Federal Mortgage Investment Company Act can receive an ordinary loss deduction, rather than a capital loss, in transactions involving such stock of the company. The transactions as to which an ordinary loss would be allowable include sales, exchanges, worthlessness in whole or in part or any other dispositions which create a loss.

Section 304 (b) amends section 582 of the 1954 Internal Revenue Code by providing that losses of a Federal mortgage investment company on transactions involving sales or exchange of mortgages will be treated as ordinary rather than capital losses. The purpose of this provision is to correlate the tax treatment of mortgages by Federal mortgage investment companies with that now accorded banks in bond transactions. Thus, under section 582 (c) our banks are enabled to treat losses on bonds on an ordinary, rather that a capital, basis and section 582 (d), as newly added, would put Federal mortgage investment companies on the same basis.

Section 304 (c) (1) is a clerical provision amending the title of part III of subchapter S to include special provisions relative to losses, reserves, mortgage discounts, and payments to holders of shares and obligations of Federal mortgage investment companies.

Section 304 (c) (2) of the bill adds three sections to the Internal Revenue Code as follows:

Section 602 provides a deduction from gross income for a Federal mortgage investment company enabling it to deduct from gross income additions to a reserve for "losses" relative to losses on the sale, exchange, or total or partial worthlessness of mortgages held by such companies. The maximum amount of such deduction is 10 percent of the annual taxable income of the Federal mortgage investment company. The purpose of this deduction is to enable the mortgage investment company to set up a continuing reserve against possible losses in its mortgage portfolio account. It is to be noted that the reserve and changes thereto may be made whether or not the loss on the mortgage account is technically a "bad debt" loss. For this purpose, foreclosure of a mortgage by an investment company would constitute an exchange and any losses accompanying such foreclosure would be chargeable against the loss reserve.

In computing the maximum 10 percent deduction for any taxable year, the Federal mortgage investment company will calculate its taxable income before deducting any amounts to the loss reserve and before deducting payments to shareholders or debenture holders as provided in section 604.

Section 603 would exclude from gross income the amount of any discount on a purchased or orginated mortgage. The purpose of this provision is to make clear that the investment company will not be required to include in its gross

income for tax purposes the amount of the discount until there has been an economic realization of such discount. This could occur when the mortgage is sold, foreclosed upon or otherwise exchanged. It could also occur in the case of installment mortgages, as payments are made by the mortgagor. It is to be noted that the tax treatment provided in section 603 has no bearing on the book treatment of mortgage discounts which can be treated as provided by regulatory agencies or by the mortgage company itself.

Section 604 authorizes a mortgage investment company to deduct from gross income amounts paid to its shareholders or debenture holders provided certain conditions are met:

1. The mortgage investment company must make distribution of amounts from taxable income. Under section 604 the distribution would be made either to holders of stock, debentures, or other obligations of the mortgage investment company.

2. The amount of the distribution must be at least 90 percent of taxable income. The computation of the 90 percent figure is to be made before calculation of amounts placed in the reserve for losses or the distributions allowable under this section.

In other words, by application of section 604, a Federal mortgage investment company has an alternative to distribute at least 90 percent of its taxable income and "pass" the amounts so distributed to its shareholders or to hold the amounts (except amounts required to be distributed by the terms of a debenture) and pay normal corporate income taxes on amounts so retained.

Senator SPARKMAN. Mr. Robert Tharpe and Mr. Samuel Neel, representing the Mortgage Bankers Association of America.

Will you gentlemen come around? We are glad to have you.

STATEMENT OF ROBERT THARPE, VICE PRESIDENT; ACCOMPANIED BY EVERETT MATTSON, VICE CHAIRMAN, LEGISLATIVE COMMITTEE; AND SAMUEL E. NEEL, GENERAL COUNSEL, MORTGAGE BANKERS ASSOCIATION OF AMERICA

Mr. THARPE. Senator, it is good to be here.

Senator SPARKMAN. Thank you. Glad to have you here. Proceed in your own way.

Mr. THARPE. Mr. Chairman, members of the committee: It is a pleasure to be back here with you again. I have had the honor to be here before and welcome the honor to be back again.

Senator SPARKMAN. We are always glad to have you.

Mr. THARPE. I have with me, as you mentioned, Mr. Samuel Neel, general counsel of the Mortgage Bankers Association of America and Mr. Everett Mattson of the J. Better Co. of Houston, who is also vice chairman of the legislative committee of the Mortgage Bankers Association.

I would like, if I may, Mr. Chairman, as I know the time is running short, to file with you our statement.

Senator SPARKMAN. The statement will be printed in full, and you may summarize it or discuss it as you see fit.

Mr. THARPE. Thank you very much. If I may, I will pass over it. I would also like to request that the statement of policy on the relationship of Government to real estate financing that was recently published by the Mortgage Bankers Association also be included in the report.

If time permits when we finish, I would like to come back to the prepared statement.

Senator SPARKMAN. That will be received, likewise.