Senator BROCK. We have several panels of witnesses. First, we will hear from the bank regulatory agencies. I am particularly delighted that we have with us the Honorable Hugh F. Sinclair, the commissioner of banking from Tennessee.

Next we will receive testimony from borrowers and lenders from the affected states.

Should we not be able to complete the testimony this morning, we will go over to 2 p.m. this afternoon. It will be appreciated if each witness will confine his opening statement to five minutes. We have your complete statements which will be made part of the record.

I would like to welcome Mr. James Smith, the Comptroller, Governor Bucher of the Federal Reserve, and Mr. Grady Perry of the Federal Home Loan Bank Board.

Gentlemen, I very much appreciate your being here and am looking forward to your testimony.

Mr. Smith, if you'll start, or whichever one you want to start.

Senator SPARK MAN. May I just say this: You say it might extend over to 2. I hope you find it possible to run through and finish. You and I have a housing conference at 1:30.

Senator BROCK. Well, yes, all right, we'll finish this morning, then, if we can.

Please proceed.

STATEMENT OF JAMES E. SMITH, COMPTROLLER OF THE CURRENCY; JEFFREY M. BUCHER, MEMBER, BOARD OF GOVERNORS, FEDERAL RESERVE BOARD; AND GRADY PERRY, JR., MEMBER, FEDERAL HOME LOAN BANK BOARD

Mr. SMITH. Thank you, Mr. Chairman.

It is always a pleasure to appear before this committee and its respective subcommittees and it is especially a pleasure to appear today in support of S. 3817.

I will endeavor to summarize my statement which the committee has and ask that it be printed in full in the record [see p. 15]. I would also like to say at the outset, Mr. Chairman, that I have been advised by the Office of Management and Budget that the views which I am expressing this morning for the Comptroller of the Currency may also be regarded as the views of the administration in this matter.

Briefly described, S. 3817 proposes to amend the National Bank Act, specifically 12 U.S.C. 85, with respect to national banks and make corresponding changes in the Federal Deposit Insurance Act and the National Housing Act so as to permit all federally insured banks and savings and loan associations in lending and discounting to corporate borrowers to charge maximum rates of interest not to exceed 5 percent above the currently prevailing Federal reserve discount rate on 90-day commercial paper.

At present, as you know, the discount rate is at 8 percent, which would mean that this bill would permit a maximum rate of interest of 13 percent irrespective of the State law in which the lending institution has its principal offices and is extending the credit. We believe S. 3817 finds a very ample precedent for its provisions in a provision of the National Bank Act, namely 12 U.S.C. 85, which has been on

the books for some 40 years, since 1933, and which today permits national banks alone to charge a rate of interest not to exceed one percent above the discount rate, irrespective of prevailing State law.

We are aware, and I know that the sponsor of the bill is aware, that historically the division of governmental authority as between. the Federal Government and the State governments with respect to regulation of maximum contract rates of interest has left the regulation primarily with the States.

And we would not today be supporting this departure, if you will, from a rather well-established precedent if we did not think that there were clear and necessary circumstances which demanded Federal intervention.

There are a number of States in which the contract ceiling rates of interest provided either by State constitution or State statute law are at levels which do not bear a realistic relationship to prevailing commercial lending rates in today's financial environment. Specifically, we have three States, Arkansas, Montana, and Tennessee, in which that contract ceiling rate is 10 percent, applicable not only to individual borrowers, but to corporate borrowers as well. In two of those three States, namely Arkansas and Tennessee, that contract ceiling rate is incorporated in the constitution of the State and could only be amended by going through the laborious and time-consuming process of constitutional amendment.

As we all know, a 10-percent rate of interest today in terms of corporate borrowing is clearly well below prevailing rates. We have a prime rate today which is at 12 percent and has been at that level for a considerable period of time. You pick up the Wall Street Journal any day and you see prime long-term corporate borrowing occurring in the range of 9 to 10 percent. Any other indices that you want indicate that 10 percent is clearly below the prevailing rate and so the result has been that, in these States, deserving corporate borrowers are today being denied essential credit.

I think it is clear that banks and other financial institutions in these States have endeavored to the best of their ability to continue to serve commercial borrowers, but it is unrealistic, it seems to me, to asume that can be done for any considerable period of time, both from the standpoint of the marginal costs of money which these institutions are having to pay to acquire funds today and also in terms of opportunity costs, if you will, for the application of their funds to alternative sources.

For example, I noticed today in the municipal bond market that the city of New York has isued a tax exempt bond in the range of 7.70 percent. In the Federal funds markets we have had daily prevailing rates in the range of anywhere from 11.5 to as high as 13 and 14 percent in recent weeks.

So on all of these bases it seems unrealistic to expect the financial institutions in these States to continue to extend credit at a level beneath the price of money to them and beneath levels which they could make alternative use of their funds. And it seems to me that the approach that you, Senator Brock, have taken in S. 3817, is a useful approach, a desirable approach. It cracks the precedent of 40 years of law and, speaking for the Comptroller's Office and for

the administration, we would certainly hope that the Congress would see fit to enact this bill and to enact it promptly.

Senator BROCK. Thank you very much.

Mr. Chairman, if you don't mind, we'll let each one testify and then ask them questions.

Mr. BUCHER. It is a pleasure to be here and express our views with regard to Senate bill 3817.

I will summarize the formal statement and ask that the statement be submitted for the record [see p. 17].

The Board has been concerned for some time about the impact which usury ceilings have in the availability of funds in the local credit markets. When limits in specific markets are limited to artificially low levels, the continued availability of credit in these markets is threatened.

There is no question but that the potential for disruption of credit flows in States with relatively low usury ceiling has increased greatly in recent months due to the general increase in interest rates in competively determined markets.

Large commercial banks have been paying rates of 12 percent or more and since July the prime rate charged by money market banks to their best customers has been at 12 percent. It is reasonable to assume that many of the lending institutions in these States are finding it unattractive to lend at the low usury ceiling.

Our information does indicate a noticeable slowdown in business lending at some of the larger banks in Tennessee and Arkansas in the last couple of months and in the last few weeks. Federal funds have traded above a 12-percent range. Thus there are some temptations for banks in States like Tennessee, Arkansas, and Montana to sell Federal funds or to direct their money into more attractive investments rather than lend to local borrowers at the 10-percent ceiling rate. Because of distortions such as these, the Board of Governors strongly encourages efforts to reduce the restraints imposed on local credit markets by usury ceilings. We would prefer that remedial action to correct these inequities be undertaken at the State level.

I know you share that feeling. We understand, however, that in some States this is a constitutional problem which may require considerable time to resolve. In view of this and given the urgency of the problems developing in the credit markets currently, the Board supports the emergency measure you proposed by S. 3817. The Board, however, has reservation about two specific items in the pending bill. First, we strongly urge that the maximum loan rate which institutions be allowed to charge not be tied to the Federal Reserve discount rate. As you are aware the discount rate is a policy rate administered by the Federal Reserve for monetary policy purposes. It is not a market determined rate and at times may not move in parallel with market rates.

Instead the Board would advise that the loan rate be tied to a market-determined interest rate, one which more clearly responds to the changes in credit market conditions. We suggest, for example, that the 90-day treasury bill rate might be appropriate.

The second concern which the Board has with the proposed bill is that the legislation would apply only on loans to corporations and would exclude noncorporate borrowers.

For equity reasons the Board believes that the bill should be expanded to cover all loans for business purposes. If lending institu tions are allowed to charge higher rates on loans to corporations, we can foresee a large diminution in the availability of credit for unincorporated businesses. Available funds will be channeled into higher yielding corporate loans and credit which is already scarce for other borrowers could become virtually unattainable.

With the inclusion of these two modifications, tying the loan ceiling to a market rate and not the discount rate and expanding the coverage to all business loans, not just corporate loans, the Board favors proposed legislation as a productive and desirable emergency measure that should help to ease disproportionate credit constraints in certain local markets.

Senator BROCK. Mr. Perry.

Mr. PERRY. Thank you very much, Mr. Chairman.

The Board has been concerned about the impact of archaic State usury laws for sometime and with today's high interest rates the problem has become acute. These State laws set maximum interest rates that are unrealistic in view of prevailing market rates and thus seriously restrict the availability of credit in those States.

Many States with unrealistic usury ceiling either set a higher rate. for corporate borrowers or completely exempt them from the usury ceilings. In such States individual mortgage borrowers are finding funds unavailable because of usury ceilings in many more States than are corporate borrowers. At the present time new commitments for home mortgages are being made at interest rates of 9 to 10 percent. Yet many State usury laws establish a rate at 9 percent or lower.

It is an economic fact of life that lending institutions will invest their money at the highest yields available and, where possible, will withdraw from mortgage lending if necessary to obtain higher yields. Such mortgage lending as they engage in will be concentrated in those jurisdictions in which they can obtain a fair interest rate. They will avoid or limit mortgage lending in a jurisdiction whose laws prevent the making of loans at the prevailing rate especially when it is costing them more than the usury limit to obtain funds from

savers.

The charging of points and other service charges is a way to achieve a market return where a usury law sets a below market ceiling and the statute does not prohibit such charges. When such charges are inflated because of a usury ceiling, the result is discrimination against lower income borrowers because this practice increases the "front end" out-of-pocket cost of purchasing a home.

Most of the arguments against restrictive usury ceilings have centered on the negative impact on new home construction. This is, of course, a serious matter because of the need for new housing resulting from household formation. However, there is also an adverse impact on those who wish to buy and sell existing homes. A homeowner who has to sell his house because of a change in job or the needs of a growing family is strongly penalized. A seller is often forced to take back a second mortgage in conjunction with an assumable mortgage or to finance the first mortgage himself, but not all sellers can do this, nor are these practices always sound.

In the present market a homeowner forced to move often finds himself an unwilling landlord who must hold on to his own house and rent it in the hope that mortgage interest rates will eventually come down to the usury ceiling.

Ironically, it is the lower income home-purchaser who is hurt more than the upper income purchaser. This is because lending institutions will often make mortgage loans at a restrictive usury ceiling if the downpayment is sufficiently high and the life of the loan sufficiently low so as to make the mortgage a prime investment that can justify a low yield. However, the lower income buyer can typically only purchase a home with a low downpayment and a long maturity.

Restrictive usury ceilings not only have a perverse effect on the people that they are supposed to help but are completely unrealistic in an economy characterized by a high rate of inflation in which long term interest rates reflect an inflationary premium. If the expectation is for an inflation rate of 7 percent per annum, the real rate of return to a lender only represents that part of the interest rate in excess of 7 percent. From the point of view of a home buyer, a high interest rate mortgage is better than no mortgage if houses are expected to appreciate in price significantly because of inflation.

Given this situation, the Board supports enactment of S. 3817. The bill would benefit certain builders and other corporate borrowers who do business with FSLIC-insured savings and loan asosciations. The Board recommends that the bill be amended to extend its provisions to unincorporated builders. Such an amendment would not substantialy broaden the scope of the bill since loans to builders are business loans. The Board further recommends that you consider the problems that usury rates post for individual home buyers and sellers, although this may be beyond the scope of the present hearings. The bill would be primarily of benefit to banks, which have many corporate clients. Most borrowers from savings and loans, of course, are individuals. With respect to individuals, national bank already enjoy a competitive advantage insofar as they can override State usury rates when the discount rate plus 1 percent would be a higher rate.

Legislation establishing an alternative Federal usury ceiling on long term mortgage loans could provide for a rate an appropriate number of percentage points above a long term benchmark interest rate, such as an average interest rate on long-term U.S. Government securities. For mortgages, this would be preferable to the standard used in S. 3817 since short-term rates fluctuate far more sharply than long-term rates.

We realize that this bill and our proposed broadening of it concerns a matter ordinarily considered within the purview of State law. However, present law gives national banks some advantage over State banks, and we believe that it is appropriate that the bill supply to State chartered FDIC-insured banks and State chartered FSLICinsured savings and loan associations so that the competitive relationships between Federal and State chartered banks and savings and loans will be preserved on a basis of substantial equality. We regard the problem created by usury ceilings as a matter of urgency which should not await the determination of the various State legislatures.