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Markets. The result of these institutions with their specialized sources of savings and limited outlets for investment was that one major financial market, the mortgage market, was burdened with limited ability to compete for saving whenever interest rates rose. Moreover, the lack of a secondary market for conventional mortgages made it impossible for these institutions to sell some of their existing assets to provide for liquidity at these times. Another market, the municipal market, suffered from a lack of potential investors on reasonable terms. The corporate bond market was primarily a new issue market with very little secondary trading while the stock market was almost entirely a secondary market with very little new issue volume. Only the government security market seemed to have an active new issue and secondary market in which many investors could participate.

DEVELOPMENTS IN THE LATE 1950'S AND EARLY 1960's

Institutions.-The latter part of the 1950's and the early 1960's saw a series of developments which accelerated the pace of financial development in the United States. More financial institutions began to show broadened interests in entering the savings market. Life insurance companies moved aggresively into the uninsured pension business. Commercial banks showed considerable interest in the market for savings deposits. For example, The Chase Manhattan Bank developed the slogan of "You have a friend at the Chase." Mutual funds continued their rapid growth as they continued to satisfy a growing demand for a prudent chance at the returns available from equities. However, neither savings and loans nor mutual savings banks showed any interest in expanding the kinds of fixed value claims they would offer. Although early in the 1960's some mutual savings banks did begin to consider offering a mutual fund. Pension funds continued to grow dramatically. The private plans moved aggressively into equities while the public plans moved out of tax-exempt securities and into taxable government and corporate issues. Savers. The options open to savers with relatively small amounts to invest improved as mutual funds began to offer returns on equity portfolios which were greater than those available on deposit type savings accounts while at the same time less risky than if these savers had bought equities directly. Moreover, returns on deposit type accounts moved up relative to other interest rates as commercial banks entered this market more aggressively. These trends continued as some life insurance companies began to sell variable annuity plans and were showing signs of moving to provide straight equity management services in the form of mutual funds. As family income levels continue to rise and equity claims continue to become a sensible part of the portfolios of more and more savers, we can expect a continuation of the very rapid growth of these institutions dealing in the equity market. Just as when they had smaller amounts of wealth and savers chose to use institutions to manage their savings held in the form of fixed value claims, savers are likely now that they have larger amounts of wealth to use institutions to manage an ever growing fraction of their savings in variable priced claims (equities).

Borrowers. More flexible institutional practice also increased the options open to borrowers. Life insurance companies began to accelerate the pace of private placement of debt issue for corporations. Much of the savings which commercial banks attracted with their increased interest in and payments on time and savings deposit accounts found its way into the municipal market and to a more limited extent into the mortgage market. Term loan to business expended as the lending policy of banks became much more aggressive and adaptive to business needs for intermediate term funds. Little change occurred in the options open to home buyers, however. There were no new entrants into the single family home mortgage market and life insurance companies came to concentrate their mortgage interest mainly on income producing properties and large tract developments.

Instruments.-No change took place in the mortgage instrument. There was little if any action taken to bring about variable rate mortgages or incorporate any of the attempts to standardize the instrument or to create a secondary market in them.

MORE RECENT DEVELOPMENTS

As a result of the pressures on financial markets which were related to the acceleration of expenditures in Vietnam, interest rates on open market

instruments rose dramatically in the last five years. With Federal Government and corporate financing requirements up sharly and with both of these sectors raising finance in the direct debt markets, interest rates on direct debt instruments rose relative to those offered by all institutions. Thrift institutions felt the brunt of this pressure. The contractual institutions like life insurance companies felt it to a lesser extent, although policy loans did rise dramatically. With commercial banks competing for savings deposits more aggressively than in earlier periods, many thrift institutions, suffered substantially smaller deposit growth and, in some cases, even deposit outflows. With the bulk of the savings shift away from thrift institutions, and with these institutions the bulwark of the residential mortgage market, residential mortgage finance fell drastically.

Moreover, the excess demand and the associated rise in prices caused the monetary authorities to attempt to restrict bank lending. Under the pressure of reduced lending availability and a very strong business loan demand, commercial banks moved away from the municipal market. Thus, it was in two very socially sensitive markets that much of the adjustment to the excessive levels of demand had to take place.

These facts have led to many proposals to force or induce some financial institutions to buy more mortgages or municipal securities than they would otherwise do. I think many of these proposals are wrong for three reasons. First, attempts to force institutions to invest in assets at lower than market returns deal with the symptoms of he problem and not with the problems themselves. If, in the eyes of a pension fund or a bank, mortgages are not attractive relative to corporate bonds or business loans, then the problem is to improve the relative return on mortgage or reduce the relative risks or illiquidity of these mortgages. There are the beginnings of new arrangements as well as several feasible proposals to improve the relative attractiveness of mortgages. Second, if the problem is to provide housing finance to families who can get finance but at what we consider too high levels of interest rates, a more efficient solution would seem to lie in income subsidies for housing directed toward the needy or subsidized loans rather than to compulsion on the lender to accept a specific volume of loans at below market rates of interest. Third, it seems patently unfair to say that the depositors in a bank, the potential recipients of pensions, or the holders of life insurance policies are to bear the burden of meeting the costs of our housing or municipal needs. Moreover, if one examines the income and other demographic features of the spectrum of the potential beneficiaries from private or public pension funds, it would seem hard to conclude that they are the appropriate group to pick to bear such a burden.

If as a Nation we are to assume the cost of providing mortgage finance in the amounts necessary to achieve our housing goals, we should specifically consider who is to pay and not decide to tax the earnings of certain groups just because they happen to hold claims on financial institutions over which we can exercise control.

The more proper set of actions to take in regard to these very serious problems in our markets for mortgage and municipal debt are actions which center on the instruments themselves and the options with respect to the kinds of assets and liabilities open to the institutions which invest in them. There are a variety of proposals which have been advanced to improve the mortgage as an investment vehicle. These measures are too complex and detailed to be treated in the limited space available. We need a uniform code for all states which would improve and homogenize the mechanics of mortgage lending. Ceilings on mortgage rates, either state usury statutes or FHA-VA ceilings, should be eliminated thereby insuring everybody an opportunity to compete for funds by paying the going market rate on investments. If as a matter of national policy we desire to provide housing to those who can't afford the higher rates, then direct subsidies should be utilized to care for the lower income groups.

With respect to municipal securities we should accelerate attempts to develop Federal financing agencies which will complement the existing public issues of tax-exempt securities by acquiring tax-exempt securities priced to yield tax-exempt rates and issue taxable Federal securities to raise the needed funds. The Federal tax revenue raised in this way will go a long way toward offsetting the operating loss of such agencies. In addition, it will limit the extraordinarily large tax shields now centered on individuals with large amounts of income. Most importantly, however, such a change would allow

the municipal market to compete with the full range of taxable securities on an equal footing. Such taxable federally issued securities would legitimately compete with corporate bonds or direct Treasury issues in the portfolios of public pension funds, or life insurance companies or mutual savings banks (and hopefully savings and loan associations).. They would also be available to individuals as an alternative to other direct taxable assets or claims on financial institutions.

With respect to the thrift institutions we should encourage them to expand the range of liabilities they offer in order to make claims they issue more attractive to savers. We should expand their ability to acquire assets so that they will be able to construct portfolios which offer the levels of return and flexibility of cash flow necessary to issue competitive liabilities.

IMPLICATIONS FOR PENSION FUND LEGISLATION

Because of the subcommittee's specific interest in the implication for financial markets of the growth of pension funds, I wish to address my closing remarks to this specific issue.

Pension funds are but one of a wide variety of institutions which assist in financing this economy. They are but one of the variety of institutions on which households hold the claims which comprise a large part of their wealth. It is imperative that it always be clear that the primary responsibility of these funds is to the beneficiaries. That they can be controlled and used to meet society's needs in no way implies that they should be so controlled. Recommendations that pension funds should be forced to put a certain percentage of their money into mortgages are extremely objectionable. These proposals in effect attempt to make a gift of someone's money to someone else and may result in regressive transfers. Pension funds will buy mortgages if they are currently paying competitive rates. Attempts to force mortgage purchases upon pensions, trust funds and other groups can be considered as attempts to enforce investments at less than going rates. It is not clear why the poor who depend on these pension funds for some of their retirement income should subsidize wealthy home owners and builders. Most considerations of equity would point to the reverse type of transfer payment.

Pension plans form a sizeable part of the total wealth position of over 30 million Americans. However, there are insufficient safeguards to protect the rights of the beneficiary. Pension rights should be vested relatively early. My suggestion would be that after a period of five years, vesting be made mandatory. I believe labor mobility and a more competitive labor market would be encouraged by the provision of portability of the aforementioned vested pension benefits. In addition, incomplete funding of the pension rights poses two problems. Portability is difficult if not impossible to achieve with partially funded pensions. More importantly, partial funding subjects the beneficiary to the risks that he will not receive the full payment of the benefits earned in the event that the contributing employer is unable to meet the continuing payments required by the pension agreement. Given that we have enacted legislation to foster pension plans in order to provide for retirement income, employers should be required to either fund the liabilities they assume or arrange for insurance to protect the earned benefits of their employees.

Finally, it is my view that there is pressing need for more adequate disclosure of the investment performance of both public and private pension funds. It is only recently that the trustees of private pension plans have begun to provide their largest trusts with relevant investment performance reports. Much of this development came from demands of the very large trustors. Those trustors whose trusts do not weigh so importantly in the eyes of the trustee still receive much less sophisticated and relevant information. Given the special interest and responsibility of the Congress in these pension funds, it would seem incumbent upon the Congress to assure that relevant performance statistics for these plans be available to both employer and employee. This information should be available for both public and private plan alike.

In summarizing my comments, I would like to argue that the appropriate legislative program for financial markets and financial institutions and in particular for pension funds is a positive program for improving the efficiency of markets and institutions in attracting and allocating savings. Our efforts should be addressed at removing impediments in our financial markets and

financial instruments and improving competition in our financial institutions, and not at introducing further restraints on our financial institutions, financial instruments, and financial markets.

GROSS ACQUISITION OF ASSETS-HOUSEHOLD SECTOR (PERCENTAGE ALLOCATION)

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Data for 1953-62 from Federal Reserve System, "Flow of Funds Data."
Data for 1900-12 from Raymond & Goldsmith, "Study of Saving," adjusted to conform to levels of "Flow of Funds
Data" in 1945.

Chairman GRIFFITHS. Mr. Murray?

STATEMENT OF ROGER F. MURRAY, EXECUTIVE VICE PRESIDENT AND CHAIRMAN, CREF FINANCE COMMITTEE, TEACHERS INSURANCE & ANNUITY ASSOCIATION AND COLLEGE RETIREMENT EQUITIES FUND

Mr. MURRAY. Thank you, Madam Chairman.

The timeliness of this hearing is readily apparent from the troubled state of the American economy. The process of relieving inflationary pressures and dispelling inflationary expectations is proving to be a painful and severe testing of the effectiveness of our institutional arrangements for the execution of economic policy. Also the stakes are high; have we the ability to direct our tremendous vitality toward realization of our goals of a rising standard of living, in all its dimensions, for all Americans?

Recent experience has again established the central role of the saving and investment process and the functioning of the capital markets in realizing our potential for a high rate of real economic growth. Recurrent crises have occurred when the deficiency of savings has become acute relative to pressing demands for public and private investment. Massive shifts occurring in the process of allocating resources through the capital markets have unbalanced growth and severely rationed the funds available to those sectors not situated favorably to bid aggressively for the deficient savings flow.

It is most appropriate, therefore, to look at the future of public and private pensions as a major savings source in the years ahead. Most of the time, unfortunately, we become so involved in the details. of specific arrangements that we fail to see retirement income programs in their very significant role as major factors in the gathering of savings and the commitment of funds to real investment.

1

Research has demonstrated that pension programs actually have a kind of multiplier effect because households covered under public and private pension plans tend to save just as much in other forms as do other households similarly situated except for the lack of pension coverage. That is to say, because people do not substitute pension saving for saving in other forms, pension saving becomes a net addition to personal saving. Without the tremendous growth in public and private programs other than OASDI, therefore, personal savings would have been significantly lower over the past two decades. Furthermore, since it appears that old-age survivors, and disability insurance programs tend to reduce personal saving on balance, the substitution of social security for voluntary employee benefit programs would have made the shortage of savings even more acute.

Unfortunately, however, the past lift given to the saving ratio is losing force. In the next decade benefits will be rising much more rapidly than contributions as plans become more fully funded and more mature. The substantial rise in interest rates, moreover, has made possible a materially higher level of benefits per dollar of contributions. What lies ahead is a period in which retirement saving rises in absolute amounts but at decreasing rates.

It would be good economics to spur all efforts to extend pension coverage as widely and as liberally as possible with the use of tax incentives and the employment of the facilities of all our financial institutions.

The flow of funds supporting future retirement benefit promises to employees of private industry, State and local governments, and nonprofit institutions reached some $16 billion last year, about 30 percent of all of the private domestic sources of funds in the capital markets. This total was allocated about two-fifths to fixed-income investments and three-fifths to equities, continuing the growth in the role of common stock and real estate holdings in pension fund asset structures. Major factors in recent years have been the substantial increases in life insurance company separate equity accounts for insured plans, the rapid rise in common stock investments by State and local government systems, and the emerging importance of variable annuities.

This is a prompt response to market forces as the demand for equity capital to finance business growth has grown rapidly. To illustrate the point, as recently as 1964-65, equity capital raised through net sales of common stock and retained earnings provided 65 percent of the total increase in long-term capital provided to nonfinancial corporations to finance plant and equipment outlays and working capital needs. Retained earnings alone were ample to margin the 35 percent raised by borrowing. In 1968-69. in contrast, flat retained earnings, even when supplemented by many more stock issues, were sufficient to cover only 50 percent of total capital raised. Increasingly. new stock issues, convertible bonds, and bonds with warrants have had to be employed to maintain balanced capital structures and to avoid a more serious deterioration in the quality of

1 This is one of the major findings discussed in the author's Economic Aspects of Pensions: A Summary Report, National Bureau of Economic Research, New York, 1968.

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