STATEMENT OF SHERMAN J. MAISEL, MEMBER, BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM

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.

Finally, I want to reemphasize the fact that legislation is needed to improve the working of the mortgage market. Similarly, the burden of monetary restraint on the mortgage market should be lightened. The Board is studying ways and means to accomplish this without impairing the use of monetary policy in achieving national economic objectives. But it should be kept in mind that the problems of the housing industry are not related solely to credit. Rising costs in construction and land have also been major impediments.

However efficient the mortgage market becomes and however successful the Federal Reserve is in achieving a more uniform impact of monetary restraint, another step is needed to insure that sufficient funds will be available to reach the national housing goals.

We must enlarge the total pool of housing credit. We probably cannot achieve our Nation's housing goals merely by enabling housing to attract a larger share of the available pool of capital.

It seems to me the most feasible way to expand the pool of housing credit is to reduce the demand that the Federal Government is making on private capital markets. This is a major reason that we must examine with caution proposals such as those having to do with secondary mortgage markets for conventional loans. Such proposals would increase rather than diminish the total credit demand of the Government and its agencies.

Thank you, Mr. Chairman.

The CHAIRMAN. Thank you, Governor Maisel.
Senator Tower?

Senator TOWER. No questions.

The CHAIRMAN. Senator Bennett?

Senator BENNETT. No questions.

The CHAIRMAN. I think you gave us a very clear statement on the bill as discussed.

Let me ask you this: In the very last paragraph of your statement: It seems the most feasible way to expand the pool of housing credit is to reduce the demand the Federal Government is making on the private capital market. This is the major reason why we must examine with caution the proposals which would increase rather than diminish the total credit demands of the government.

Now, in making the demand on the Federal Government and the capital market, why would that not include the administration's proposal to make this additional capital available to the Home Loan Bank Board or handling it through the savings and loan associations? Where is the Government going to get that money?

Mr. MAISEL. I think it does apply partly to that, Mr. Chairman. Part of the money. I take it the actual subsidy would come out of the normal budgets of the general fund. But it is true that the money that the Federal Home Loan Bank I will advance will have to come from the general pool of funds.

If I might expand on this point a little more, I think there is a good deal of perhaps undue optimism when we think of the agency market. It is a market that I have supported for a long, long time. I think in a cyclical period such as we are in now it becomes very important.

As the normal flow of funds to the deposit institutions dries up, the agencies have a way of going around the normal institutions, going directly to the market and making funds available in that way.

Thus if we look at the last half of 1969 we find that about 50 percent of the mortgage money, instead of going through the normal deposit institutions, came from the agencies raising money in the capital markets.

I think that is very useful and very important. If we had not put FNMA outside the budget and set up the Home Loan Bank Board as it is, the mortgage market would be in a great deal more difficulty today than it is. So this has been very useful.

On the other hand, if we look at the total, there is no indication that this has actually increased the amount of money available for the mortgage markets. The money that comes through the agencies happens to be roughly the same amount of money that did not come through the deposit institutions. I am not suggesting there is a 1 for 1 substitution in this matter, but they are closely related.

When we look at the agencies we find there are several channels by which they work. In the first place, certain lenders such as pension funds, some large banks and some small banks, State and local governments, trusts, et cetera, are not equipped to lend in the mortgage market. So there is a certain amount of money which normally does not flow into the mortgage market; they will, however, buy agency issues and mortgage backed securities of all sorts.

So there is a possibility of their shifting some of their money into the mortgage market. But when you look at these sources of funds, they are not a tremendous amount. I am not going to try to put any order of magnitude on them, but we are talking about money probably in the millions, but not a tremendous amount of money when we see the total need.

Second, the agencies use the Government's name and prestige. As a result, the amount they pay on their paper will be somewhat less than if a similar amount of money was borrowed directly from the market. But again we are not talking about large differences in interest rates, particularly when we have a period such as we have just been through when the agencies increased their borrowing tremendously.

They have to bring in new customers and people who will lend to them. The way they do that is by raising the rates they offer in the market. As a result, the difference, the normal benefit we get by using the Government's name and prestige, becomes less when all the agencies go into the market together and raise far larger sums.

Then there is the third possibility that we are talking about with respect to the home loan bank proposal; that is, subsidizing part of the rate directly by the Government. This, of course, is done with many other types of agencies so that we do pay part of the costs from the general revenues and get whatever benefits there are in that method.

Another thing that I think has been very important is that as a result of the FHA and VA, we have one type of standardized mortgage. It is in a specific form. It has certain appraisal techniques behind it. It is recognized throughout the country.

This is simply lacking at the moment in the conventional field. By the agencies going into the conventional market, there would be the hope that we could get a far better mortgage instrument, one that could be traded, so that when a lawyer looked at it in New York he would know what it meant, he would not have to be a lawyer from North Dakota or somewhere else from where the mortgage originated.

If you have looked at mortgages, I am sure you recognize how different they are throughout the country. So we would have some hope by improving the market by standardizing the instrument.

Finally, the agencies do convert mortgages, basically a long-term asset, into securities more in line with market desires. Thus FNMA issues commercial paper, short-term bills and intermediate-term notes and longer term debentures, all to purchase long-term mortgages. As a result it is able to slice up the capital markets into more pertinent parts. This makes it easier for many types of institutions to put money into FNMA paper than they could put into mortgages directly and as a result we do get an increased marketability, indirectly, in mortgages.

But I think the point I am trying to stress, Mr. Chairman, is that we have gone a long way in the use of these techniques. There is a great deal of mortgage money going through the agencies. As I said in the last half of the year it was about 50 percent of all mortgage money which was going in that way but I don't think that any of these channels greatly enlarge the pool of capital available.

When we are talking about the long-term capital needs, we are talking about a problem of finding more resources to invest in the capital of this country. Congress, and I think properly, has said that for the next 10 years we ought to greatly increase the amount of capital investment in the United States. Specifically, they said that increase will take place because we want to see the amount of capital going into housing increased considerably. But I think we have to recognize that the amount of capital that can be formed in any period depends upon the amount of money that the people are willing to save or the amount of money that Congress is willing to vote from tax revenues for capital appropriations.

At the moment we are in a situation where traditionally Congress has said we can take care of the capital investment in housing without voting it from tax revenues. We will vote subsidies as we have through the FHA and sections 235 or 236; we will vote subsidies as in the public housing program. But all of that capital will have to be raised from existing savers.

Congress should consider steps it can take to see that the amount of capital available in the country is greater. It is not enough to try to divert savings into the housing market that would otherwise flow into other markets.

I think the main point of my statement today is to say that I think Congress is going to have to think about this problem very seriously. Are there more ways of attracting existing savings into housing or by trying to do this do we simply raise interest rates all across the board? If we are going to have a greatly expanded capital program in housing, then I think we have to ask where is that money going to come from and it can only come through people increasing the amount of their savings or the Government raising it through taxes.

The CHAIRMAN. Well, Governor, let me say this committee has discussed over the last 15 years or more the possibility and the hope of getting pension funds into the support of the housing market.

You know, of course, we haven't made much headway. There is not much we can do toward making uniformity in mortgages, although as you point out, the FHA and VA have done very well in that.