Treasury and the Board used the borrowing authority they already have. Why saddle the hard-pressed taxpayer with still another burden? Why go through all this extra rigamarole when a solution is already within your grasp?

2. Have you ever discussed the use of the $4 billion borrowing authority with the Treasury and if so, what have been the results?

3. I notice that in Senator Sparkman's proposal for a secondary market operation for the Home Loan Bank Board (S. 3508) the new corporation would be set up as a separate operation from the Bank Board and would not enjoy the Treasury back up that the Board enjoys. Under this arrangement, do you think it would be possible for the new corporation to market its obligations at a reasonable rate of interest?

4. Would you favor a similar arrangement if FNMA is permitted to deal in conventional mortgages?

5. How would you guard against the possibility of Savings and Loan Associations dumping their worst mortgages upon the new corporation? Would you favor some program of private mortgage insurance to help guard against this risk?

6. Under the Administration's yet to be submitted bill for subsidizing the lending activities of the Home Loan Bank Board, will there be any restriction that the funds advanced to member savings and loan associations be restricted to middle income homebuyers?

ANSWERS TO SENATOR PROXMIRE

1. The expanded Treasury credit line is a most important factor in System liquidity. However, its significance goes to availability, not to rate, and rate is our problem now. System borrowings have gone to $1.2 billion just in the month of March 1970. Six of our Banks are at 74 percent on short term advances and one is at 8 percent.

The rates on Treasury borrowings are approximately 30 basis points lower than our market rates. This is not a sufficient cost savings on marginal borrowings to make an appreciable difference to the rate charged on advances by our Banks to member institutions.

There is a definite advantage at this time in regarding the Treasury standby borrowing authority as an emergency source of funds to be utilized only in periods of strained capital market conditions when the System would have difficulty in obtaining funds. This is not the case today.

2. The use of Treasury borrowing authority has been discussed with the Treasury Department from time to time, and a modus operandi agreed upon. 3. Our preliminary study indicates that a separate corporation would have to have System guarantee to market those obligations at a reasonable rate of interest. The FHLBB proposal formally transmitted to the President of the Senate on March 5, 1970 proposes a separate corporation, but one with access to System advances. Separate obligations would not ordinarily be issued. GNMA guaranteed securities would be an exception.

4. This Board has no position on whether or not FNMA should exercise conventional secondary market operations through a corporation separate from FNMA.

5. This Board contemplates buying and selling all mortgages at the market, not the book values. 90 percent of the portfolio would be in mortgages originated one year or less before time of sale. Every transaction would require agreement of substitution, recourse, participation by the seller, and even possibly over collateralization. The Board does not oppose private mortgage insurance as another alternative.

6. There is no restriction in the Administration bill HR 16331 to limit the use of subsidized advances to middle income homebuyers. The vast majority of S&L loans already go to and will continue to go to such homebuyers and to apartment builders of middle-income type housing.

The Board presently has programs to encourage associations to purchase HUD-subsidy mortgages, used primarily for low-income housing, both through special ten year advances to finance such mortgages and through the proposed packaging and purchase of such loans from member institutions as a pool against which to issue GNMA-guaranteed bonds. These programs ensure that the Board will assure an equitable flow of S&L funds into this vital area of housing need. The special advances would be eligible for subsidy funds.

The CHAIRMAN. Senator Tower.

Senator TOWER. No questions.

The CHAIRMAN. Any comments from the other board members? (No response.)

The CHAIRMAN. Well, thank you very much, gentlemen.

(The full prepared statement of Mr. Martin follows:)

STATEMENT OF PRESTON MARTIN, CHAIRMAN, FEDERAL HOME LOAN BANK BOARD

Mr. Chairman and Members of the Subcommittee, all of us present here are concerned and distressed about the severe impact that tight money has had and is having on housing. The middle income American, who finds himself faced with spiraling costs in the purchase price of his home, also faces spiraling costs in the interest on his mortgage, if he is fortunate enough to be able to obtain a mortgage. Many borrowers are reportedly turned away. The apartment dweller has been hurt, too, as vacancy rates have declined to new lows and the pressure of demand on the limited supply of available units has pushed up rents. The low income American, whose housing condition remains woefully deficient, often is dependent upon subsidized Federal programs with limited funds that can subsidize less and less housing units as interest rates go up.

Meanwhile, private housing starts have been steadily trending downward to an annual rate 1,166,000 units in January, 1970. Under these conditions, the goal of 26 million new and rehabilitated housing units over a ten-year period appears less attainable than ever, and the need for new policies and programs in the area of housing becomes all the more urgent.

As you are 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 flow 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 $1.0 billion.

There is no doubt that the very aggressive advances policy that the Federal Home Loan Bank Board has been pursuing, in combination with the substantial support given the mortgage market by FNMA, have been principal reasons why housing actiivity has not yet fallen to the nadir of late 1966 despite the higher interest rates prevailing in 1969 and early 1970.

However, there are limits to even 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 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 limited. 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 now 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. 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.

This is a proposal that can bring short-run, substantial benefits. The savings and loan industry is now underutilized, and it has the manpower and expertise to commit mortgage funds immediately as more funds are made available to it.

Skilled mortgage and housing specialists are being laid off. We would be using an existing system apparatus and would have no need to set up new, expensive, Government bureaucracies.

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, 1 percent, to induce an association to utilize advances to make new loans, this would require only $10 thousand 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, this means that $70 thousand 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. If the subsidy were less than 100 basis points, this would further increase the leverage.

An improvement in general money market rates will tend to reduce System credit support. The Board is particularly concerned that, even with some moderate easing in credit markets, associations may find it advantageous to use the resulting increase in savings flows not to increase their contribution to the mortgage market but rather to retire their advances, which are a more costly source of funds than savings.

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 $22 billion to a level sharply lower than even the pre-1966 level of advances outstanding. This cancelled 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 so large that it would cancel out the beneficial effects of several other programs. 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.

The House of Representatives included in its passage last December of S. 2577, the bill to extend rate control, a provision that would have authorized the several Federal Home Loan Banks to purchase, sell, or otherwise deal in mortgages originated by members of institutions whose accounts are insured by the FSLIC or FDIC. This provision was deleted in conference so that the House and Senate Banking and Currency Committee would have time to study this important proposal in depth.

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. What the Board has in mind can be far-reaching in terms of volume of funds during a tight money period such as the present. If such a program provided $2 billion more for conventional home mortgages per year it would be equivalent to financing housing for about 80,000 additional families per year.

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 to also comment on a bill which I understand has been introduced by Senator Sparkman and referred to this committee. Obviously,

many decisions must be made in setting up a secondary market operation. I will sketch what is our present thinking on the matter.

First, a separate corporation under the aegis of the Federal Home Loan Bank Board would appear 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. We already have knowledge in this field and start out with a broad understanding of the problem. Our member institutions, savings and loan associations 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 functions. Further, we administer an $8.8 billion consolidated obligation portfolio. Thus, we can be quite responsible in designing and administering a secondary market 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.

Secondly, there is the problem of sources of funds and capitalization. Equity would be necessary, geared to the volume of operations and the degree of risk in a secondary market operation. Equity may be initially provided by the Federal Home Loan Banks, as it would in Senator Sparkman's legislation.

Third, we are evaluating carefully the question of mortgages eligible for purchase. Eligibility could be based on (1) the quality of the mortgage itself and (2) the underlying faith and credit of the mortgage originating institution through participations of, say 10 percent, recourse or substitution of good for defaulted mortgages. Overcollateralization can also be utilized.

Fourth, while the purchases should be primarily in mortgages originated within one 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, we are putting great emphasis upon 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 secondary market becomes a two-way 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 now to an analysis of the Middle Income Mortgage Credit Bill, S. 3503 introduced by Senator Proxmire, with the express purpose of providing mortgage credit to middle-income families. The bill would channel up to $3 billion a year through the Federal Home Loan Bank System to member institutions and to other regulated mortgage lenders. The funds would be obtained by discounting special Housing Certificates at the Federal Reserve Banks at a rate no greater than 6 percent.

These funds would 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 per unit, with the income of the homebuyer 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 be almost surely permanently "in warehouse," saleable 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 62 percent. To now provide mortgages at a 62 percent rate to middleincome families would require far more than $3 billion a year. As much as I dislike the high mortgage interest rates, these rates are only a sympton 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 in come 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 61⁄2 percent rate while others would have to obtain them at a market rate averaging 8.3 percent presently.

The bill would also, of necessity, 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 based on mortgages currently being issued at 9 percent or even more. There would be little or no aid to middle income families in large metropolitan areas such as New York and even Washington where housing units costing less than $25,000 are rare but would be great benefit obviously to middle-income families in smaller cities and rural areas.

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

The Board's preference is to work toward solving the nation's housing credit shortage by means that divert a large volume of funds into the mortgage market and not to provide a subsidy rate on mortgages except for lower-income families for whom housing is absolutely impossible without some such subsidy.

I certainly share with the distinguished Senators of this Subcommittee the desire for a much larger volume of mortgage credit rates below the very high levels prevailing now. Our differences are only one of policies, not objectives. Finally, let me touch on three proposals relating to savings and loan associations contained in S. 3442, introduced by Senator Sparkman. I agree in large measure with these proposals.

First, this bill would strike out the $40 thousand limitation on single-family 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 state-wide 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, my present 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.

Finally, the bill would liberalize the terms on which commercial banks could make home mortgage loans to a maximum 90 percent loan-value ratio and to a maximum maturity of 30 years. I believe that the bank regulatory agencies are the only ones who can assess the significance of this from a safety and soundness point of view, and I would defer to their recommendation on this. I believe that I have spoken long enough now, although the urgency of the housing credit situation merits such discussion. I will close by expressing the hope that you give sympathetic consideration to the proposals that we have put forth above and which we believe can make important contributions toward meeting our housing goals.

The CHAIRMAN. Next we have Governor Maisel of the Board of Governors of the Federal Reserve System.

Governor Maisel, we are glad to have you and we shall be glad to hear from you.