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March H , 1950.

Dear Bill:
I a enclosing herewith two sets of the following papers:
m
1.

General statement covering the housing legislation
entitled "S 224611 j

2.

An appraisal of the principal provisions of Title
I I I of S 2 4 6 as referred to on page 6 of
2*
the general statement;

3.

A statement by m covering "The Effects of Housing
e
Finance on Federal Reserve Policies". This
statement you can use as your own or put i t in
the record, i f you choose to, as a statement
by m given to you at your request.
e

The general statement is not as effective as I would like i t
to be, but i t is the best that could be done in the time limitation.
I hope i t will be of assistance to you.
Sincerely yours,

M* S. Eccles.
Honorable William J. Fulbright,
United States Senate,
Washington, D* C.




March 14, 1950

S. 2246
S. 224.6 is the latest, and probably not the last, of a series
of legislative actions and proposals designed to provide special Government aid to enable the American people to obtain housing of higher
quality and at lower prices than might be available without such aid.
The major question is whether this chain of development, in
which S 2246 is the latest link, has gone further than is necessary and
is leading to establishment of special privilege groups and to the accumulation of financing procedures which will operate as inflationary
stimulants with the danger of overbuilding and subsequent collapse of
values.
The early actions of the Federal Government to intervene in
housing problems were reasonably successful before the war in achieving
their purposes, which were mainly to encourage the formation of stronger
mortgage financing institutions, to secure greater mobility of funds
available for mortgage lending, to relieve distress—on the part of
both mortgage lenders and debtors—and to provide a method of distributing
the risk of home ownership and financing in such a way that people would
be willing to take their proper share of the risks.
Before the war, the Federal Housing Administration was successful in achieving a distribution of risks which made for wide acceptability of insured mortgages. This led to the use of the insured mortgage
as a device by vhich the Federal Government assumed the risk of emergency
building during the defense and war periods, and since the war, the
Government has continued to assume a larger part of the risks of lenders
and builders than was necessary or desirable.
The prewar progress toward raising standards of construction
has been halted, and the Government has become a party to lowering
standards, and shares the risk of this deterioration with the borrowing home owners. In the case of rental housing, the owners do not
even share the risk, the Government carries practically a l l of i t .
The borrowing home-owner has been encouraged to overlook his
risk by being able to obtain insured loans almost large enough to cover,
in many cases, the entire cost of the property, and by having his monthly payment cut—both through low interest rates and through long amortization periods—to a level that is in many cases less than the cost of
renting.
All of this has been done with the object of broadening the
market for housing* Toward the end of the war i t was decided that the
market had been made so broad that veterans returning from the services
would not be able to compete successfully for housing. So an entirely
separate program, providing s t i l l easier financing terms, was provided




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for veterans—but without curtailing any of the easy terms on new housing available to non-veterans.
Maximum interest rates have been legislated at a level which
is so low as to stimulate demand beyond the supply of savings available .
So the Government is forced to advance the funds through Fanny May,thus
adding to the Government deficit and inflating the cost of housing. I t
is now proposed in S 224-6 that the Veterans Administration have power to
make direct loans, using additional Government money. Maturities have
been lengthened so that twenty-five years has become common, and, under
s m programs, thirty years is possible.
o e
This easing of terras has been introduced at a time when demand
would have been strong enough in any case to absorb the supply of housing
that could be made available. People wanted houses. Enough of them had
funds for larger down-payments, and had sufficient incomes to support
larger monthly payments.
I t has been argued that not every family could have met the
more traditional terms. This is true, but i t is also true that even under
the best of circumstances, not every family can have a new house. The
supply of housing can be increased only slowly, even when building goes
forward at capacity. The million houses built in 19A9, for example,
added only about 2 1/2 per cent to the total supply. The bulk of the
families must depend upon existing houses for their homes.
When demand for housing rises rapidly, as i t did after the war,
building is stimulated. But building cannot be increased indefinitely.
When demand increases faster than building can increase, consumers are
bidding against each other for land, labor, and materials to build new
houses, and for possession of old houses.
So the fact that not every family could have met more traditional
mortgage terms does not mean that the easier terms got many more families into
houses. Under more traditional terms, many families would not have been
in the market. With the easier terras, many families have been priced
out of the market. More houses may have been built since the war in the
very strong market which Federal programs have helped to produce than
would otherwise have been built. But i t may be doubted that this additional
building will compensate for the inflation of building costs and property
values which has also resulted.
Problems have been raised for the future. W have used exe
tremely easy terms during a period of high economic activity and demand
for housing, when people had large amounts of accumulated savings. What
terms shall w offer in a period of lower economic activity or slack dee
mand for housing, or when people's savings are smaller or needed for
other purposes? W may very well find that the cheap credit w have
e
e




-3-

offered in recent years will turn out to be very expensive.
These programs have not only created inflation in the housing
market, but have also added to general monetary inflation. Widespread
extension of credit on mortgages, stimulated by the Federal programs, has
resulted in over-all monetary expansion. At a time when Federal Reserve
authorities were attempting to restrain inflationary pressures by appropriate actions to make credit more difficult to obtain, insurance companies
and other investors in Government securities have been encouraged to sell
such securities and obtain insured mortgages. The Federal Reserve has had
to support the market for Government securities and indirectly that for
insured mortgages. In this process additional inflationary bank reserves
have been created.
S .224.6 continues these developments
S.224-6, in a l l of its major provisions, would accentuate the
main developments of recent years. I t would permit Section 608 of the
National Housing Act to expire, but would transfer to various portions of
Title I I many of the provisions for easy terms which were first written
into Title VI as emergency provisions—such as making 90 and 95 per cent
mortgages widely available. I t would increase the number of persons
eligible to borrow under the terms of the Servicemen's Readjustment Act,
and would authorize the Administrator of Veterans1 Affairs to make direct
loans to those eligible to borrow under that Act. I t would broaden the
authority of the Federal National Mortgage Association to purchase mortgages,
and increase the amount of loans the Association might hold.
Altogether, the b i l l would increase the authority for Government
underwriting, buying, or making of mortgage loans by somewhat more than
3.6 billion dollars. But i t does not say that this is the end.
Hasnft the time , c m to stop broadening Government participation
o e
in real estate financing and to revert to the encouraging of private parties
to assume the risks that are rightly theirs as under the prewar F.H.A. plan?
I f this is the appropriate course, is i t proper to make easier
the present financing arrangements?
Is i t proper to provide for further
expansion of operations under existing arrangements? Might i t not be desirable to curtail s m existing programs and substitute in part new proo e
grams under which more risk would be borne by private persons, and less
support would be lent to private obligations? Should not programs be
sought -which will not reinforce booms and add further to the already d i f f i cult job of credit and monetary management?
Title I I I of S.224.6. In part, the provisions of Title I I I reflect
the competitive deterioration of standards which has developed in mortgage
financing programs during the past decade. Just as i t was felt necessary




- u -

to make terms under the Servicemen's Readjustment Act somewhat easier than
those available under the F. H. A. programs of the time, and then to
successively relax terms "under both programs, i t is now felt necessary to
ease terms for middle income families who want to try obtaining housing
through cooperative efforts. I t is difficult to see what other effect
progressive relaxation of terms by Government action can have, or whether
the process can logically stop. Someone is always likely to be priced out
of the market by relaxed terms which sustain inflation. And there will
always be someone who cannot meet even the easiest terms.
Attached is an appraisal of the principal provisions of Title
I I I , indicating the differences between its probable operation and existing
F.H.A. procedures. (The statement by Governor Eccles discusses more fully
the differences between the two programs with respect to their financing
and the effects on the money market.)
The conclusions that may be drawn from an appraisal of the
b i l l and comparisons with existing legislation may be summarized as follows:
(1) The middle income cooperative housing provisions would
within the limits established by the Act stimulate the building
of cooperative projects, because of the more favorable terms, than
would otherwise be available.
(2) These projects would have definite advantages in competition with existing and other newly constructed projects and
would tend to depress the markets for other housing.
(3) Purchasers of the Corporation's debentures would be much
more adequately protected against risk and the inconvenience of
foreclosure ana default than is generally the case for other Government corporations such as Federal Land Banks and H m Loan Banks.
o e
(4) The debentures would be practically the s m as Governa e
ment guaranteed obligations, thus in effect restoring a practice which
was abandoned years ago as undesirable.
(5) Under the guarantees and safeguards now in the b i l l , the
Corporation should be able to borrow in the money market in competition with Government securities at only slightly higher rates.
(6) The effect on the monetary situation of the issuance of
such securities would be practically the same as a Government deficit.
Purchasers would either sell or refrain from buying Government securities in the form of direct obligations. Banks, and to s m extent
o e
the Federal Reserve, would then have to buy more Government securities.
The result would be an expansion in bank credit and the supply of
money, that is, a credit inflation.




-5-

W should be moving away from, instead of further into, the
e
kind of program that has developed toward socialization of housing credit.
Title I I I suitably modified could provide a means for bringing about s m
o e
of the necessary changes.
Amendments which would improve Title I I I of the amendment in
the nature of a substitute for S.2246 are attached.




March 14, 1950

PRINCIPAL PROVISIONS OF TITLE III, S.2246,
A D C M A I O WITH FHA-INSURED L A S
N O P RS N
ON
The National Mortgage Corporation for Housing Cooperatives would
have greater control over the kind of housing i t would finance and the
timing of its operations than existing agencies have for the most part.
The Corporation would be in a stronger position to enforce standards in
the public interest and to audit costs. I t would also be in a position
to minimize the inflationary influences of building i t financed. All of
these advantages could, of course, be nullified i f the program were used,
as other programs have been used, to satisfy housing demands faster than
is economically desirable.
In general effect, the cooperative financing plan is closely
similar to much of the financing now being done with MA-insured mortgages,
although the mechanism used would be different. Under the F A plan, private
H
lenders advance their o n money on mortgages covering either existing propw
erties or properties to be built. The loan may represent not more than 80
per cent of the value of an existing house, as determined by FHA, and i f
S.2246 is enacted may be as high as 90 or 95 per cent of FHAfs estimate of
value in the case of new construction which, according to many, may be equal
to or greater than actual construction cost. The loan may bear interest at
not more than 4> 4-1/2, or 5 per cent, depending on the transaction involved,
and may run for as long as 20, 25, or 32 years.
In addition to interest, the borrower under an F A mortgage pays
H
an annual insurance premium of 1/2 of 1 per cent, in most cases, of the
average outstanding principal. Out of this premium F A pays its operating
H
expenses and sets up a reserve fund to pay losses. Credits to this reserve
have apparently amounted to about l / 4 of 1 per cent of outstanding balances.
I f a mortgagor defaults, the mortgagee has the task of foreclosing. After
foreclosure, he may turn the t i t l e over to MA and in exchange obtain debentures payable by F A and fully guaranteed by the United States, vdiich are
H
negotiable, bear interest at not more than 3 per cent, and mature 3 years
after the maturity of the defaulted mortgage. In practice, F A has called
H
such debentures very soon after issue.
Under the cooperative financing plan, the proposed National
Mortgage Corporation for Housing Cooperatives would obtain its i n i t i a l
capital of 100 million dollars from the Treasury, as other housing agencies
such as FHA, H0LC, and the Federal H m Loan Banks obtained their capital,
o e
and would be authorized to have outstanding eventually not more than 1
billion dollars of debentures. These debentures would not be guaranteed,
but would provide that, i f the Corporation defaulted on its debentures, i t
would exchange them for debentures fully guaranteed by the United States
vjhich would be negotiable, bear interest at not more than 3 per cent, and
mature three years after the maturity of the original debenture.




- 2 -

Cooperative associations or non-profit housing corporations would
be able to borrow from the Corporation only for the construction of housing
for "middle income families"• Before borrowing from the Corporation they
would be able to obtain a certain amount of technical assistance from the
Housing and H m Finance Agency, and, i f the project looked sound, a loan
o e
for planning and development from the HHFA, which would be paid off from
the proceeds of loans from the Corporation,
Property loans from the Corporation would run for as long as 50
years, and would provide for possible extensions to a maximum of 63 years.
The loans would bear interest at the rate determined by the Corporation so
as to cover the cost of money to the Corporation, operating expenses, any
reserves the Corporation might decide on, and a sum equivalent to 1/4 of 1
per cent of the outstanding loan balance to be credited to an "Insurance
Fund11 against which losses on mortgages would be charged.
The maximum amount of loan would be the cost of the borrower1 s
project, but the borrower would buy stock in the Corporation equivalent to
2-1/2 per cent at the time of application, another 2-1/2 per cent on completion of construction, and 5 per cent during the succeeding 20 years. When
the loan had been paid down so that the remaining balance was equal to the
amount of the borrower's stock, the stock could be applied as payment in
f u l l . The report of the Senate Committee on Banking and Currency calculates
that a 50 year loan would be paid off in this way in 36 years. " h n the
We
private capital in the Corporation amounts to one-half of the Government
capital, the Corporation would begin retiring the Government capital.
The attached statement of Governor Eccles includes further discussion of methods of financing the Corporation and its possible effects on
the money market and on Federal Reserve policies. I t also contains a further
comparison with F A procedures and their effects on the money market.
H




March 14, 1950

EFFECT OF HOUSING FINANCE O FEDERAL RESERVE POLICIES
N
Statement Prepared by Marriner S. Eccles,
Member of Board of Governors of the Federal Reserve System
Under Title I I I of Senate B i l l 22^6—the Housing Act of 1950—the
obligations vhich would be issued by the proposed National Mortgage Corporation for Housing Cooperatives would compete directly with Government securities in the money market. They would be purchased largely by banks and
other investors, which otherwise would probably hold Government securities.
As a result, either the Federal Reserve would have to purchase additional
Government securities, thus creating new bank reserves, or prices of Government securities would decline, i . e . , interest rates would rise.
Although the protective aspects of the Corporation's obligations
authorized by the b i l l are designed to be similar to those of F A mortgage
H
insurance, there are important differences between the two. Apart from the
original capital of the Corporation, the funds extended by the Corporation
would be private funds, but the ultimate lender, i . e . , the purchaser of the
debenture, is more adequately protected against difficulties and risk of
loss than is the mortgagee or holder of an FHA-insured mortgage. I f the
Corporation defaults on a debenture, i t itself makes the exchange for a
guaranteed debenture, whereas i f an F A mortgagor defaults on his mortgage,
H
F A makes the exchange of the mortgage for a guaranteed debenture after the
H
mortgagee has foreclosed and obtained title to the property. It would be
reasonable to expect, moreover, that the Corporation would have less occasion to issue guaranteed debentures because, while F A issues guaranteed
H
debentures for every individual mortgage which is foreclosed, the Corporation would not have to issue guaranteed debentures in exchange for its other
debentures until a very large proportion of its mortgages had gone bad and
its capital, surplus, and reserves had been impaired to a point where the
Corporation could not meet its obligations.
For these reasons and because of the other safeguards, the Corporation's debentures issued to obtain new funds should have an even more
favorable market than the obligations of other Government corporations, such
as Federal Land Banks, which are not protected in the s m manner, and would
a e
be in effect the s m as guaranteed Government securities. The competition
a e
which would arise in the market between Government securities and obligations
of the Corporation would, therefore, be very direct. Most of the buyers of
the debentures would be banks, institutions, and other investors that would
probably otherwise hold Government securities.
As the b i l l stands, the Corporation would have a great deal of
discretion about the gross interest rate to charge borrowers and the mortgage maturities to permit* The Corporation would probably be able to borrow
at slightly above the long-term Government rate, and the lowest gross rate
to borrowers might be l i t t l e over 3 per cent, although i t would have the
authority to charge higher rates and build up reserves. On the other hand,



by issuing short-term debentures, the Corporation slight get its money as low
as 1-1/4 or 1-1/2 per cent, vhich might permit a gross rate much lower than
3 per cent.
I f the Corporation were to obtain fmds for long-term mortgage
lending by borrowing substantial amounts on short-term obligations, i t would
not only run the risk of adverse market fluctuations, but i t would in a l l
likelihood obtain these short-term funds largely from expansion of bank credit.
This could be undesirable in a period when general credit policy was directed
toward limiting expansion of bank credit.
In view of the safeguards with respect to capital of the Corporation and insurance reserves against the debentures included in the law, i t
is unnecessary to add the undesirable feature of what is in effect a direct
Government guarantee of the debentures. The Corporation should be able to
borrow on terms just as favorable as the Federal Land Banks and the H m
o e
Loan Banks, which now have no such guarantee. The debentures then would be
more truly of the nature of private obligations and compete less directly
with Government securities.
The practice of issuing securities guaranteed by the Federal Government was abandoned many years ago because such issues c m to be viewed
a e
as practically the s m as direct Government obligations and were an ina e
direct means of keeping the expenditures out of the budget. Issuance of
guaranteed obligations has the s m effect as an increase in the public debt.
a e
Investors buying the new securities might sell direct obligations of the
Government. Either the prices of Government securities would f a l l and interest rates rise or the Federal Reserve would have to support the market by
buying securities, thus creating bank reserves.
Action by the Federal Reserve of this nature might at times be inconsistent with major aims and statutory obligations of the Federal Reserve.
An excellent description of the appropriate aims and procedures of Federal
Reserve policies is given in a recent report of the Subcommittee on Monetary,
Credit, and Fiscal Policies of the Joint Committee on the Economic Report,
after conducting a comprehensive inquiry under the Chairmanship of Senator
Douglas. This description may be summarized and paraphrased approximately
as follows:
The role of the Federal Reserve in our economy is to supply the
banking system with adequate lending power to support a growing and relatively stable economy and to exercise restraint upon excessive credit expansion that will lead to instability. This task has been made exceptionally
difficult by the tremendous wartime growth of the public debt, the pervasive
distribution of Government securities among many holders, and the tendency
of these holders to view their securities as liquid assets readily convertible into money to be spent or otherwise invested. Attempts to sell these
securities, unless buyers are readily available, tend to lower their prices,
which means a rise in interest rates. In the absence of a demand by other
investors, declining prices can be prevented only by Federal Reserve purchases.




- 3 -

But any expansion of Federal Reserve credit has the effect of supplying banks
with additional reserve funds, on the basis of vhich the banking system by
lending or investing and relending can expand bank credit, and the volume of
money, by many times the amount of the reserves supplied.
This process of monetary inflation can be somewhat restrained by
limiting Federal Reserve purchases of Government securities. As the Douglas
Subcommittee report pointed out,i/"the essential characteristic of a monetary
policy that will promote general economic stability is its timely flexibility. " But Federal Reserve policies cannot be varied in response to changing
needs without affecting interest rates. For the Federal Reserve to endeavor
to maintain a rigid level of interest rates would mean supplying a l l credit
demands in time of expansion and absorbing a i l of the unused supply of credit
in times of contracting demands. Such policies would tend to create instab i l i t y , because they would tend to reinforce both the expansion and the contraction phases of economic fluctuation.
Another general point which should be kept in mind is that there
are many interest rates which reflect, on the one hand, varying degrees of
risk and liquidity involved in different obligations and, on the other hand,
the supplies of funds that may be seeking relative safety and liquidity at
the sacrifice of higher return or vice versa. For example, the Treasury can
borrow at between 1 and 1-1/4 per cent on short-tem obligations and at less
thacr 2-1/2 per cent on long-term bonds, while business borrowers at banks
pay from 1-1/2 to more than 6 per cent, depending on the size and risk of
the loan, and consumer loans cany higher interest charges. These differences in the structure of interest rates must be taken into consideration in
the determination of Federal Reserve policies.
What bearing do these observations have on housing finance and
housing legislation? An important aspect of most of the housing legislation
of the past two decades has been to make i t possible for lenders to tap money
markets at lower rates of interest and on more favorable terms than were previously available* These were and are, on the whole, desirable aims, as institutional arrangements in the mortgage market have had much need for improvement. Particularly during periods of depression and substantial unemployment i t was most helpful to facilitate the flow of available inve stable
funds into the mortgage market at reduced rates of interest. I t is quite
another matter, however, to adopt measures which will lead to the creation
of new money to finance construction at a time when activity is already fully
utilizing available supplies of material and labor and prices are higher than
a large portion of potential buyers can afford.
The aim of many of the measures adopted and proposed has been to
lower the cost of housing by obtaining low interest rates on mortgages—an
important cost of h m ownership. This is generally done by attaching s m
o e
o e

T/ "Monetary, Credit, and Fiscal Policies", Report of the Subcommittee on
Monetary, Credit, and Fiscal Policies of the Joint Committee on the Economic
Report, January 23, 1950, p. 19.



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A

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sort of Government insurance or guarantee to the mortgages or to the obligations of mortgage lending agencies or by providing facilities for increasing their liquidity. One result is that these obligations can tap sources
of lendable funds that would otherwise not have been available to them. The
lower rates and increased availability of funds tends to stimulate borrowing.
Obligations guaranteed or insured by the Federal Government are to
a considerable degree competitive with Government securities; therefore an
increase in such obligations is likely to result in a decline in prices of
Government bonds, i . e . , a rise in interest rates. In the absence of a large
unused supply of loanable funds in that sector of the market, the only way a
general rise in interest rates could be avoided would be by Federal Reserve
purchases of Government securities, which would mean the creation of new
money.
Thus the issuance of additional amounts of obligations directly or
indirectly guaranteed by the Federal Government would have the effect either
of depressing the prices of Government securities or of requiring creation
of supplies of new money by the Federal Reserve. In the case of the first
alternative, the benefits of lower interest rates expected by the sponsors
of the measures to provide cheaper housing would not be fully realized and,
in addition, a l l other Government securities would decline in price. In the
latter case the inflationary policies might result in higher prices. Whether
such a result ensues depends upon the general economic situation at the time.
I t is because of these possible consequences that the Federal Reserve has a particular interest in housing finance and in the various legislative proposals that have been made. Their effects on the economy, and perhaps their success in accomplishing their objectives, will in the final analysis influence, or be influenced by, Federal Reserve policies.
While the monetary consequences of financing the amount of debentures proposed under the present b i l l might be slight, the principle, however, is one which, i f adopted in a moderate amount for one purpose, might
well be extended in magnitude and scope. I t is difficult to provide special
privileges to one group and deny them to others. This principle, i f widely
adopted, could unduly stimulate housing construction at lowered interest
costs and eventually undermine the values of existing houses and of mortgages
outstanding against them. I t would be at f i r s t an inflationary factor and
ultimately lead to a deflation of values.