This brings me to S. 3503, the fourth bill to be considered in this hearing. It would empower the Federal Home Loan Bank System to obtain funds through the Federal Reserve discount window at a discount not exceeding 6 percent per annum and lend them to Federal Home Loan Bank members (and certain nonmembers) at interest rates between 6 and 64 percent per annum, as determined by the Federal Home Loan Bank Board. Any institution borrowing such funds could use them only to enable any family having an annual income not over $10,000 to purchase a dwelling or membership in a housing co-operative appraised at no more than $25,000. While presumably this is intended to provide housing for the families so helped, I see no provision restricting them to purchases of homes for their own occupancy. The institution could not make such a loan at an effective interest rate exceeding 61⁄2 percent per annum. Our principal reaction to the bill is that the permissible spread between cost of funds to the lending institution and the interest rate it could charge is so unrealistically low as to offer very little incentive for an institution to make use of the funds. This is especially true because changing modes of operation in the savings and loan industry tend to increase costs of operation. The development of the practice of using a variety of savings plans in the past few years has increased the operating expense of associations. While comparatively large associations having multi-million dollar assets might find it possible to make some use of these funds as a community service, smaller associations would find it impractical to operate on so low a spread. The Subcommittee may wish to consider whether S. 3503 in its present form would accomplish its intended purpose. This concludes our comments on the proposed legislation presently being considered in this hearing. I appreciate the opportunity of bringing to you the views of the National League on the proposals. SUPPLEMENTARY STATEMENT OF WILLIAM F. McKenna, GENERAL COUNSEL, NATIONAL LEAGUE OF INSURED SAVINGS ASSOCIATIONS This statement for the record dealing with costs of operating savings and loan associations is submitted in response to Senator Bennett's inquiry regarding the cost of doing business in a savings and loan association having about $86 million in assets and in general in the savings and loan industry. Working from the particular to the general in an effort to provide helpful statistics, the 12-month average expense as a percentage of assets at the first of each month was as follows for one such association:1 1967, 1.34 percent; 1968, 1.07 percent; and 1969, 1.28 percent. For purposes of comparison, the comparable statistics for all Federal Home Loan Bank member associations in Illinois were: 1967, 1.15 percent; 1968, 1.17 percent; and 1969, 1.22 percent. On a national level, the annual total operating expense as a percentage of average assets for all members of the Federal Home Loan Bank System, where "total operating expense" includes compensation, office expense, advertising and other operating expense, but not the cost of interest charges to the association, taxes, non-operating charges and non-operating income, or the cost of dividends on withdrawable accounts, is as follows: 1967, 1.06; 1968, 1.08; 1969 (1st half), 1.10 (annual rate). (For 1967 and 1968 data see Combined Financial Statements-1968-Federal Home Loan Bank, Table 15, page 31. 1969 data were obtained later from the Federal Home Loan Bank Board staff.) However, as noted above, the total cost of doing business in a savings and loan association includes pertinent items not included in the category "Total operating expense". To obtain working capital, associations must pay interest on borrowings and dividends or interest on savings. They must also pay taxes. 1 Germania Savings & Loan Association, Alton, Ill. Federal Home Loan Bank statistics for 1967 and 1968 (supra) show the following breakdown of costs among these categories for all members of the Federal Home Loan Bank System: The ratio of expense to income has a tendency to decrease as associations increase in size, as shown by a January 1967 Survey prepared by the National League. The following table demonstrates this quantitatively on the basis of various savings capital size groups as of the end of 1965: That the savings and loan industry is a low margin of profit industry is demonstrated by statistics for 1967 and 1968 (supra) as follows: Balance for addition to reserves, surplus, and permanent stock dividends. Balance for addition to reserves, surplus, and permanent stock dividends as a percentage of average assets.. 6, 105, 553 6,765, 862 5,477, 586 5,891, 795 Balance for addition to reserves, surplus, and permanent stock dividends as a percentage of gross operating income.. But part of the additions to reserve is mandatory and cannot be considered to be true profit of the association. At present, section 403(b) of the National Housing Act provides that Federal Savings and Loan Insurance Corporation regulations must require a buildup of reserves by institutions that have savings accounts insured by FSLIC, to 5 percent of all insured accounts within a reasonable period not exceeding 20 years. Section 563.13 (a) of the Regulations for Insurance of Accounts issued by the Federal Home Loan Bank Board as governing body of FSLIC requires a buildup by specified stages to 5 percent of all savings accounts (not just insured accounts) by the twentieth anniversary of the institution's admission to FSLIC membership. That section requires in addition a setaside by the institution of an amount equal to 20 percent of its "scheduled items" (meaning assets presumably involving more than normal risk, including slow loans (only 20 percent of Federally insured or guaranteed loans) and real estate owned by the institution as a result of foreclosure or in lieu of foreclosure). 42-120-70-20 Obviously, the amount to which these requirements will dip into income varies with the particular institution involved, depending upon the length of time its savings accounts have been insured by FSLIC and the amount of its scheduled items. But whatever these requirements are in the case of an individual institution, they freeze the amount of money involved and detract from the true usable profits of an institution. The Study of the Savings and Loan Industry under the direction of Professor Irwin Friend of the Wharton School of Finance and Commerce in the University of Pennsylvania commented on the declining profitability of savings and loan associations. The study defined "profitability" as net income allocable to reserves, surplus and dividends on permanent stock divided by average net worth, adjusted for an estimate of future mortgage losses not covered by specific reserves. The study notes (at page 6 of the Summary and Recommendations printed by the Federal Home Loan Bank Board, dated September 1969) that association profitability declined sharply from an estimated 12.5 percent of net worth in 1962 to 4.1 percent in 1967. The study attributed this decline mainly to the more rapid rise in cost of money than in the return on assets. The lag in increase in return on assets, according to the study, reflected the insensitivity to increases in interest rates of yields on mortgages already in association portfolios. While reportedly the profitability percentage increase somewhat in 1968 to something in excess of 8 percent, the fact remains that as an industry, savings and loan associations rank comparatively low in the scale of profitability. Reverting to Illinois statistics for more recent soundings, there was a 1.7 percent increase in association expense and a 3.3 percent increase in income in 1968 as compared with 1967. But in 1969 the expense increased 4.3 percent while income increased only 2.9 per cent over 1968. Thus the increase in the rate of expense was increasing while the increase in the rate of income was decreasing. Mr. William G. Osborn of Alton, Illinois, the National League witness, expects this trend to continue even beyond the current period of tight money. These factors should be considered by the Subcommittee in its deliberations as to what spread between cost of money and yield on its investment will induce savings and loan associations to make use of funds that would be made available to the Federal Home Loan Bank System under S. 3503 if it is enacted into law. Senator PROXMIRE. The committee will recess and reconvene tomorrow morning at 10 to hear five witnesses. (Whereupon, at 12:30 p.m., the committee was recessed, to reconvene at 10 a.m., Friday, March 6, 1969.) SECONDARY MORTGAGE MARKET AND MORTGAGE CREDIT FRIDAY, MARCH 6, 1970 U.S. SENATE, COMMITTEE ON BANKING AND CURRENCY, Washington, D.C. The subcommittee met, pursuant to adjournment, at 10:15 a.m., in room 5302, New Senate Office Building, Senator John Sparkman, (chairman of the committee), presiding. Present: Senator Sparkman, Proxmire, Tower, and Percy. The CHAIRMAN. I have been waiting, hoping some other Senators would come in. Several have said they would be here. I hope some of them will be here later. We have a pretty full program, so I think we had better proceed. Our first witness is Prof. John C. Payne, of the law school of the University of Alabama. Professor Payne, we are very glad to have you here with us today. We have a copy of your prepared statement that will be printed in full in the record. You may handle it as you see fit; read it, summarize it, discuss it-however you wish. We will be glad to hear from you now. STATEMENT OF PROF. JOHN C. PAYNE, LAW SCHOOL, UNIVERSITY OF ALABAMA Mr. PAYNE. I think I should begin by saying I am somewhat uncertain as to why I was called here before the committee today. Presumably I am being called as a qualified expert on what we will call closing costs-I believe they are called settlement costs in the bill—and I would like to disclaim and say there isn't any such thing as a qualified expert on closing costs, that nobody knows very much about them. Presumably the reason I have been called is that I have recently completed a very cursory pilot study of closing costs based on information from slightly less than 500 lawyers in all of the States and the District of Columbia. The information which I have obtained is highly tentative and simply lays the predicate for further investigation. But up to the present time it is the only thing that has been attempted along those lines, and that is my sole qualification as an expert. The matter before the subcommittee this morning is Senate bill 3442, and I expect to direct my attention to section 2. I filed a short statement with the subcommittee. It was rather hurriedly gotten up, and I will simply try to stress some of the points brought out in that memorandum. As I read it, section 2 provides for two types of action. The first is the fixing of settlement or closing costs by the Secretary for Housing and Urban Development, and the Administrators of the Veterans' Administration. The second is a joint study, and I quote, "*** with respect to legislative and administrative actions which should be taken to reduce mortgage settlement costs and to standardize these costs for all geographical areas, with a report to Congress by July 1, 1970." I am not entirely clear as to what this language means, but at a minimum it seems to authorize a study of existing costs. I don't think you can order a reduction of costs until you know what the present ones are. As I have already said, we know very little about costs. What we do know is that there is almost complete chaos in the field, but we have little or no hard data. The first question explicit in the bill as it is now drafted is who should carry out the study. The study, I presume, will be done primarily by the Federal Housing Administration, operating under the Department. Now, experience in the past with some small studies that the FHA has attempted are not encouraging. They have shown an almost complete lack of sophistication and understanding of real estate transactions. In the first place, they have shown that the FHA authorities do not understand that we face a very, very complex problem in determining true closing costs. Initially there is no standard transaction which they predicate. Most real estate transactions are closed on the basis of a percentage of the sales cost, or the amount of the mortgage. We must, therefore, start with a standard transaction if comparable data is to be obtained. When we compare costs in transactions on houses priced at anywhere from $10,000 to $20,000, we are comparing unlike things. Furthermore, there is no indication in the existing studies that there are different types of costs having no relationship to each other, or that there are costs reflected in closing statements which are not truly costs of transfer. For example, the allocation of taxes or insurance premiums are not costs of transfer, but are costs of ownership. On the other hand, other costs which have been prepaid may be omitted. Within the realm of actual costs there are several distinct categories. For example, the cost of establishing title is entirely different from the cost of obtaining money. Also, the cost for effectuating the sale, and the various governmental charges and fees for recording, and the like, are separate and distinct and involve different problems of policy and different people. Costs within the country show an enormous variation. These variations occur within particular localities, and from locality to locality. For example, if you compare a transaction in New Jersey with one in South Dakota, you get a completely different result. I might cite by way of illustration figures extracted from my study. The cost of establishing title in the purchase of a $20,000 house financed by a $16,000 mortgage may range from as little as $18 to as much as $820. Statutory costs range from $1 to $426. I am giving those simply as evidence of the enormous differences in costs we find throughout the country. |