MORTGAGE CREDIT

MONDAY, JUNE 12, 1967

U.S. SENATE,

COMMITTEE ON BANKING AND CURRENCY,

SUBCOMMITTEE ON HOUSING AND URBAN AFFAIRS,

Washington, D.C.

The subcommittee met at 10 a.m. in room 5302, New Senate Office Building, Senator William Proxmire presiding.

Present: Senators Sparkman (chairman of the committee), Proxmire, Muskie, and Mondale.

Senator PROXMIRE. The Housing Subcommittee of the Banking and Currency Committee will come to order.

Before we begin, I would appreciate it if the entire panel would come up to the table, not only for the purposes of convenience and expedition, but also to have a better colloquy and a more stimulating give and take among the members of the panel. So I would appreciate it if Mr. Dervan and Mr. Bertsch would join Mr. Weaver and his associates.

Mr. Dervan, would you bring your assistant?

The hearings today are the beginning of a second phase of the Housing Subcommittee's study of mortgage credit. The first phase was completed upon the publishing of a compendium of 30 papers written by Government, industry, and private individuals on the subject.

The purpose of the study is to learn all we can about the deplorable 1966 mortgage credit experience and to obtain recommendations on the action to take to avoid recurrence of this experience and to provide an adequate flow of mortgage credit to meet the housing needs of our expanding population.

Since 1950 we have had four so-called tight-money periods with serious adverse effects on the availability of mortgage credit for home financing. The 1966 experience was the worse in sharpness of decline of credit and reduction in housing starts. New residential mortgage credit was $7 billion less in 1966 than in 1965, and housing starts were off 19 percent from the previous year.

A serious byproduct of the credit shortage was the exorbitantly high interest rates charged home buyers during this period. The national average reached 6.5 percent with some areas having contract rates well over 7 percent.

The discount point system became widely used, not only for FHA and VA loans, but also for conventional loans. Discount charges generally were made to increase the yield on fixed interest rate mortgages, but in many cases points were paid to the mortgage broker as a finder's fee.

The Housing Subcommittee distributed earlier this year a report on mortgage discounts prepared by the Department of Housing and Urban Development.

The papers submitted to the committee contain a variety of recommendations on the problem of mortgage credit, but were on three principal subjects:

1. The need to establish a Federal policy on mortgage credit and the working arrangements within the Government to implement this policy. This would include a policy on the proper use of fiscal and monetary powers, on the use of Treasury funds to back up mortgage purchases, and a decision on interest rate and dividend rate controls. 2. The strengthening of the FNMA system to back up the FHA and VA programs during tight-money periods. This would include changes in the present arrangements to increase FNMA's borrowing capacity, to enable it to sell more of its portfolio in good times so that it would have more resources in tight-money periods, also to increase its coverage to buy and sell conventional mortgages.

3. The strengthening of the Federal Home Loan Bank system and its member thrift institutions. This would include the possibility of both wider borrowing authority and wider investment authority of savings and loans associations and mutual savings banks.

There are many other recommendations, some of which require legislative changes, but most of which can be carried out on the administrative level.

It is the purpose of the hearings today to review the recommendations with officials of Government agencies. This morning we have the ranking officials from the three operating agencies, the Department of Housing and Urban Development, the Veterans' Administration, and the Farmers Home Administration. These could be considered as consumer-type agencies in view of their dependence on an adequate flow of mortgage funds to carry out their administrative responsibilities. This afternoon, officials from agencies which have responsibil ity for developing the policy on mortgage credit flows and in many respects hold the key to adequate funds will appear before us.

And our initial witness this morning is a very distinguished member of the Cabinet and an old friend of this subcommittee, Hon. Robert Weaver, Secretary of the Department of Housing and Urban Development. And, Secretary Weaver, if you would, present the members of your Department who are appearing with you this morning. STATEMENT OF ROBERT C. WEAVER, SECRETARY, DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT; ACCOMPANIED BY PHILIP N. BROWNSTEIN, ASSISTANT SECRETARY FOR MORTGAGE CREDIT-FEDERAL HOUSING COMMISSIONER; WILLIAM B. ROSS, DEPUTY UNDER SECRETARY FOR POLICY ANALYSIS AND PROGRAM EVALUATION; AND HENRY B. SCHECHTER, DIRECTOR, OFFICE OF ECONOMIC AND MARKET ANALYSIS

Mr. WEAVER. On my right is Assistant Secretary Brownstein, who is also the Commissioner of FHA. To my left is Mr. Schechter, who is our principal housing economist, and on his left is Mr. Ross, who is the Deputy Under Secretary.

Mr. Chairman, it is a privilege to appear with this panel of Federal administrators of housing programs in the first session of the subcommittee's series of hearings on mortgage credit.

Those of us who have been close to the mortgage market over the past few years and who have watched the recent cycle of scarcity in mortgage funds must necessarily be impressed with the extraordinary complexity of the problems. This complexity extends both to the causes of mortgage fund shortages and to the resulting impacts upon real estate financing and housing construction.

The fundamental strengths and weaknesses of our residential finance system are more clearly revealed by such testing experiences, and it is desirable to reexamine them while we still have fresh memories of how badly the roof leaked.

This subcommittee is a particularly appropriate forum for such a review, and the papers already submitted by participants represent impressively incisive analyses. I am confident that the series of panel explorations of the wide range of remedial suggestions will be equally revealing and helpful.

The paper submitted by my Department was only one of several which stressed that the mortgage market problem has two distinctthough closely interrelated-facets: The secular trend in the longrun position of mortgages in competition with other demands for investment of the flow of savings, and the cyclical problems resulting from abrupt, short-run shifts in the supply of, or competitive demands for, these savings.

Clearly, short-run flows of mortgage funds can temporarily-but only temporarily-conceal fundamental changes in the way in which the Nation's savings are channeled into investments to the ultimate advantage or disadvantage of residential finance.

Equally clear, the housing industries will fare best in the seemingly inevitable monetary cycles if the basic attractiveness of mortgage investments is strong.

Thus, the emphasis in our thinking has been placed on improving the comparative advantage of residential finance instruments over alternative investment media. This is not a path strewn with quick and spectacular results, but we firmly believe it is the only path that will lead to sound, constructive, and-above all-lasting mortgage market improvements of the type this subcommittee, the industry groups, and the Department believe to be necessary.

As background for considering the longer run housing capital problem, our paper presents some normative projections of the demand for, and potential supply of, housing funds to the year 1975.

Let me stress that these projections are not predictions but rather extrapolations of what the existing institutional framework could produce if recent patterns of economic behavior could be assumed to persist unchanged.

Essentially, our projections show what could happen with

(a) A near full employment economy growing at 4 percent a year in real terms accompanied by moderate price trends;

(b) Sufficient expansion in the Nation's money supply coupled with continuing trends of increasing velocity of money; and

(c) A pattern of net savings inflow into the Nation's financial institutions that approximates the experience of 1962-65 in relation to the gross national product.

Against this version of the overall economy, we have compared the potential demands from other major sectors of the capital markets including

(a) Municipal securities;
(b) Corporate securities;

(c) Treasury securities; and

(d) Federal agency securities.

The remaining funds potentially available, under these assumptions, to the financial institutions would appear to be adequate to finance the mortgage requirements arising from a volume of new residential construction which takes into account the amount of housing needed to— (a) Accommodate the increasing population;

(b) Replace losses from the housing supply;

(c) Accommodate population shifts;

(d) Allow for an increase in vacancies proportionate to the large housing supply; and

(e) Replace all dilapidated units from the occupied housing supply by 1976.

The results of these projections support some optimism that our problem is soluble. There is reason to believe-—

1. That a stable, growing economy can generate an adequate supply of savings; and

2. That mortgage-oriented financial institutions can attract the share of savings needed for residential finance purposes.

But this optimism cannot become complacency. Clearly, the pattern of economic growth will be less steady and less stable than we have assumed. And clearly, the competition for access to the supply of investable funds will resume when pressures on the respective financial institutions make it profitable or necessary.

There is a continuing need to improve the competitive position for long-term investments in housing and related facilities. We must deal (1) with features of the basic investment instruments themselves; (2) with alternative instruments; (3) with strengthening the financial institutions which have housing investment orientations, and (4) with the basic determinants of total economic and monetary conditions. Some innovational steps have already been taken. The FHA and FNMA have participated on a limited scale in the issuance of bonds rather than a single mortgage to finance multifamily housing projects. The FNMA now has extensive experience in the issuance of certificates of participation against pools of federally held loans. Both of these devices are intended to be attractive to investors who would normally avoid direct holding of mortgages.

While we have reached no conclusions as yet, the Department is exploring several other devices with potential attraction for the reserves of pension and retirement funds. One suggestion is to establish wholly owned subsidiaries of private financial institutions which would be authorized to issue long-term bonds, with the proceeds to be used to buy mortgage loans from financial institutions.

A second suggestion would be to establish a private institution, which would issue long-term bonds with the proceeds to be loaned to existing savings institutions on a long-term basis; and these institutions, in turn, would invest the money in mortgages.

A third suggestion would permit savings institutions to issue longterm obligations to counterbalance their vulnerability to large-scale withdrawals of interest-sensitive savings.

A fourth proposal would expand the use of bonds to finance FHAinsured multifamily residential projects.

A fifth proposal would involve the assemblage of sizable packages of FHA-insured or VA-guaranteed mortgages, with bonds to be issued against the pool of federally underwritten loans. Under a variant of this proposal, since the underlying security for the bonds would be federally underwritten mortgages, the FHA insurance would be formally extended to the bonds.

Among the considerations to be examined is whether the large investment banking firms can be induced to underwrite such housing bond issues and to deal thereafter in the secondary bond market. The feasibility of any of these proposals, however, rests upon the interest rates at which these bonds can be sold and the additional costs occasioned by an interposition of another layer between the homebuying borrower and the ultimate lender. These matters are undergoing further study.

In the institutional strengthening area, the administration has proposed the Federal chartering of mutual savings banks to expand the use of this form of mortgage-oriented savings institution.

From these hearings and from our own continuing consultations with investor groups, we are hopeful that some improvements in the mortgage instrument itself can be identified for further development as well as new or improved intermediary instruments and institutions. As most of your contributed papers indicate, however, housing finance will continue to be unusually vulnerable to monetary cycles as a result of its particularly heavy dependence upon long-term credit. Our paper, and our report earlier this year on the mortgage discount problem, have shown the impact of monetary conditions upon housing generally and upon FHA-insured housing through 1966. In brief, the data show for the year as a whole:

A 19 percent decline in total construction starts for privately financed nonfarm dwelling units;

A 37 percent decline in applications for FHA insurance on purchases of existing homes;

A 58 percent increase in mortgages offered to FNMA for purchase under secondary market operations; and

A 24 percent increase (December 1965 to December 1966) in estimated yield on FHA-insured home mortgages.

It belabors the obvious to point out that these indicators clearly reveal the disproportionate burden which housing bore in the economic adjustments of the past year. The cyclical vulnerability of housing gives the industry a particularly heavy stake in economic stability in general and of course-in the achievement of that stability to the maximum possible extent through fiscal rather than monetary actions. Nevertheless, there are some possibilities for helping housing adjust to the more sudden monetary changes if these cannot be entirely avoided.

First, several programs of FHA-insured mortgages have interest rate ceilings which are lower than the general maximum. These mortgages, as a result, are unduly handicapped in competing for mort