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We are advised by the Bureau of the Budget that there is no objection to the presentation of this report from the standpoint of the Administration's program. Sincerely,

Rurus H. WILSON,
A88ociate Deputy Administrator

(For and in the absence of

Donald E. Johnson, Administrator). The CHAIRMAN. Our first witness this morning is the Honorable Preston Martin, who is Chairman of the Federal Home Loan Bank Board.

Mr. Chairman, we are pleased to have you with us, and you may proceed in your own way. We have a copy of your statement. The full statement will be printed in the record, which is usual (see p. 64). You may proceed as you see fit, to either present it to us or summarize it, or discuss it—just as you wish.

We are glad to have you before us again.



Mr. MARTIN. Thank you, Mr. Chairman. I appreciate the opportunity of appearing before the committee. The chairman and the distinguished members have such a long record of concern and action in the fields affecting our people, particularly in the housing field.

I have with me today a fellow Board Member, from St. Louis, Mo., the Honorable Carl O. Kamp, Jr., several members of the staff of the Federal Home Loan Bank Board, including the gentleman on my right, Dr. Bruce Ricks, who is the Director of our Office of Economic Research.

I appreciate the opportunity to summarize the statement in view of the many pressures upon the committee's time.

Beginning at the bottom of the first page of the formal statement, as the committee is aware, the Federal Home Loan Bank System has been using every means at its disposal to provide credit to the housing markets. System advances to members were increased at a record $4 billion rate in 1969 and financed between 40 to 50 percent of the total increase in mortgage portfolios of savings and loan associations.

As savings flows into associations have diminished, associations and the housing market have become increasingly dependent upon the continued availability of System advances. Liquidity requirements were twice reduced, stimulating a shift from liquid assets to mortgages exceeding $1 billion.

Let me interpose, Mr. Chairman, if I may, and in all frankness and candor indicate to this committee that our Board does not feel that it can commit to an increase in 1970 at 1969's level of $4 billion in our advances to our members. There are limits to these policies during a period of tight money such as we have been experiencing. The ability of the System to continue to provide adequate advances is seriously jeopardized in 1970. The fact is that, as long as the System must remain self-supporting, the interest rate on advances must be

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related to the System's cost on borrowed funds. The Bank System is absorbing part of its cost of money now, but its ability to do this is Jimited. At current interest rates at which the System must raise new money or refinance existing bonds, the rate on advances will soon be up to 8 percent and above.

For many savings and loans, advances are not becoming a substantial proportion of funds. Thus, any further increase in the rate on advances will further depress associations' earnings, already reduced by higher interest rates paid on savings. State usury laws and borrower resistance limit management's ability to pass on rising money costs. Under these conditions member associations are increasingly reluctant to borrow further from the System. In fact, they are becoming reluctant to hold outstanding their present level of advances.

Some associations are retiring advances as rapidly as possible, at the expense of mortgage lending. In short, the System is "pricing itself out of the market.” The most feasible solution to this problem is a congressional authorization of funds to the Federal Home Loan Bank Board which can be made available to the Federal home loan banks to hold their rate on advances below the cost of borrowed funds. This would allow associations to be able to afford both new advances and to continue to rely on existing advances. The result will be to provide the continued massive support to the mortgage and housing markets so deeply in the public interest. The Board and the administration are requesting that Congress authorize up to $300 million for this purpose, which would be expended over the next several years.

The regional banks are charging below the cost of their money, as much as 50 basis points below, and averaging around 20 basis points

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We seek authority to commit now, but the expenditures would be spread over the term for the commitments—periods such as 5 years. This is a proposal that can bring short-run substantial benefits. The savings and loan industry is now underutilized as a mortgage originator. It has the manpower, the expertise to commit mortgage funds immediately, as more funds are made available to it at prices which it can afford.

We believe this measure cannot wait. Skilled mortgage and housing specialists are being laid off. Our proposal is to use an existing System apparatus, and it would have no need to set up a new expensive Government bureaucracy.

This proposal also has a substantial leverage factor. A relatively small subsidy on an advance can induce an association to use the funds and support a substantial volume of housing.

Take a simplified example: If it took an interest subsidy of 100 basis points, i percent, to induce an association to utilize advances to make new mortgage loans, this would require only $10,000 in cost absorption per year to support $1 million in advances. Even if the advances were to remain outstanding for 7 years, which is a typical life of a mortgage today, this means that $70,000 in cost absorption would support $1 million in mortgages—a ratio of about 15 to 1.

Since associations may not require the advances for as long as the life of the mortgage, or the need for subsidizing the advance may not be necessary during its entire life, the ratio of mortgage volume generated per dollar of subsidy may well be above the 15-to-1 ratio. Further, if the subsidy were less than 100 basis points, this would further increase the leverage.

I think it is the duty of our Board to point out to this committee that an improvement in general money market rates would tend to reduce System credit support. The Board is particularly concerned that, even with some moderate easing in general credit markets, borrower members may find it advantageous to use the resulting increase in savings flows not to increase their contribution in the mortgage market, but to retire their home loan advances, which are a more costly source of funds than savings.

There aren't many mortgages on the market, Mr. Chairman, and their volume on that market is declining. The Federal home loan bank advances, in contrast, are at historic highs, and the rates charged are likewise at their highest, and rising.

The behavior of associations in 1967 is a good example of what might happen in this respect. Despite a continued shortage of mortgage funds during 1967, associations reduced their advances by over $2.5 billion, to a level sharply lower than even the pre-1966 level of advances outstanding.

This canceled out much of the beneficial effect of the recovery in savings flows that occurred during this period.

The Board wants to prevent a repetition of this. The magnitude of the potential repayment of advances might be great enough to cancel out the beneficial effects of several other programs designed to increase mortgage flows. Under these conditions, System advances will have to continue to play a vital role as a source of funds even if monetary conditions produce some recovery in savings flows.

As important a role, however, as advances policy can play in supporting mortgage credit, it will not be enough, as the events of 1969 illustrated. For reasons of financial conservatism and of local mores, over 2,000 member associations continue to refrain from borrowing from the Federal Home Loan Bank System. In addition, advances can induce associations to add more mortgages to their portfolio, but do not provide a means whereby the vast mortgage-originating expertise of associations can be used to originate and package mortgages that would be held in some form by other institutions such as pension funds that have the financial resources to acquire substantially more mortgages in a period of tight money.

This is why the Board is proposing a secondary mortgage market facility, particularly aimed at conventional mortgages, by the Federal Home Loan Bank System, to broaden and deepen private secondary market facilities.

I will summarize my testimony, Mr. Chairman, moving to page 6_our general counsel is now preparing legislation that would clarify existing language authorizing the Federal Home Loan Bank System to conduct such a secondary mortgage market in conventional as well as federally-underwritten mortgages. We envision that the legislation will allow the secondary mortgage facility to deal in mortgages originated by institutions whose accounts or deposits are insured by either the FSLIC or FDIC, so that the secondary market can take advantage of the mortgage-originating expertise of mutual savings banks and commercial banks, as well as member institutions, and to allow for the economies of operation of a broader secondary market.

We have been asked also to comment on S. 3508, dated February 26, 1970. Obviously, many decisions must be made in setting up a secondary market operation. I will sketch what is the Board's present thinking on the matter.

First, a separate corporation under the aegis of the Federal Home Loan Bank Board would appear to our Board to be desirable.

At this point I would like to answer the question of why we should be involved in secondary market operations as well as FNMA. Our System already has knowledge in this field, and starts with a broad understanding of the problem.

Our member institutions, savings and loans, and many mutual savings banks, frequently deal with the Federal Home Loan Bank System. We are aware of the particular problems and needs of these institutions. We currently regulate participation loans, and the purchase and merger of institutions whose assets are essentially conventional mortgage pools. We have a large and experienced staff of examiners who evaluate mortgage portfolios as a part of their routine function and supervision.

Further, we administer $8.8 billion consolidated obligation in our portfolio. Thus, we are quite responsible in designing and administering a secondary mortgage facility. Like FNMA's expertise in FHA and VA, the System always has specialized in the conventional lending process. As FNMA's purchases are primarily with mortgage bankers, our activity is primarily with insured, supervised institutions in conventional mortgages.

Second, there is the problem of sources of funds and capitalization. Equity would be necessarily geared to the volume of operations and the degree of risk in a secondary market operation.

The Board envisions equity would be provided by the 12 Federal home loan banks, as it would in Senator Sparkman's proposed legislation.

Third, we are evaluating carefully the question of mortgages eligible for purchase. Eligibility could be based on the quality of the mortgage itself and the underlying faith and credit of the mortgageoriginating institution, through participations of, say, 10 percent. It could be provided by recourse or substitution of good for defaulted mortgages. Overcollateralization could also be utilized.

Fourth, while the purchases should be primarily in mortgages originated within 1 year prior to purchase, we suggest that up to 10 percent of purchases be not so restricted where the Board determines such purchases would enhance the marketability of new housing mortgages.

Fifth, the Board is putting great emphasis on the type of securities to be issued by the secondary market corporation, because this provides an opportunity to tap sources of funds for the mortgage market that are not now going into mortgages directly or indirectly through Federal home loan bank or FNM, obligations.

We envision the design of long-term bonds, with protective call devices, that can be attractive to pension funds and other long-term investors and can bring funds indirectly into the mortgage market in much larger quantities. This is another way in which the secondary market can supplement the advances mechanism.

We hope also to develop means of selling mortgages, individually, in packages, or through participations and mortgage-backed securities,



so that the Federal home loan bank secondary market becomes a twoway operation, and not merely a warehouse of mortgages.

We believe that Senator Sparkman's bill provides a good starting point for the type of legislation that we are seeking. However, the Board would prefer to have the authority to deal in mortgages of all FSLIC- and FDIC-insured institutions and not merely those of members of the Federal Home Loan Bank System.

I would like to turn to the analysis of the middle-income mortgage credit bill, S. 3503, introduced by Senator Proxmire.

As the committee knows, the funds will be obtained for this operation by discounting special housing certificates at the Federal Reserve banks at a rate no greater than 6 percent. These funds will be advanced to member institutions, and other regulated lenders at a rate between 6 and 674 percent. These advances, in turn, could be used only for mortgage loans for housing costing less than $25,000 a unit, with the income of the buyer limited to $10,000, and with a maximum interest rate on the mortgage, including all points, not to exceed 642 percent.

Because of their below-market characteristics, these mortgage instruments would almost surely be permanently “in warehouse," salable only at deep discounts.

My comments on this proposal will be brief. Our Board believes that our proposed temporary cost absorption subsidy administered through its System is a more economical approach, less involved in monetary policy, and it respectfully suggests this as an alternative.

I wish very much that mortgage credit could be made available at a rate as low as 612 percent. To now provide mortgages at 642-percent rate to middle-income families would require far more money than $3 billion a year, if all such families were to be accommodated. As much as I dislike the high mortgage interest rates, these rates are only a symptom of tight money and serve the function of rationing the limited supply of credit. S. 3503 would create a two-tier pricing system for mortgage loans to middle-income families. Lending institutions would be faced with the problem of rationing funds available under this bill so that some eligible families would be able to obtain mortgages at the preferential 642-percent rate, while others would have to obtain them at a market rate averaging 8.3 percent presently.

The bill would be discriminating on the basis of the standards set forth in it. There would be no aid to the large number of young households whose current preference is for living in apartment buildings, where rents are in part based on mortgages currently being issued at 9 percent or more. There would be no aid to middle-income families in large metropolitan areas such as New York or Washington where housing units costing less than $25,000 are rare, but would be a great benefit to middle-income families in smaller cities and rural areas.

The end result would still be relief only to a select and limited number of families. I believe that the direct subsidy the Federal Home Loan Bank Board is proposing for our System would provide a large volume of mortgage funds on a more equitable and uniform basis to homeowners, and indirectly to apartment renters. The increase in the supply of funds would tend to hold mortgage rates down through market processes.

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