We believe it desirable that the conventional mortgage market be served by one source of secondary financing, if possible. We recognize, however, that while there is some degree of overlap, the mortgage market is basically divided into two segments, one of which (primarily mortgage bankers) is accustomed to dealing with FNMA, the other (primarily savings and loans and banks) with the Federal Home Loan Bank System or comparable regulatory bodies. It may be necessary, therefore, to have two secondary conventional mortgage market facilities in order effectively to accommodate all mortgage market participants.

Whatever system is established as a secondary source of funds for conventional mortgage loans, it will be necessary for the regulatory authorities to establish detailed procedures and requirements regarding the appraisal of the real property covered by the mortgage, the underwriting of the credit of the borrower, and other essential elements of mortgage lending. These problems have already been dealt with for FHA and VA loans through the adoption of rules and regulations by the Federal Housing Administration and the Veterans Administration, and similar requirements will doubtless have to be established for any system under which public funds are used for the purchase of conventional mortgage loans.

The establishment of basically uniform standards is essential if we are to have a truly secondary market for conventional mortgage loans, where these mortgage instruments will be readily marketable. Such marketability will add to the attractiveness of mortgage loans for investors and should broaden considerably primary sources of mortgage credit.

In our opinion, the adoption of a free market rate for FHA and VA loans will substantially increase the use of this method of financing home purchases, with a correspondent reduction in the need for the adoption of another form of support for the national residential mortgage market. Recent improvements in the processing and in the procedures of the FHA have substantially lessened the time required for the processing of FHA mortgage applications. Further improvements could probably be made, including authorization for the underwriting of individual loans to be done by the lender, similar to the procedure followed by the Veterans' Administration. The primary factor inhibiting the increased use of FHA and VA financing is the limitation on the contract rate of interest with the resulting imposition of substantial discounts which are unacceptable in the marketplace. Our statement does not include any comments on S. 3503 because it was received by us after the statement was prepared and filed. I would like to make a few comments on that bill in view of Senator Proxmire's interest in it.

We believe the injection of $3 billion into the housing industry would certainly be helpful to housing. We caution, however, that if injected in the manner provided in the bill it may be inflationary and self-defeating unless adequate steps are taken to eliminate $3 billion in spending in other areas.

If this is put on top of other funds being spent in our economy, it would merely drive interest rates even higher and make the thrift institutions supplying the large part of the conventional and insured home loans even more unable to compete for funds. We suggest that

a direct subsidy of the interest differential under a free-rate system might be preferable. There have been suggestions that Treasury funds of $300 million be provided not for the purpose of making loans, but for the purpose of paying the differential between the current interest rate and what the homeowners should be expected to pay.

This would be a similar procedure to that under FHA for section 235 and 236 loans. This has been successful. We are using it in my home State in Pennsylvania and all we need is more funds to permit more people to take advantage of it.

Lastly, we believe the differential allowed to the mortgage lenders under S. 3503 should be studied. I am not sure this would be adequate to entice some smaller lenders into the market. Perhaps a half-percent markup would be adequate to larger institutions, but not to smaller lenders. Obviously, what housing needs most is a period of low interest rates. If we can't get to that situation immediately, then we believe, basically, housing should be able to compete for money at the high interest rates that FHA ceilings should be taken off, that Federal and State statutory ceilings should be taken off that housing should compete for funds in the market. Low income families who are unable to make the high mortgage payments should be subsidized directly.

This completes my statement. May I again express my appreciation for the opportunity to testify on these important matters.

The CHAIRMAN. Well, thank you very much, Mr. Krout. You have given us a very interesting and informative statement.

Let me ask you just this offhanded question with reference to the interest rates. Can you estimate the number of people that are thrown out of the housing market as interest rates are increased? Say for interest a quarter percent or half percent. It does limit the market more and more, doesn't it?

Mr. KROUT. Yes, sir. As the interest rate goes up the monthly payment on the mortgage goes up and the man is less able to buy a house or buy a house of the kind he should or would like to have.

I don't think I could estimate any statistics on how many hundred thousands are pushed out of the market by an increase of a half or 1 percent. If you would like, perhaps we could go back and make such estimates and send them to you later. Unless Dr. Klaman carries them in his head.

Dr. KLAMAN. No: I do not.

The CHAIRMAN. Senator Tower.

Senator TOWER. We have several proposals before the committee. It occurs to me what we need is a little fast pump priming here and it is my impression that the administration proposes to appropriate $250 million by the Home Loan Bank Board. This could be the fastest source of assistance being considered by the committee. Would you comment on that?

Mr. KROUT. As a short-run solution this is probably the one which will work the fastest and best. There is no question that the Home Loan Bank Board has made substantial advances over the past year has helped the production of housing to this extent.

With the interest rate structure changing and these advances costing the savings and loan associations even more and more, I think the fear is that they will not continue this effort and that they might repay some of the advances and thereby limit the amount of financing

they do. To the extent that the Home Loan Bank Board, through the Treasury Department, supplement the differential between what the price of money and the mortgage rate, I think the benefits could be felt very quickly.

Of all the things we are talking about, that is probably the one that would have the most immediate effect.

Dr. KLAMAN. May I supplement that in one brief way? What Mr. Krout says is true. At the same time I would say that it seems to me evident that if that much money is available directly from Treasury revenues through the Federal Home Loan Bank System that we should also clearly make available the funds which have been authorized but not appropriated, yet remaining for FHA, sections 235 and

236.

There is a supplemental bill, I understand, before the House Appropriations Committee which HUD is asking for the use of $50 million out of $85 million which is still available for 235 and 236. It seems to me strange indeed that these FHA interest subsidy programs which as Mr. Krout pointed out the savings banking have used quite effectively, is denied: $85 million of funds which is a direct injection into the housing market into areas in which housing is needed, low- and middle-income housing; while providing a Treasury fund of $250 million for one segment of the financial community, as important as that segment is seems to me entirely inconsistent.

As Mr. Krout said, we are hardly opposing the Treasury subsidy provision, but I think it is quite inconsistent to push on that front and inake it available and deny $85 million for 235 and 236.

As I understand the $250 million, there are no restrictions on how that money is to be used. As I read the proposal, it could be used for $100,000 homes as well as lower priced housing.

Senator TOWER, Would your institutions have access to these funds!

Mr. KROUT. Some savings banks would not have access to these funds. The large majority of thêm would not. I believe in some of the Federal home loan bank proposals there was a suggestion of extending this provision to all institutions which are supervised, not necessarily by the Federal Home Loan Bank Board. I am not sure that would be a part of this proposal. Without such a provision, most savings banks would not be able to take advantage of it. Because only 45 sayings banks are members of the FHLB system.

About the 233 and 236 loans, we are making those loans in Philadelphis where my bank is. The authorized funds ran out early last year and we had many people who wanted to buy a home, who needed this interest rate subsidy to buy it and could not do so. Later in the year some funds were produced and they were appropriated and they are now flowing. But we are coming to the bottom of the barrel. These loans go to persons in the low income area with an effective income 86,000 to $8,000 a year.

ator Tower. How would it affect the practice of charging dis-
if ceilings on FHA and VA merreages were raised?
Kote. The provisions of this bill to create a dual system under
you would abolish the ceilings world provide there could be no
its charged on loans not subieer to the selling. This would mean
mstead of a lender taking an 8-percent loan and charging a

4-percent discount, which is a pattern, he would make a 9-percent loan with no discount. That means nobody would have to come up with those four points. Many people can't sell their houses today because the points they have to come up with under this law plus the sales commission are more than their equity in the property.

This is our other proposal, that even under the fixed rate the points could be paid by the buyer. This is the only way you are going to get a lot of money flowing into housing. Then you could subsidize the payments for those needing the help.

Senator TOWER. Would it be necessary to abolish the discount by law?

Mr. KROUT. Theoretically it would not be, but we thought perhaps the free market rate would be more palatable to Congress if there were a prohibition on discounts tied to it. I think with a free market rate, that would set the rate just like in the conventional market and there would be no points.

Conventional mortgage financing is done at an interest rate and there are no points charged. There have not been traditionally.

Dr. KLAMAN. Senator Sparkman knows-I had the, privilege of serving with him on the Commission on Mortgage Interest Rates-the dual market rate proposal that this bill advances is a compromise. The Commission did not agree on an absolutely free rate. But I would like to suggest to this committee that its staff might review the experience of our small neighbor to the north, Canada, which sometimes advances beyond us in certain areas. It has gone through a series of successive adjustments with respect to NHA loans which are comparable to our FHA loans. They have tried the fixed rate, the rate figured to a Government bond rate. Each plan has been found wanting in several different respects. This year or last year, 1969, they went to an absolutely free market rate, having tried every other mechanism. They find this is the technique which works best.

As Mr. Krout pointed out, where you have an unfettered rate, basically the rate rises to meet the market needs or drops as the conditions warrant, but discounts are not a part of that market.

Senator TOWER. Thank you.

The CHAIRMAN. Senator Proxmire.

Senator PROXMIRE. Mr. Krout, you said that you thought the fastest source of funds in getting housing moving in a hurry would be the subsidy program; is that correct?

Mr. KROUT. Yes, sir.

Senator PROXMIRE. I take it you base that on the assumption that Congress will act with lightning-like speed. As you know, this is going to be a long road. It has to pass the House and the Senate and go into conference and be signed by the President and then you start all over again on the appropriations. Our progress with appropriations can be very sticky on these things. So I think while your case is strong, in theory, once you get it in operation I think vou are absolutely right, it would be effective. I am somewhat troubled as to how long it is going to take.

Mr. KROUT. I was merely suggesting that after whatever provision you adont becomes law, I think this would work most quickly. I suppose you have this problem with everything proposed.

Senator PROXMIRE. Not everything. The proposal I have could start immediately. After authorization. No appropriation is required. The appropriations process can take a long, long time. You said the trouble with the bill I proposed is that the money would have to be taken out elsewhere, that is the $3 billion for housing. If you are going to continue in a consistent fight against inflation you are going to have to sell Federal securities in open market operations. In doing so you drive interest rates up and depress mortgages. And the result is selfdefeating.

I would like to calculate the amount of feedback you get. I think there is some feedback, undoubtedly, no matter how you would do it. I don't think it would be 5 or 15 percent, not anything like that. Furthermore, it is exactly the same thing when you provide the subsidy you are talking about. There you subsidize the Home Loan Bank Board. They have to go out and borrow more money. Regardless of how you get the money into housing there is a feedback there which tends to be to some extent self-defeating, to a modest extent. But if you do the job you have to recognize that, isn't that true?

Mr. KROUT. I think that is right. Dr. Klaman is smarter than I am on that.

Dr. KLAMAN. Hardly smarter. But the one difference is the Federal Reserve is the only Federal Institution in this country which can create money.

Senator PROXMIRE. You don't necessarily create any more money with this program because, as I say, the Board would balance the $3 billion purchase by other open market operations.

Dr. KLAMAN. There is no requirement in the bill that they do.

Senator PROXMIRE. That is up to them. They control monetary policy in this country, as we all know. They are the ones that have the authority to determine whether or not we need a greater supply of money or need to hold it down. This would put it squarely in their hands.

Dr. KLAMAN. I agree. I would suggest this. If you have testimony from any distinguished group of economists that you would select, I would be most interested in seeing how many objective economic observers would feel that by imposing a requirement on the Federal Reserve to buy $3 billion worth of housing securities, that would in effect pump $3 billion of money into housing without any side effects that are quite serious in the economy.

Senator PROXMIRE. I think if those economists had worked for the Federal Reserve Board I think you might get that response. If not, you might get a response favorable to the bill. They must realize what is happening to housing. There must be some way we can prevent this kind of devastation.

Dr. KLAMAN. I couldn't agree with you more. The best way to do it is to run a Federal surplus and have the necessary fiscal restraints which would permit monetary policy to ease. Until we do so housing will continue to be in serious trouble.

Also, as we said before, to reorder priorities so that the money is. spent for housing and not for something else. If it is spent in addition to something else we go in that circular flow.