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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 $212 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 condítions 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 FŅMA's expertise in FHA and VA, the System always has specialized in the conventional lending process. As F'NMA'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 insti. tutions 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 proriding 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 644 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 672 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 642 percent. To now provide mortgages at a 642 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 642 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.



Mr. MAISEL. I am very pleased to be here. I welcome the invitation to present the views of the Board of Governors of the Federal Reserve System on the bills before you.

At the outset, let me say that improvements in the primary and secondary mortgage market, above and beyond the numerous steps already taken, are clearly needed. We need to make residential mortgages more competitive so that they can attract a larger share of the total pool of available money and credit. At the same time, a more efficient mortgage market would help to promote a more efficient allocation of resources in general.

Mr. Chairman, I am presenting my statement for the record, but I will summarize it briefly. In considering S. 2958 having to do with agency operations of a secondary market for conventional mortgages, attention should be called to certain problems.

I will not go into the benefits, but I would like to underline some of the problems. The first problem is that not much progress can be expected in establishing a secondary market without standardization of mortgages and some standardization of lending practices. Second, a government agency entering the secondary market will need a good deal more capital than one dealing only in government insured or guaranteed issues. Losses will necessarily increase as compared to present types of operation.

In contrast to the present, mortgages purchased will no longer be insured or guaranteed by the Federal Government. There will be lack of uniformity in appraisals and adverse selection against the secondary market maker will mean greater losses.

If risks by the secondary market maker are properly charged, there will be the normal tendency for only those lenders making the riskiest loans to participate in the program. The best lenders simply will not find it worth their while on economic grounds.

In addition, because these mortgages will be less standardized, and because they will not be issued or guaranteed, the liquidity of the market-making agency will be far less. This would apply whether it is FNMA or the Home Loan Bank System.

Third, since there is almost certainly a limited pool of funds for mortgages available to the Government agencies, if the Government agencies shift their operation into the conventional market, that shift will necessarily be at the expense of Federal programs which up to now have been considered to have a special public interest.

Fourth, fewer houses will probably be aided. Since Federal programs are designed for moderate- and low-income groups while conventional mortgages primarily go to larger and higher income groups, the substitution of conventional mortgages for FHA and VA mortgages will mean that the average mortgage size will be larger, and the average number of housing units financed will be smaller.

Turning now to S. 3503, the Federal Reserve opposes the enactment of this bill. In effect, S. 3503 would require the Fed to lend a sum limited only by the fact that it can rise by no more than $3 billion each year to the Federal home loan banks at 6 percent for relending to moderate-income families.

Why do we oppose this, Mr. Chairman? We believe that when Congress determines a major program has sufficient national interest to be supported and subsidized, it should be in the budget. This is the only way Congress can properly meet the need for correctly evaluating a program's position in national priorities.

The administration is supporting a subsidy bill for the Federal home loan banks to be financed with

congressional appropriations, the one that Chairman Martin just discussed. We believe such an approach is proper because it does go through the normal congressional procedures and appears in the budget.

Clearly we are not recommending what types of subsidies Congress should vote. It is up to Congress whether Congress wants to vote subsidies to high-income families, to families all across the board, moderate-income families, low-income families, or any other type of family. We believe this type of decision is properly made by Congress. This is another reason we feel the comparison of these bills is helpful and brings out these choices more specifically:

Next, it should be recognized that when the Federal Reserve loans to any group, these loans are at the expense of existing Government credit and Treasury issues are forced into the market.

It does not increase the supply of lendable funds. In other words, if the Federal Reserve is to lend to any specific group, that lending does not increase the total amount of funds available. It simply substitutes one type of lending for another.

The only way in which we do not have substitution is if the Federal Reserve creates new reserves and thus creates new money. In that case, however, we increase the rate of inflation and, as we have seen in recent years, as the rate of inflation goes up, the pressure on the mortgage market increases.

So I think the logic of the situation is that the more money the Federal Reserve creates the less money there will be available for mortgage lending.

Finally, I would point out that in discussing the creation of Federal Reserve money for specific purposes, there are many claimants for Federal subsidies. While I am not a believer in the "camel's nose in the tent argument," I think it does apply here. It is difficult to draw lines. If people mistakenly believe that Federal Reserve surplus earnings are free money, rather than money which goes to increase governmental revenues, they would be more likely to attempt to spend it.

Thus it is important that excess earnings continue to go into the general fund revenues and not be parceled out to special uses no matter how worthy.

Finally, with respect to S. 3442 the Board approves the proposals based on certain recommendations of the Commission on mortgage and credit. These include the experimental dual market system for contract interest rates on FHA and VA mortgages.

We believe that further attempts to reduce the costs of transferring property and real estate financing may bring considerable dividends.

Similarly, the Special Advisory Commission on Housing may increase our ability to analyze problems in this field and, finally, we continue to support, as we have in the past, liberalization of the authority of national banks to make real estate loans.

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