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 FNMA 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 64 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 62 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 612-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 612-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. 42-120 0-705 Finally, let me touch on three proposals relating to savings and loan associations contained in S. 3442. I agree in large measure with these proposals, as the other Members of our Board do. First, this bill would strike out the $40,000 limitation on singlefamily home mortgages made by Federal associations and allow the Board to determine this by regulation. I believe that there is real merit in having the regulatory flexibility that makes occasional adjustments desirable. Second, the bill would authorize savings and loan associations to serve as trustees of so-called Keogh funds, a step that I believe is long overdue. Third, it would allow statewide lending with the discretion that the Board could limit this where State-chartered associations do not have comparable lending rights. I believe that such an expansion in lending territory has much merit in channeling funds more efficiently into capital shortage areas and perhaps even promoting more competition. However, our Board's present indication and inclination is to tie such a broadening of lending territory to areas within reasonable distance of branch offices so that the lender has personnel familiar with the risk characteristics of the local mortgage markets. In some areas we have evidence that lending beyond the 100-mile limit, where allowable under grandfather clauses, led to substantial losses. Other safeguards might include that the association meet certain supervisory standards or be of a certain size. Now, skipping to page 13, and I appreciate the patience and attention of the committee, let me sum up the Board's position. In summary, our Board asks the support of the distinguished members of this subcommittee to two major proposals by the Federal Home Loan Bank Board. We are asking for financial aid to continue to expand our lending volumes to member institutions in the face of historically high interest costs on our massive borrowing. Help us raise our credit supply from almost $10 billion at present to $14 billion this year, or a $4 billion increase. This would finance 160,000 loans at the 1969 average loan size. Second, give us the power to deal in conventional and other loans so that we can reach the nonborrowing members and so that we can divert new funds into housing finance, both by the mortgage bank obligation and by packaging and selling mortgages directly. The housing crisis and the building recession cry out for innovative new approaches. Thank you very much. The CHAIRMAN. Thank you. On page 6 you start to say "our general counsel is now preparing legislation to clarify existing language" and so forth. Mr. MARTIN. Yes, sir. The CHAIRMAN. Is that in addition to the bill I just introduced? Mr. MARTIN. Yes, sir. The CHAIRMAN. This would be additional legislation? Mr. MARTIN. It would be, Senator. The CHAIRMAN. Would it be taken up in connection with these matters or would it be a separate matter? Mr. MARTIN. I believe our timing is such that, although we are immediately working on the legislation, I am not sure we can have it before the committee in time during the course of these hearings. We will make every effort to. The CHAIRMAN. Just offhand it seems to me it would be preferable for us to have it in connection with this. Mr. MARTIN. Yes, sir; we will burn the midnight oil, I assure you. The CHAIRMAN. We have a full schedule up here and it might be some time before we can get to it. Mr. MARTIN. All right, I appreciate the suggestion. The CHAIRMAN. One other item I wanted to ask you. On page 8, right at the bottom: 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. In the bill we have before us now it does limit to members of the Home Loan Bank System? Mr. MARTIN. Yes, sir. The CHAIRMAN. And you would like to have that expanded? Mr. MARTIN. Yes; we would like to provide the stimulus of a secondary market stressing conventional loans to these other kinds of institutions in order hopefully to divert more of their funds now going into other investments into a more marketable mortgage. The CHAIRMAN. Now, this new legislation you are working on, is that a part of the package submitted some time back, that the President promised us would be forthcoming? Mr. MARTIN. Yes, sir. The CHAIRMAN. I believe when the announcement was made he stated that he did plan to make funds available to the Home Loan Bank System for greater activity in the market; is that it, roughly? Mr. MARTIN. I believe, Senator, that the statement made by me and by Secretary Romney at and during the course of the hearings 2 weeks ago before the House Banking and Currency Committee were to the effect that the request for the obligation of funds was to be made of the Congress. That this be an action by the Congress. The CHAIRMAN. You say on page 5 of your statement that a good many local associations do not make use of the borrowing right they have with the Home Loan Bank System for reasons of financial conservatism and local mores. You say 2,000 member associations, more than 2,000 member associations, continue to refrain from borrowing from the Federal Government system. I just don't figure out in my own mind why they do not. Of course you say it is because of the financial conservatism. I think I can understand that. But also because of local mores. What would develop in a community that would discourage getting money where it is legitimately available? Mr. MARTIN. The institutions themselves tell us, Senator, that it gives them great personal satisfaction and standing in their community to be able to put on their statement of conditions distributed to the public no borrowings. It is a matter of pride and attitude of the local folks, these are smaller communities, mostly, that their financial institutions just do not borrow. On the other hand, the same individuals indicated if there was a secondary market and a great shortage of housing in their community they would be willing providing the price is right to trade in mortgages with our facility. But they have no plans to become borrowers at all. The CHAIRMAN. Do they sell their mortgages to you? The CHAIRMAN. But they will not borrow from you? The CHAIRMAN. Well, I concede that some might be in affluent surroundings where savings would be adequate to do a good job, but it seems to me in most cases operating as we do today it would be rather restrictive. Mr. MARTIN. Yes, sir. The CHAIRMAN. Senator Bennett. Senator BENNETT. I have no questions, Mr. Chairman, except I would make a comment that I think I can understand that in some communities the local people might feel that the institution is a little unsafe to show it had been forced to borrow in order to continue its operations and I think that is the thing these people are trying to avoid. They don't want any run on their institutions and I recognize that it is an emotional attitude that probably grows out of unsophistication, but I can still understand it. Some people might think an institution that had to borrow was unsafe. The CHAIRMAN. Well, I wouldn't call it lack of sophistication. I am sure you are right on it, but I just can't conceive business being carried on without credit in this fast-moving world of ours where credit plays such a big part, particularly when they are dealing in credit. Wouldn't that discourage their clients from borrowing on the whole? That is their business. Senator BENNETT. I still think the word "mores" is a good selection. I think it is an attitude on the part of some communities. The CHAIRMAN. I can understand it, but I wanted to know what was in back of it. May I ask this one further question? If the savings and loan associations are now no longer using the advances from the Federal homeowners banks because of high interest costs would not the same limitation be present under S. 3508? Mr. MARTIN. I wonder if I could review S. 3508 and give you that response in writing. The CHAIRMAN. Very well. In that connection, Senator Proxmire is not able to be here this morning and he wishes to submit some questions in writing that we will ask you to answer for the record, if you will. (The answers to Senator Proxmire follow :) QUESTIONS FOR PRESTON MARTIN FROM SENATOR PROXMIRE 1. You indicate that the cost of Home Loan Bank Board borrowing is becoming so high that member savings and loan associations can no longer afford to borrow from the Board. This is precisely why Congress last year increased the authority of the Board to borrow up to $4 billion from the Treasury to meet such an emergency. As you know, the Treasury can borrow anywhere from 75 to 100 basis points below the board for a comparable issue. I am somewhat puzzled therefore as to why the Board doesn't use this new authority. Instead, the Administration is planning to request an appropriation of several hundred million dollars in order to subsidize the lending activities of the Home Loan Bank Board. Appropriated subsidies would not be needed if the |