(a) The adoption of a wider variety of liability instruments by more thrift institutions. Longer term certificates and special time accounts paying higher rates, but with a larger penalty on withdrawal, were very useful this past year.

(b) The use of more flexible liquidity or secondary reserve requirements.

(c) The introduction of more investment options should be carefully analyzed as should the Federal chartering of mutual savings banks.

(d) The Federal home loan bank system should consider the use of longer term bonds based on similar length advances, as well as the possibility of furnishing more flexible short-term credit.

There are major risks when institutions borrow most of their money in the short-term market and lend long. The dangers of these policies increase when investment funds are attracted from other markets since such funds flow among outlets primarily on a basis of relative returns alone. A structure of differing rates on varied types and maturities of liabilities can reduce the average cost of funds while helping to insure their availability in times of need. Similarly a variety of assets can increase flexibility.

4. More thought is required of the logic and procedures to be used when public measures are adopted in an attempt to ease directly the impact of tightening general credit conditions on the availability or price of residential mortgage credit. Care must be taken to insure that such measures do not have undesired results opposite to those intended through increasing prices and inflationary pressures. Furthermore, we believe that the extent and form of the subsidy element involved in such proposals should be carefully considered and revealed. Many schemes which involve subsidized credit may work to penalize those most in need of housing while subsidizing those with more than adequate funds to cover their own requirements.

Mr. Chairman, I am very pleased to be here this afternoon. I welcome any questions either on the paper submitted by the Board of Governors or in my individual capacity on any of the many interesting questions raised by your compendium.

The CHAIRMAN. Thank you very much, Mr. Maisel.

Next we will hear from Mr. Schwartz of the Home Loan Bank Board.

STATEMENT OF HARRY S. SCHWARTZ, ADVISER TO THE BOARD, FEDERAL HOME LOAN BANK BOARD

Mr. SCHWARTZ. Mr. Chairman, it is a privilege for me to appear on behalf of the Federal Home Loan Bank Board to discuss the Board's report on mortgage credit. As the report indicates, it was developed as a staff analysis. The Board approved its transmittal and generally accepts a good many of the findings but, in some cases, its agreement is tentative and the Board remains open-minded on the degree to which some suggestions should be adopted or pursued.

The report attempts to review the developments in the mortgage market in the 1950's and 1960's to determine how well the mechanism has functioned. In general, it finds that the supply of mortgage credit

has been adequate. This is evident from the substantial volume of residential construction and the reduction of backlogs of demand which existed even in 1950.

The report finds that there have been four periods since 1952 in which housing activity has declined principally because of mortgage market conditions and 1966 was the most dramatic of these periods.

The curtailment in mortgage supply has been due to tight credit conditions generally resulting from restrictive monetary policy. In evaluating these episodes, it is necessary to bear in mind that the mortgage market is the largest single user of funds, and even if we confine our observations to the home mortgage market, we find that home mortgage debt, in the period 1952-66, accounted for 26 percent of all funds raised in credit markets and 42 percent of long-term private debt.

It is not surprising, therefore, that stringent monetary conditions cause restriction or even reduction in the availability of mortgage funds. The basic difficulty is that the mortgage market usually absorbs a larger share of the effects of tight money than is the case for most other financial markets.

Prior to 1966, most of the decline in mortgage lending resulted from reductions by lenders other than savings and loan associations, and a large part of the reduction occurred in the FHA and VA mortgage areas. Last year, however, the sharpest drop in lending was recorded by savings and loan associations. This reflected, in addition to credit stringency, more severe competition for savings from commercial and mutual savings banks than in the past and greater competition from market instruments. Because of the very pronounced impact of last year's events on savings and loan associations, most of the decline in mortgage financing was in the conventional rather than the FHA and VA area.

Many suggestions have been made for remedying the situation. The report attempts to evaluate some of those which have been most prominent. The assessment has attempted to test the cost of the various proposals, he probability that they would increase the supply of mortgage funds in a tight credit market, and any related consequences. In general, the report finds that a number of the proposals, based on evidence available for our economy and some European economies, are not too promising. Costs may be too high, the probability of increasing the supply of loanable funds is usually far more limited than a first glance review may suggest, and the proposals introduce other issues that need careful consideration.

In the case of suggestions for new types of organizations in the mortgage market, the cost of funds to such organizations when credit is tight may be too high to permit effective operation. What is more, the proponents of one of these plans for conventional mortgages have suggested an increased in the supply of mortgage credit which, even if we can accept it, would not make a sufficient contribution to dealing with the central issue of tight money. These comments do not apply to Federal charters for mutual savings banks which the Board has endorsed in other statements.

The recent proposals to tap pension funds through the issue of various special instruments seem to run counter, to a large degree, to investment preferences of those funds, though it should be said

that there is some possibility for obtaining greater direct participation in the mortgage market by these funds.

Another recommendation involves the issuance of long-term savings accounts or long-term debt issues by savings and loan associations. The first of these is already possible but no great degree of interest is evident in such accounts. The long-term debt approach poses some difficult questions that cannot be answered satisfactorily and, in the case of German mortgage banks, which do issue such securities, stringent credit market conditions have had a severe impact on their ability to raise funds.

Variable interest rate mortgages, another proposed scheme, have not been as successful as an abstract view of this scheme would sug gest. Experience in England, cited in the report, reveals some of the problems.

While the Board accepts these findings as of now, it reserves its position on these recommendations to permit further study. It has, in fact, directed that a special study be made of the long-term savings account and debt instrument for savings and loan associations. That study is to be conducted this summer.

The report reviews three proposals which appear likely to make for a better response to tight money by the savings and loan industry and the Federal Home Loan Bank System. These proposals are endorsed by the Board and to some extent in other reports to this committee. These are:

1. Better liquidity management by savings and loan associations, with a recognition that liquidity should be built up when credit conditions are moderate so as to provide a buffer when credit is tight.

2. Greater flexibility on the part of the Federal home loan banks through the development of a larger liquidity pool and the use of more medium- and long-term debt.

3. The possibility of requiring member institutions to keep part of their liquidity with the Federal home loan banks in order to provide the resources on which to build a broader liquidity pool. The Board believes this set of steps would be more effective than other suggestions, but does not exclude the possibility that some other proposals may be beneficial.

The CHAIRMAN. Thank you, Mr. Schwartz.

Senator Proxmire, I announced in the beginning that there is to be a rollcall at 3:30 and there will be at least one more after that.

I started the hearings before the other Senators got here in order that we might hear the statements. Now we have gone through the three statements and I propose we ask questions now, and we can ask them of any specific one or put it to the whole panel. Do you have some questions?

Senator PROXMIRE. I would like to ask the whole board questions along the line I was asking them this morning, because I think all of us are very much concerned with the experience we had in 1966 when we had a tight money situation that was especially disastrous for homebuilding.

Of course, this is one of the reasons for these hearings, I presume. This morning we got the impression, or at least I got the impression from Mr. Weaver and Mr. Bertsch and the VA people who were here

that there hadn't been any significant substantial institutional change since the first half of 1966.

There has been an increase in the capacity of FNMA to relieve the mortgage market. There are some very alarming economic developments, including the estimate by the chairman of the Ways and Means Committee that we might have a deficit as high as $30 billion this year, might have.

And as I go over this, the Joint Economic Committee staff tells me they wouldn't be surprised if it were close to that. With the Vietnam war continuing, it would seem that we might very well have something like a repetition of the situation we had in 1966. It will be necessary to keep the supply of money reasonably tight, or we are going to have inflation, if we have anything like this kind of deficit, even half of that kind of deficit, we might very well have problems of this

sort.

I would like to ask first if you gentlemen can think of alternatives you haven't mentioned. One thing that occurs to me is the possibilities of standby consumer credit controls, for example. We have had that in the past. This would tend to some extent to diminish the pressure on demand for prices. It might mean the funds would tend to go into the mortgage market instead of the consumer credit area.

Mr. BARR. Senator, at the moment we see no reason to consider standby controls, especially in light of the fact that our plants are not operating near the rate that they were last year. Our labor supply seems to be getting quite a bit easier. In spite of the fact that the unemployment rate has gone up only slightly, there is an indication that many people have left the labor market because the market was getting a little soggy. They just pulled out of the labor market.

Also, I am sure you have noticed that wholesale prices, basic commodities especially, are much weaker at this time than last year. As far as standby controls or price controls are concerned, Senator, I can make no case for them at this time. We are not considering that. Senator PROXMIRE. I agree wholeheartedly under present circumstances. I could add to this the fact that inventories are still high in relation to sales, and the fact that the big inflationary, one big inflationary element in the past has been business investment in plant and equivalent which increased sharply in 1964, 1965, and 1966, but the most recent estimate is it is below what they even expected a month ago.

So there are contrary elements here. At the same time, I am not talking about June 1967, I am talking about December 1967, possibly the first quarter of 1968, if this deficit does develop, given the kind of relatively tight labor market we have now, and a level of operation which, as you say, is not quite as high as it was before, but is what, 88 or 89 percent of capacity instead of 91 or 92, it seems that there is not a lot of difference in the economy and it is not as much as we have had certainly many times in the past.

I am just wondering what, under those hypothetical circumstances, not now, but under those hypothetical circumstances, if we do develop more stringency, are we going to have to go through this nightmare in the homebuilding industry again, or is there some alternative we can use besides that?

It is obvious that Congress can increase taxes by $10 or $15 billion, and we know that. You don't have to tell us that. It is also obvious we are not going to do what the President recommended last January on the first of July and we may not do it later in the year.

I wonder what else we can talk about.

Mr. MAISEL. May I try this, Senator. Isn't the question you are really asking, given a certain available amount of savings in the economy, what is the most efficient way of distributing that savings? It seems to me that we can't rule out the tax question, because that is a major method of increasing the amount of saving and reducing the problem. If you rule out the tax question, then you have to ask what parts of the economy have resources that you are willing to free for housing? Do you want to cut back on the automobile industry? Probably not unless you are overusing the resources of the automobile industry. It seems to me you wouldn't want any sort of consumer credit control, unless you first determined that autos were in an inflationary situation or that there were resources in the automotive industry that you wanted to free for defense production or for Vietnam or similar areas. I don't think you can answer it in a global manner. There are certain selective credit controls which might possibly free particular

resources

Senator PROXMIRE. That puts the question very well.

Mr. MAISEL. If asked that way, I would say clearly there are possible controls, but I don't think the circumstances you are projecting would make their use logical. They would be a very expensive way of avoiding a tax increase. I think a much more efficient and cheaper procedure for the economy would be to recognize what the problem is, where extra demands are arising, and what we need to do to get the extra savings. Everything we know says that the Government, if it wants to save through taxes, is a much more efficient saver than individuals.

Senator PROXMIRE. I don't mean to avoid a tax increase. I think we will probably end up with a substantial tax increase. But what I am talking about is what are the other actions which can be takensay, we have a $10 billion tax increase. We still might have a fairly substantial deficit, still have inflationary pressure, we still could require the Government to be in the market borrowing a substantial amount of money and under circumstances that might tend to drive interest rates up.

What are the alternatives available to Congress and to the Government to provide that the available funds are more equitably distributed among the lenders than was true in 1966?

Mr. MAISEL. Well, I think the types of actions we have listed in our statement are really of the other sort, which I would prefer. They go to the point of how to make the mortgage market more competitive, how you make it able to go in and pay the price needed to get money.

Along this line the "Q" ceilings did, I think, give the thrift institutions an important competitive edge into the total savings pool, and that is really what we are talking about.

Second, the experience of last year showed clearly that the Home Loan Bank and FNMA were able to come into the market and increase in a major manner the flow of funds into the mortgage market. I think if we were to face another mortgage shortage we would