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ECONOMIC REVIEW

Additional copies of the ECONOMIC REVIEW may
be obtained from the Research Department, Federal
Reserve Bank of Cleveland, P. O. Box 6387,
Cleveland, Ohio 44101. Permission is granted to
reproduce any material in this publication providing
credit is given.

JULY 1971

SOME CHARACTERISTICS
OF FOURTH DISTRICT
FCA BANKS: A
COMPARI SON WITH THE
O T H E R M E M B E R BANKS
The Federal Reserve Bank of Cleveland has offered a
Functional Cost Analysis (FCA) program to member banks

IN THIS ISSUE

in the Fourth Federal Reserve District since I965.1 FCA is a
uniform cost accounting system that enables a participating
bank to measure the expense and revenue of each of its

Some Characteristics of
Fourth District FCA
Banks: A Comparison
w ith the Other
Member B a n k s ............. 3

principal activities and to compare these measurements
w ith figures from similar banks that also participate in
FCA. The program is now available to all member banks in
all Federal Reserve Districts.
1

This program was developed by the Federal Reserve Banks of

Boston and New Y o rk and gradually adopted by other Federal

The Secondary Mortgage
M a rk e t.......................... 14

Reserve

Banks.

For

a more

detailed

explanation

FCA

see

“ Average Functional Cost and Revenue fo r Banks in Three Size
Categories, 1 9 6 6 -1 9 6 9 ," Econom ic Review, Federal Reserve Bank
of Cleveland, April 19 71.

ECONOMIC REVIEW
In the past five years of operation, the FCA
program has included an annual average of 975

(a measure of return on invested capital), net
income to total assets

(a measure of return on

Federal Reserve member banks, 74 in the Fourth

total funds), and total operating revenue to total

District. A very large body of data, therefore, has

assets (a measure of gross yield on total funds); for

1969 and 1970, total operating expenses to total

commercial banks in the United States.2 These

been

accum ulated

the

operations

assets (a measure of the cost of acquiring and

data have been subjected to systematic analysis in

maintaining a stock of income-producing assets)

several studies,3 but relatively little attention has
been paid to the differences in performance of

were compared.
Generally, it was found that all four ratios

FCA and non-FCA banks.

tended to be higher for FCA banks than for

The FCA program was designed to improve

non-FCA banks. Although the pattern of d iffe r

decision-making by participating bank manage

ences does not permit the drawing of firm con

ment and, hence, the performance of these banks.

clusions, it was observed that the difference

This article reports on a comparison of some

between net income as a percent of capital fo r the

characteristics of Fourth District FCA banks with

all-FCA average and the non-FCA member bank

those of the other Fourth District member banks

average increased from 0.5 in 1964 (a year before

before and after the FCA program was initiated.

the program started) to 0.8 in 1965 and 1.4 in

Three operating ratios were compared fo r FCA

1968—all in favor of the FCA banks. Similarly, the

and all non-FCA member bank averages over the

difference between net income as a percent of

1964-1970 period: net income4 to total capital5

total

assets fo r the all-FCA average and the

non-FCA member bank average increased from
See,

fo r

e x a m p le ,

Functional

Cost

Analysis,

1970

Average Banks, available fro m th e B an k R elatio n s and

—0.02 (the FCA banks were lower) in 1964 to 0.0

P ub lic In fo rm a tio n D e p a rtm e n t, Federal Reserve B ank o f

(FCA and non-FCA member averages were equal)

C levelan d.

in 1965, to 0.01 in 1966 and 0.05 in 1968. The

Examples of studies using these data are: Frederick W.

differences, although small, are important because

Bell and Neil B. M urphy, Costs in Com m ercial Banking: A

of the direction of change.7 Other differences

Q uantitative Analysis o f Bank Behavior and Its Relation
to Bank Regulation, Federal Reserve Bank of Boston,
1968; Michael A. Klein and Neil B. M urphy, "T h e Pricing

noted in this comparative study were the tendency
for the average FCA bank to be larger and to grow

of Bank Deposits: A Theoretical and Empirical Analysis,"

at a faster rate than the average non-FCA member

Journal o f Financial and Q uantitative A nalysis," V I, 2

bank.

(March 19 71) pp. 7 4 7 -7 6 1 ; and Stephen M. Hagins, " A
Preliminary Investigation into the Supply of and Demand
for Demand Deposits Produced by an 'Average' Bank,"
unpublished

M .A .

thesis

(University

Wisconsin —

M ilwaukee, 1 9 6 9 ).
4

In summary, the findings of this paper indicate
that FCA banks do exhibit differences compared

Net income is total operating revenue less total operating

cost and taxes plus or minus the effect of securities gains
and losses and extraordinary items.

To tal capital is the sum of equity accounts, including

c
A fter

1968,

to tal

assets

are

net

hypothecated

deposits.
^Nevertheless, the differences in FC A and non-FC A ratios
may not be significant in a statistical sense. Because of
technical

difficulties, it has not yet been feasible to

surplus and undivided profits; total reserves on loans and

conduct such a test for significance; however, research in

securities were included after 1968.

this area is continuing.

JULY 1971
w ith the non-FCA banks, but the influence of the

FCA member ratios for 1967, and so on. The 1964

FCA program in explaining these differences has

and 1965 all-FCA averages that were used are for

not been identified.

1965 participants. Additionally, to eliminate the
effect of fluctuations in the FCA average ratios

AVERAGE OPERATING RATIOS

caused by changing FCA membership, ratios were

An attempt to compare FCA and other member

calculated fo r a constant group consisting of 47

bank average operating ratios over a period of time

banks that have participated in FCA for at least

immediately presents a problem: which banks

five of the six years that the program has been

should be considered FCA banks in a particular

offered in the Fourth District.

year? Difficulties arise because member banks are

The non-FCA member bank average ratios used

free to opt into and out of the program each year

in this study are based on Member Bank Operating

and because the major benefits of FCA partici

Ratios, Fourth Federal Reserve D istrict.9

pation are thought to occur in the years following
the year of initial membership. The turnover in

AVERAGE EARNINGS RATIOS

FCA participation may impart a pattern to the

Table I contains figures depicting average net

year-to-year changes in the operating ratios of the

income as a percent of total capital for the 47

FCA averages that is independent of the effect of

FCA, all-FCA, and all non-FCA member banks in

the FCA program.8 The effect of FCA partici

the Fourth District from 1964 through 1970. For

pation is not likely to be reflected in the initial

each year, the average ratio fo r all FCA banks

year's ratios because participants do not receive

exceeds the average ratio fo r all non-FCA member

their cost and revenue analysis reports until the

banks.10 Similarly, the average ratio for the 47

year following the year of initial membership in
the program.
The Composition of the Bank Groups. To allow
for the lagged impact, the FCA ratios that were
used in this analysis for a given year were limited

This report is published annually by the Exam ination

D epartm ent, Federal

Reserve Bank of Cleveland. The

average ratios are "norm alized " by the exclusion of ratios
that are considered outside reasonably norms. To assure

to those banks that participated in FCA the

com parability between

previous year. Thus, 1965 FCA participants' ratios

averages, the same norms have been applied to the FC A

for

1966 were compared w ith

the non-FCA

member average ratios for 1966; 1966 partici
pants' ratios fo r 1967 were compared w ith non-

banks and all

FCA and the non-FC A member

"abn orm al" ratios excluded. It may be

observed th at the published member bank operating ratios
are averages for all (F C A and non-FC A ) member banks.
However, since the follow ing are known: the mean ratios
for all member banks, the number o f member banks, the

g
S im ilarly, the " n o n -F C A " average w ill be affected by
FCA turnover. One possibility is that the " n o n -F C A "

mean ratios fo r all FC A banks, and the number o f FC A
banks, it is possible to calculate mean ratios for non-FC A
member banks.

averages w ill be raised as FCA banks drop out o f the
program. This im pact is assumed to be negligible, how

1 0 During

ever, since the present number of form er FCA banks is

member banks has ranged from 50 6 to 4 7 0 , while the

small (about 50) relative to the number o f Fourth District

number of FCA participants since the program began has

1 9 6 4 -1 9 7 0 ,

the

number of

Fourth

District

member banks th at have never participated in FCA (about

ranged from 71 to 79. Fourth District banks that have

3 4 0 ).

had at least one year in FC A number 127.

ECONOMIC REVIEW

TABLE I
Net Income as a Percent of Total Capital
Fourth District (4D) FCA and Non-FCA Member Banks
1964-1970
(Averages of Individual Bank Ratios)
1964
47 4 D FC A banks
All 4D FCA banks
All 4D non-FC A
member banks

1965

9.2%
9.1

9.3%
9.1

8.6

8 .3

1966

1967

1968

1970

1969

10.8%
10.0

11.0%
10.5

11.4%
11.0

10.7%
10.4

8 .8

9 .3

9 .6

9 .9

11.5%
11.1
11.0

N O T E : Although year-to-year comparisons involving 19 69 and 1 9 70 are not
strictly valid, bank group averages for these years are comparable. The
principal difference in 1969 is that the individual bank operating ratios
were calculated from the average o f the June 1969 and December 1969
call reports. In other years, the call report from the previous year's
December was averaged w ith th at for the current year's June. In addition,
fo r both 1969 and 1970, hypothecated deposits are subtracted from loans
and deposits and, hence, from total assets. Also, after 19 68 reserves on
loans and securities were included in total capital. However, the same
procedures have been used in calculating the FC A and non-FC A ratios
w ithin a given year.
Source: Federal Reserve Bank of Cleveland

TABLE II
Net Income as a Percent of Total Capital
Fourth District (4D) FCA and Non-FCA Member Banks
Selected Size Groups
1964-1970
(Averages of Individual Bank Ratios)
Bank Size Group
$5 to $ 1 0 m illion

1964

1965

1966

1967

1968

1969

1970
*
*

47 4 D FCA banks
A ll 4D FCA banks
A ll 4D non-FC A member banks

9.6%
7 .6
8.7

8.9%
8.2
7.8

$ 1 0 to $ 2 5 m illion

47 4D FCA banks
All 4D FCA banks
All 4D non-FC A m ember banks

9 .4
9.7
9 .2

9 .6
9.1
9.1

12.4
10.9
9 .4

12.0
11.4
10.0

10.0
10.1
9 .8

9 .0
10 .3
10.2

11.2%
10.5
11.5

$2 5 to $ 5 0 m illion

47 4 D FC A banks
All 4D FCA banks
All 4 D non-FC A member banks

8.7
9 .2
8 .3

9 .3
9.2
8 .5

10.1
10.5
9 .0

10.9
10.6
9 .6

11.7
11.8
9.7

10.6
10.3
10.3

11.5
11.2
11 .6

$ 5 0 to $ 1 0 0 m illion

47 4 D FC A banks
All 4D FCA banks
A ll 4 D non-FC A member banks

8 .9
9.1
8.5

8 .4
8.9
8.4

8 .6
9 .0
9 .4

9 .7
10.2
9 .8

14.5
13.7
9.1

11.4
11.3
10.2

12.2
11.7
11.1

9.0%
8.2
8.8

* N o t shown to avoid disclosure of individual bank ratios.
N O T E : 19 69 and 1 9 70 not comparable w ith other years, see note on Table I.
Shaded cells are those in which both FC A groups exceed the non-FC A
average o f similar size banks by a m inim um of 0 .3 percent.
Source: Federal Reserve Bank of Cleveland

10.8%
8 .7
9 .5

9.0%
9 .5
9.7

8.7%
9.1
9 .6

JULY 1971

NET INCOME AS A PERCENT OF TO TAL CAPITAL, FOURTH
DISTRICT MEMBER BANKS, BY SELECTED SIZE GROUPS,
1964 AND 1970
(AVERAGES OF IN D IV ID U A L BANK RATIOS)
PERCENT
15

o
o

14
13

1970

1964

11
10 —

o
o 1-

—

9
8

—

Under 1

1 -2

2 -5

........
5 -1 0

1 0 -2 5

2 5 -5 0

5 0 -1 0 0

100250

250500

50 0 and
Over

(AVERAGE DEPOSITS OF BANKS—M lLLIO N S OF DOLLARS)
*For 1970, the smallest size group is up to $5 million.
tF o r 1964, the largest size group is $100 m illion and over.
Source: Federal Reserve Bank of Cleveland

FCA

banks consistently

exceeds the all-FCA

A d iffic u lty of interpretation, however, is raised

average. Moreover, the gaps between the average

by the tendency for net income as a percent of

ratios for the two FCA bank groups and the

capital to increase w ith bank size. One reason for

non-FCA banks widened after the beginning of the

this tendency is that the ratio of capital to total

FCA program, at least through 1968. A fter 1968

assets varies inversely w ith bank size. Chart 1

and the change in the method of ratio calculation

illustrates

(see note on Table I), the FCA bank group

between net income as a percent of capital and

averages exceeded the non-FCA average by about

bank size. Note that in 1964, before the FCA

the same amount as in 1964.

program began, and in 1970, larger banks achieved

the

resulting

positive

relationship

ECONOMIC REVIEW

Chart 2.

SIZE D ISTRIBUTIO N OF FCA AND NO N—FCA MEMBER BANKS IN THE
FOURTH D IS TR IC T, 1970
PERCENT

(AVERAGE DEPOSITS OF BANKS—MILLIONS OF DOLLARS)
Source: Federal Reserve Bank of Cleveland

higher net income to capital ratios than smaller

performance of the average of all similar size

banks. Chart 2 shows that the FCA bank group,

non-FCA member banks in at least one year. Most

when compared w ith non-FCA member banks, is

of the high performance ratios were recorded by

heavily weighted w ith medium and large size

FCA

banks. Thus, the higher average values for the net

However, Table II does show that the higher

income to capital ratios at FCA banks were due in

income to capital ratios presented in Table I were

part to the larger size of FCA participants.

not due solely to the larger average size of the

One direct way of dealing w ith this size-induced

banks

the tw o

largest size groups.

FCA banks.

bias is to group both FCA and all non-FCA banks

Ratio of Income to Total Assets. It is possible,

by size so that each group of banks is compared

of course, that a comparison of the ratio of net

with banks in a similar size class. This has been

income to capital favors the FCA banks because of

done in Table II where, owing to the small number

biases introduced by factors other than size. It

of FCA banks above $100 m illion in deposits

was, therefore, desirable to compare the earnings

(until recently) and below $5 m illion, size groups

of FCA banks and non-FCA member banks in

from $5 to $10, $10 to $25, $25 to $50, and $50

terms of some other ratio. Table III shows the

to $100 m illion are considered. The comparison,

ratios of net income to total assets fo r FCA and

covering a span of seven years, reveals that the

non-FCA member banks. As shown in Chart 3, the

FCA banks in each size group surpassed the

ratio is less consistently related to bank size than

JULY 1971

TABLE III
Net Income as a Percent of Total Assets
Fourth District (4D) FCA and Non-FCA Member Banks
1964-1970
(Averages of Individual Bank Ratios)
1964
47 4 D FCA banks
All 4D FCA banks
All 4D non-FCA
member banks

1 9 65

1967

1966

1968

1970

1969

0.80%
0.77

0.77%
0.6 4

0.85%
0 .7 6

0.86%
0.81

0.88%
0 .8 5

0.9%
0 .9

1.1 %
1.0

0 .7 9

0.7 4

0.7 7

0 .8 0

0.8 0

0.9

1.0

N O TE : 1969 and 1 9 70 not comparable w ith other years, see note on Table I.
Source: Federal Reserve Bank o f Cleveland

TABLE IV
Net Income as a Percent of Total Assets
Fourth District (4D) FCA and Non-FCA Member Banks
Selected Size Groups
1964-1970
(Averages of Individual Bank Ratios)
1964

Bank Size Group

1965

1966

1967

1968

1969

19 70
*
*

47 4D FCA banks
A ll 4D FCA banks
A ll 4D non-FC A member banks

0.90%
0.67
0.7 7

0.83%
0 .7 2
0 .6 6

0.72%
0.6 6
0.7 3

0.83%
0.6 9
0 .8 0

0.68%
0.7 7
0 .8 0

0.8%
0.8
0.9

$1 0 to $25 m illion

47 4 D FCA banks
All 4D FC A banks
All 4D non-FCA member banks

0 .8 0
0 .7 9
0.7 8

0.77
0 .7 3
0 .7 6

0.9 6
0 .8 3
0 .7 5

0.9 2
0.8 7
0.81

0.7 8
0.77
0.77

0.8
0.9
0.9

1.0%
1.0
1.0

$2 5 to $ 5 0 m illion

47 4D FC A banks
All 4D FCA banks
All 4D non-FC A member banks

0.7 4
0 .7 4
0 .7 2

0.71
0.67
0.6 8

0.81
0.75
0.7 3

0.85
0 .7 9
0.77

0.8 7
0.8 8
0 .7 5

1.1
1.0
0.8

1.1
1.1
1.1

$5 0 to $ 1 0 0 m illion

47 4 D FCA banks
All 4D FC A banks
All 4D non-FCA member banks

0.7 5
0 .7 4
0 .6 8

0 .7 4
0.7 8
0 .6 4

0.67
0.72
0.71

0.7 9
0.8 3
0.7 3

1.14
1.09
0 .6 3

1.0
1.0
0.8

1.2
1.1
0.9

$5 to $ 1 0 m illion

* N o t shown to avoid disclosure o f individual bank ratios.
N O T E : 1969 and 1 9 7 0 not comparable w ith other years, see note on Table I.
Shaded cells are those in which both FC A groups exceed the non-FCA
average for similar size banks by a m inim um of 0 .0 5 percent.
Source: Federal Reserve Bank o f Cleveland

the ratio of net income to capital. The breakdown

calculated for Member Bank Operating Ratios may

of this ratio by bank size group is shown in Table

obscure some differences between the FCA and

IV.

the non-FCA averages after 1968. Nevertheless, it

A change in the rounding method from two

is clear that the net income to total assets ratio of

decimal places to one when these ratios were

both FCA bank groups rose more rapidly than that

ECONOMIC REVIEW

Chart 3.

NET INCOME AS A PERCENT OF TO TAL ASSETS,
FOURTH DISTRICT MEMBER BANKS, 1964 AND 1970
PERCENT
1.5
1.4

1970

— ©

1964

—

1.3 —

—

1.2 —

—

1.1

*
1.0 — o

0.9 —

—

I
1—2

G
I

L_
2 -5

5 -1 0

1 0 -2 5

—

o t
°

—

0.7

Under 1

0.8 —

0.6

2 5 -5 0

I
5 0 -1 0 0

I
100250

I
250500

500 and
Over

(AVERAGE DEPOSITS OF BANKS—M lLLIO N S OF DOLLARS)
*For 1970, the smallest size group is up to $5 m illion.
tF o r 1964, the largest size group is $100 m illion and over.
Source: Federal Reserve Bank of Cleveland

of the non-FCA average after

1964, at least

through 1968. Again, based on the similar size

OPERATING REVENUE RATIOS
Given that the FCA banks have tended to have

comparisons shown in Table IV, the appropriate

higher

conclusion seems to be that the higher FCA ratios

banks, it seems logical to attempt to determine if

were not due solely to differences in bank size. It

this was due to higher revenues, lower costs, or

is also of interest to note that eight of the eleven

both.

average

earnings ratios than

non-FCA

shaded (high performance) cells in Table IV are

Chart 4 depicts total operating revenue as a

common to the shaded cells in Table II. Thus, the

percent of total assets fo r Fourth District FCA and

patterns exhibited by the two income ratios are

non-FCA banks fo r the 1964-1970 period. It is

very similar.

immediately apparent that the FCA banks are

JULY 1971

Chart 4.

TO TAL OPERATING REVENUE AS A PERCENT OF TO TAL ASSETS,
47 FCA, A LL FCA, AND ALL N O N -F C A FOURTH DISTRICT MEMBER
BANKS
PERCENT

ANNUAL

Last entry: 1970
Source: Federal Reserve Bank of Cleveland

higher revenue-generating institutions. To avoid
biases that may be introduced by differences in

OPERATING EXPENSE RATIOS
The ratio of total operating expense to total

size of FCA and non-FCA banks, Table V permits

assets

equal size comparisons. Even though there seems

Operating Ratios until 1969 and, therefore, is not

to be little difference in revenues earned by FCA

readily available prior to that date. In 1969 and

was

not calculated

fo r

Member Bank

and non-FCA banks in the $25 to $50 m illion

1970, however, total

group, fo r the other size groups, the FCA banks

percent o f total assets tended to be somewhat

have had markedly higher revenue to assets ratios

higher fo r FCA banks than the average of the

than the same size non-FCA average. Thus, bank

non-FCA member banks (see Table VI). The total

operating expense as a

size is not the sole explanation fo r higher than

figures substantiate this, and it is also true for

average revenues at FCA banks.

some o f the individual size groups.

ECONOMIC REVIEW

TABLE V
Total Operating Revenue as a Percent o f Total Assets
Fourth District (4D) FCA and Non-FCA Member Banks
Selected Size Groups
1964-1970
(Averages of Individual Bank Ratios)
1965

1966

1967

1968

47 4 D FCA banks
A ll 4D FC A banks
A ll 4 D non-FC A member banks

5.04%
4 .8 5
4 .7 3

5.20%
4 .8 5
4.7 9

5.09%
4.9 9
4.91

5.41%
5.2 6
5 .0 4

5.54%
5.4 8
5.2 9

5.9%
5.9
5 .6

$ 1 0 to $ 2 5 m illion

47 4 D FC A banks
A ll 4 D FCA banks
All 4 D non-FCA member banks

4 .9 4
4 .8 4
4.6 9

4 .9 8
4 .9 5
4 .7 5

5 .2 3
5 .1 3
4 .9 3

5.3 4
5 .4 2
5.1 2

5.3 4
5.4 2
5.3 2

5.7
5.7
5.6

6.4%
6.4
6.2

$2 5 to $ 5 0 m illion

47 4D FCA banks
All 4D FCA banks
All 4D non-FCA member banks

4 .7 6
4 .6 4
4.81

4.91
4.7 8
4 .8 4

5.0 6
4 .8 3
5.15

5.31
5 .3 6
5.25

5.4 8
5.51
5 .4 8

5.8
5.8
5.8

6.5
6.5
6.5

$5 0 to $ 1 0 0 m illion

47 4 D FC A banks
All 4 D FC A banks
All 4 D non-FCA member banks

4 .4 8
4 .6 3
4 .7 2

4.61
4 .6 6
4 .6 3

5 .0 0
5.0 4
4 .8 8

5.3 5
5 .3 6
5.1 8

5.6 2
5 .7 0
5 .3 0

5.9
6 .0
5.6

6.9
6.7
6 .3

Bank Size Group

1969

19 70

1964

$5 to $1 0 m illion

*
*

* N ot shown to avoid disclosure of individual bank ratios.
N O TE : 1 9 69 and 19 60 not comparable w ith other years, see note on Table I.
Shaded cells are those in which both FCA groups exceed the average for
similar size banks by a m inim um of 0 .1 0 percent.
Source: Federal Reserve Bank o f Cleveland

FCA and Bank Growth. The revenue and cost

percent, while deposits at all Fourth

District

characteristics of the FCA banks suggest that these

member banks rose at a rate of only 6.7 percent.

banks may also have experienced high growth in

During the same period, the combined deposits of

the period examined, inasmuch as an association

Fourth District member and non-member banks

between high revenue, costs, and growth has been

increased at an annual average rate of 6.8 percent.

observed in the past.11 In fact, from 1964 to

In summary, Fourth District FCA banks have

1970, inclusive, deposits at the 47 FCA bank

tended to be more rapidly growing, to have had

group increased at an annual average rate o f 9.3

higher earnings, revenues, and costs than the
non-FCA member bank average. However, a lack
of uniform change in performance by FCA banks

11 Lyle

G ram ley, "G ro w th and Earnings at Individual

Commercial

Banks,"

Essays on

Com mercial Banking,

Federal Reserve Bank of Kansas C ity, 1 9 6 2 , pp. 13-15.

in all size groups, along w ith discontinuities in the
data, prevents the analysis from reaching firm
conclusions on the causal impact of FCA.

JULY 1971

TABLE VI
Total Operating Expense as a Percent of Total Assets
Fourth District (4D) FCA Banks and Non-FCA Member Banks
Selected Size Groups
1969-1970
(Averages of Individual Bank Ratios)
Bank Size Group

1969

1970

$5 to $ 1 0 m illion

47 4 D FCA banks
All 4D FC A banks
A ll 4 D non-FC A member banks

4.8%
4 .5
4 .3

$ 1 0 to $2 5 m illion

47 4 D FCA banks
All 4 D FC A banks
All 4D non-FC A member banks

4.7
4 .4
4.4

5.1%
5.2
4.9

$2 5 to $ 5 0 m illion

47 4 D FC A banks
All 4 D FC A banks
All 4D non-FC A member banks

4 .4
4 .4
4.7

4.8
5.1
5.2

$5 0 to $ 1 0 0 m illion

47 4D FC A banks
All 4D FCA banks
All 4 D non-FCA member banks

4 .5
4.8
4 .6

5.2
5.4
5.2

$ 1 0 0 to $ 2 5 0 m illion

47 4D FC A banks
All 4D FC A banks
All 4 D non-FC A member banks

4.7
4.7
4 .4

5.4
5.3
5.1

TO TAL

47 4D FC A banks
All 4D FC A banks
All 4D non-FC A member banks

4 .6
4 .5
4.4

5.1
5.2
5.0

* N o t shown to avoid disclosure o f individual bank ratios.
N O T E : 1969 and 1 9 7 0 not comparable, see note on Table I.
Source: Federal Reserve Bank of Cleveland

ECONOMIC REVIEW

THE S E C O N D A R Y M O R T G A G E M A R K E T
INTRO DUCTION

second section discusses the post-World War II

As part of its stated policies to help provide

developments in the secondary mortgage market

adequate housing for all citizens, the Federal

and the

Government has long

efficient market; the third section analyzes the

been

interested

in the

problems involved in establishing an

nation's mortgage market. One of the Govern

behavior of the mortgage markets since 1965. In

ment's primary objectives has been the establish

the conclusion, some of the more widely discussed

ment of a viable and active secondary market for

suggestions for improving the secondary mortgage

mortgages. A secondary market facilitates the

market are presented.

transfer of a mortgage from its originator or any
other subsequent holder to other investors. The
existence of an active market provides needed
liquidity to lenders and makes it possible to attract

BACKGROUND OF THE MORTGAGE
M ARKET AND FEDERAL
PARTICIPATIO N

more diverse types of investors. Combined w ith

Whenever a borrower gives a lender a lien on

Government-fostered standardization of some of

property as security fo r repayment of an obli

the mortgage instruments, the secondary market

gation, a mortgage is created. Prior to 1934,

has led to greater participation by national "long

amortized mortgage loans were very rare; instead,

distance" lenders than would otherwise be the

most loans were in the form of notes requiring

case. Because of the localized nature of housing

payment of the entire principal and interest at

and the

m aturity.1

heterogeneity of individual mortgage

Arrangements

for

renewal o f the

instruments, a mortgage holding, in the absence of
a secondary market, becomes a long-term invest
ment w ith little opportunity for liquidation.
The first section of this article discusses the

A m o rtization

principal

and

requires
interest

the
of

mortgagee
the

mortgage

repay
in

the

specified

instalments over the term o f the loan. There are numerous

history of Federal participation in the primary and

types of am ortization , w ith the most popular providing

secondary mortgage markets in the 1930's. The

for equal m onthly payments.

JULY 1971
unamortized mortgage, however, could be made at

Housing Administration (FHA) was created by the

the discretion of the participants. Loans made

enactment

prior to

addition to its program of mortgage insurance, the

1934 also differed from the modern

the

National

Housing

Act.

mortgage in that they required much larger down

FHA was given authority to charter and supervise

payments.

private national mortgage associations in the hope

As banks failed and credit markets virtually
collapsed in the early 1930's, there were many

of stimulating investment in home financing. In
conjunction w ith

FHA insurance, the national

foreclosures, unrenewed loans, and very few new

mortgage associations were intended to organize a

mortgages were made. With the scarcity of funds,

secondary mortgage market and thereby more

financing home ownership became more d ifficu lt,

efficiently allocate the limited available supply of

and virtual stagnation existed in the home con

mortgage credit. Although the FHA insurance
program is still in effect and has added some

struction and home financing industries.
Federal Home Loan Bank System and Home

stability to the mortgage market, the FHA did not

Owners Loan Corporation. Beginning in 1932, the

succeed in establishing a single private mortgage

Federal

association, even though several applications for

residential

charters were filed. The authority of the FHA to

mortgage financing. The first of these programs

charter private national mortgage associations was

was the establishment of the Federal Home Loan

repealed in the Housing Act of 1948. Thus, the

Bank System (FHLB). The primary goal of this

desired level of secondary market activity failed to

new organization was to increase the volume of

develop.

Government

program s

initiated

intended

number

revitalize

funds available fo r home financing. Although the

The Veterans Administration (VA) was created

FHLB remains an important indirect source of

by the Serviceman's Readjustment Act of 1944.

mortgage funds today, its authority to make direct

As the name of the act implies, the original

loans to home buyers was repealed in 1933, with

purpose of the program was to aid servicemen

establishment of the Home Owner's Loan Corpor

returning to

ation (HOLC).

however, has developed into a major housing

civilian

life.

The

mortgage,

The HOLC operated between 1933 and 1954

market instrument, paralleling the FHA insured

and was authorized to refinance existing mortgages

mortgage. Although the specific terms, conditions,

on one to four fam ily dwellings that were due to

and eligibility requirements differ between the two

be foreclosed or otherwise canceled. The most

programs, both FHA and VA provide backing for

significant contribution made by HOLC was the

individual

popularization

more liquid secondary market instruments.

mortgage.

innovation

This

the

long-term

amortized

residential

mortgages, making them

in home financing

Reconstruction Finance Corporation Mortgage

played a major role in stabilizing the home finance

Company. The Federal programs of the early

market and fostered the phenomenal growth in

1930's failed to aid in the development of the

private home ownership that has taken place since

desired secondary mortgage market, and they also

the 1930's.

failed to establish an efficient, well-functioning

Federal Housing Administration and Veterans
Administration.

June

1934,

the

Federal

primary market in each local area of the nation. In
an attempt to aid the reestablishment of a normal
15

ECONOMIC REVIEW

mortgage market, the

Reconstruction

Finance

FNMA

instituted

tw o procedures designed to

(RFC) created the RFC Mortgage

improve the agency's performance as a secondary

Company in 1935 under Section 5(c) of the RFC

market fa cility: the stand-by commitment and the

A ct.2 Until its dissolution in 1948, this organi

purchase option.

Corporation

zation, in cooperation w ith the FHA, assisted in
the

development

are

agreements by

FNMA to purchase a specific mortgage w ithin a

FHA-insured

stipulated time period at an agreed-upon price that

mortgages and, later, mortgages guaranteed by the

was below the current market price.4 Builders

VA.

taking out stand-bys were able to obtain construc

Federal

through

the secondary

Stand-by commitments

mortgage

m a rk e t

purchases

National

Mortgage

Association.

tion loans from commercial banks that otherwise

1938, when it became apparent that no national

would not have been w illing to make loans. If the

mortgage associations would be formed and that

mortgage market had improved by the time the

the RFC Mortgage Company purchases would not

final mortgage was placed w ith the bank, the

be sufficient to meet the home financing needs of

holder

the

by the

mortgage to the highest bidder. If no alternative

President to organize a national mortgage associ

buyers were available, FNMA would purchase the

nation, the

RFC was requested

the

stand-by could

sell the

final

ation. The primary purpose of the new Federal

mortgage

National Mortgage Association (FNMA) was to

provided the stand-by commitments fo r a fee of 1

provide:
secondary market facilities for home
m o rtg a g e s ,... [a n d ] supplementary
assistance to the secondary market for
home mortgages by providing a degree
of liquidity for mortgage investments,
thereby improving the distribution of
investment capital available for home
o
mortgage financing...

percent of the

At first, only FHA mortgages were eligible for

intended to provide a greater degree of liquidity

purchase by FNMA, but eligibility was extended

for mortgage investments and were used until

to cover VA mortgages in 1948. FNMA remained a

1968.

the

pre-arranged

price.

FNMA

mortgage balance, which was

absorbed by the builder or passed on to the final
mortgage buyer, depending on market conditions.
For an additional fee of 0.5 percent, the seller of a
mortgage to
option

which

mortgage from

FNMA

could obtain a purchase

allowed him to repurchase the
FNMA w ithin

nine months at

FNMA's purchase price. These procedures were

subsidiary of the RFC until 1950 when it was

The legislation creating HUD in 1965 provided

transferred to the Housing and Home Finance

that FNMA retain its separate identity, allowing

Agency, which became the Department of Housing

FNMA to be reorganized in 1968 and divided into

and Urban Development (HUD) in 1965. In 1956,

two separate corporations. Under the terms of this

reorganization,
Section 5(c) was added to the RFC A ct on January 1,

1935, by P. L. 1, 74 th Congress.
3

all

the

Federally

financed

Special Assistance Functions and Management and
Liquidating Functions were turned over to a new

Federal National Mortgage Association Charter A ct, as

amended through December 31, 1969 (Washington, D. C.:
Office of the General Counsel, Federal National Mortgage
Association) p. 1.

Since May 4, 1 9 6 8 , stand-by com m itm ents have been

lim ited to m ulti-fam ily mortgages.

JULY 1971

Government operated corporation, the Govern

this article, a secondary market transaction has

ment National Mortgage Association (GNMA). The

taken place if the mortgage being traded was

privately financed secondary market operations

already in existence at the time the transaction

remained

was first initiated. This definition is designed to

w ith

FNMA,

which

later

became

privately owned and managed by its stockholders.
Summary. From the 1930's until the passage of

eliminate

mortgage

purchases dependent upon

commitments from the final lender.5

the Housing Act of 1968, the secondary market

Problems. The major obstacles to the develop

for mortgages was virtually limited to VA and

ment of a competitive secondary mortgage market

FHA

can

backed

mortgages.

Even

among

these

grouped

into

five

categories:

(1)

Government supported mortgages, trading was

commodity differentiation, (2) lender differenti

light

ation, (3) differentiation among states, (4) d iffe r

commitments, technically making them primary

and

most purchases were preceded

entiation w ithin states, and (5) imperfect market

market transactions. Usually today when FHA and

information. The fact that FHA and VA backed

VA mortgages are sold, either w ith or w ithout

mortgages have a known risk, represent a more

commitments, they are grouped into blocks, and

standardized instrument, and, therefore, are more

the originator

capable of being traded nationally has led to the

of the mortgages continues to

service them fo r a small fee.

relative success of the secondary market for these

Although the Federal programs did not succeed
in developing a viable secondary

instruments.

market for

The

problem

of commodity differentiation

mortgages, these programs and the wider use of

stems from the fact that differences in the quality

amortization had a great effect on the terms of a

of the real property and the credit standing of the

typical mortgage. For example, the length of the

borrower affect the risk and asset value of a

mortgage was greatly

increased to allow full

mortgage. In turn, this results in differences in

amortization of the loan and still provide reason

y ie ld s ,

able m onthly payments. Instead of being similar to

insurance. The state laws governing issuance of the

a m o rtiza tio n ,

equity,

and

Federal

a short-term renewable note, the mortgage became

mortgage, as well as the measures of property

a long-term obligation, usually w ith a m aturity

value,

may

also

cause

variations

from

one

between 15 and 30 years. The loan to price ratio,

mortgage to another. When all of these variables

an indication of the relative sizes of the mortgage

are taken into consideration, it is often d iffic u lt

and the downpayment, also increased. As am orti

for a nonlocal secondary buyer to determine

zation and Government insurance attenuated risk,

precisely what he is purchasing.

lenders became more willing to accept larger loans
relative to downpayments.

Mortgages also differ by the type of lender
making the original loan. The various groups of
lenders tend to concentrate their holdings among

DEVELOPMENT OF THE
SECONDARY M ARKET
Before discussing the secondary mortgage mar

particular
5

types of

Com m itm ents

mortgage

holders

mortgages having distinct

this
to

instance

purchase

are

agreements

specified

volumes

by
of

ket, it is necessary to define what is meant by

mortgage loans from a mortgage originator prior to the

secondary market transactions. For the purpose of

closing of the loan.

ECONOMIC REVIEW
characteristics.

For

example,

life

insurance

companies, mortgage companies, and most savings

market.
Mortgage Companies. During the

1948-1954

banks prefer to deal in FHA and VA mortgages,

period, some important developments did occur,

while commercial banks and savings and loan

particularly the emergence of the modern-day

associations prim arily hold and purchase conven

mortgage company. Due to the pent-up demand

tional mortgages.

for housing after World War II and the fact that

Differentiation of mortgages among states is

FNMA was not successful in establishing a national

due to differences in laws governing foreclosure

secondary mortgage market, a large proportion of

procedures, usury ceilings, and taxation of out-of-

the financing of new homes was met by private

state

institutional

lenders.

Differences

within

states stem

lenders. While commercial banks,

chiefly from differences in the costs of doing

savings and loan associations, and mutual savings

business in metropolitan areas as opposed to rural

banks were expanding in their local markets, life
insurance companies began purchasing mortgages

areas and small communities.
The

great

diversity

among

mortgages

has

on a national basis. Mortgage companies developed

resulted in imperfect market knowledge. Because

as the agents of the insurance companies to

of the lack of homogeneity among mortgages, it is

facilitate the investment needs of the life insurance

d iffic u lt for potential buyers of mortgages to

companies and meet their desire to avoid servicing

participate in a unified national market trading a

loans—which would have required local offices. To

uniform

knowledge

encourage these correspondent relationships and

concerning availability of existing mortgages for

to ensure the availability of large volumes of

purchase and sale is restricted to small groups of

mortgages, life insurance companies committed

potential investors.

themselves to

product.

Generally,

the

purchasing mortgages from

the

To encourage and facilitate trading in the

mortgage companies prior to the actual closing of

secondary mortgage market, it was necessary to

the loans, and frequently before construction of

foster changes in the mortgage instrument itself.

the homes. Some mortgage companies currently

Most other capital market instruments have larger,

conduct some uncommitted business, but it is of

more uniform, nonamortized denominations and

relatively little importance.6 On balance, the bulk

are easily traded, making them more attractive to

of all mortgage company sales are still based upon

most capital market investors. In its initial form,

prior commitments.

however, the mortgage instrument is denominated
in relatively small amounts and requires on-site

The

volume

loans

that

life

insurance

companies add to their portfolios fluctuates w ith

knowledge of the property being mortgaged for an

money and capital market conditions, as well as

accurate

The most

their cash flows. This has caused the mortgage

common method of overcoming heterogeneity,

companies to turn to FNMA and mutual savings

increasing the denominations, and attenuating the

banks (which were permitted after 1951 to hold

risk of holding an individual mortgage is the

Federally

judgment

its quality.

underwritten

mortgages

originating

packaging of numerous individual mortgages into
large blocks or pools. These blocks of mortgages
can then be bought and sold in the secondary
18

®The

introduction o f pass-through participations may

increase the volume o f uncom m itted business done by
mortgage companies issuing the new securities.

JULY 1971

outside of their market areas) fo r commitments.

tures in the money and capital markets. The

Because of wide fluctuations in the inflow of

agency performs many of the functions of a

savings, however, mutual savings banks prefer to

central mortgage bank and, in its role in the

operate w itho ut prior commitments. This pref

secondary market, acts prim arily as a "buyer of

erence and the reluctance of some other investors

last resort." To encourage sellers to seek other

buyers, FNMA has tried to keep its offering prices

enter

the

mortgage

market—e.g.,

pension

funds—has encouraged some mortgage companies

at a minimum

to maintain an inventory of mortgages in reserve, a

provided repurchase arrangements which allow the

practice that in turn has furthered the develop

seller to repurchase a mortgage previously sold to

ment of a secondary mortgage market. FNMA also

FNMA at the original purchase price w ithin a

began making stand-by commitments in 1956, in

specified option period, normally nine months.

effect providing a buyer of last resort to the
m ortgage

companies.

The

warehousing

level. Since 1956, FNMA has

From the mid-1950's and 1960's, FNMA was
successful in establishing a secondary market for

mortgage loans by commercial banks also helped

Government underwritten mortgages. While it is

provide

true that the vast m ajority of transactions were

mortgage companies w ith

needed liq

uidity. These companies obtain interim financing

based on commitments, the market mechanism

by putting up notes against the collateral of their

was established and some transactions did take

total

place. Since

assets, which

include unsold

completed

mortgages as well as partially completed mortgage

1956, sales by

FNMA from

its

portfolio have been generally moderate, although

loans that may or may not have committed

in 1958 and 1963 the dollar volume of sales

buyers. These "warehoused" mortgages are then

exceeded purchases (see Table I). The greatest

redeemed

from

the

commercial

payment is received from

banks when

the final mortgage

shortcoming

the

developed was the

secondary
exclusion

market

as it

of conventional

mortgages—the largest category of mortgage debt.

holders.
Role o f FNMA. The establishment of FNMA

Mortgage-Backed

Securities.

Following

the

provided a buyer of FHA mortgages; in its first

most recent reorganization of FNMA in 1968 and

year o f operation, FNMA purchased 17 percent of

the passage of the Emergency Home Finance Act

all mortgages insured by FHA. During the World

of 1970, the stage was set fo r a more active

War II years, however, FNMA sold most of its

development of a secondary market for conven

mortgage holdings at a p ro fit and did not return as

tional mortgages, and the secondary market for

an active supporter of a secondary mortgage

Federally underwritten mortgages was expanded.

market until after its new charter and reorgani

The most important innovations over the past few

zation in November 1954. Prior to 1956, all sales

years have been the packaging of mortgages into

represented existing

blocks fo r sale, either directly as pass-through

mortgages and, therefore, were true secondary

mortgages

participations or indirectly as mortgage-backed

market transactions. Since August 1956, FNMA

bonds, and the establishment in 1970 of the

has made advance commitments, but only for

Federal

FHA

and

FNMA

mortgages.

Loan

Mortgage

Corporation

purchases

(FHLMC), a subsidiary of FHLB. Both FHLMC

mortgages with funds raised through issuing deben

and FNMA have been authorized to purchase FHA

FNMA

Home

ECONOMIC REVIEW

TABLE I
Federal National Mortgage Association's Purchases and Sales of
Federal Housing Administration and Veterans Administration Mortgages
(Thousands of Dollars)
Total
Purchases

Year

FH A
Purchases

VA
Purchases

Total
Sales

(2)

(3)

(4)

(1)
1954
1955
1956
1957
1958
1959
19 60
1961
1962
1963
1964
1965
1966
1967
1968
1969
1970

24
8 6 ,0 4 9
5 7 4 ,5 3 8
1 ,0 2 1 ,0 4 4
2 5 9 ,5 3 5
7 3 4 ,5 6 9
9 8 0 ,4 9 5
6 2 4 ,3 9 0
5 4 7 ,4 2 7
1 8 1 ,2 9 0
19 7,54 8
7 5 6 ,9 3 3
2 ,0 8 0 ,6 1 7
1 ,3 9 9 ,6 0 2
1 ,9 4 4 ,3 8 0
4 ,2 1 9 ,9 6 9
5 ,0 7 8 ,8 1 3

11
19 ,9 3 4
12 1,61 9
2 3 8 ,7 9 9
1 8 4 ,5 5 0
5 5 3 ,5 2 6
6 9 6 ,4 5 3
4 5 3 ,6 9 5
404,941
1 6 2 ,8 5 0
18 1,98 9
6 2 7 ,1 3 4
1 ,6 3 5 ,1 2 4
9 1 1 ,7 0 8
1 ,2 9 7 ,5 6 8
2 ,8 0 7 ,3 8 7
3 ,7 9 1 ,5 2 3

13
6 6 ,1 1 5
4 5 2 ,9 1 9
7 8 2 ,2 4 5
7 4 ,9 8 5
18 1,04 3
2 8 4 ,0 4 2
17 0,69 5
14 2,48 6
1 8 ,4 4 0
15,559
12 9,79 9
4 4 5 ,4 9 3
4 8 7 ,8 9 4
6 4 6 ,8 1 2
1 ,3 1 2 ,5 8 2
1 ,2 8 7 ,2 9 0

FHA
Sales

VA
Sales

(5)

(6)

___

—

------

5 ,0 1 4
2,8 87
4 6 5 ,5 6 8
3 ,4 7 4
4 2 ,0 9 3
5 2 1 ,9 9 9
3 9 0 ,6 6 7
7 7 9 ,8 2 4
78,091
4 6 ,5 6 2
73
1 1 ,744
358

___
------

1 ,2 50
2 ,0 4 9
1 3 8 ,8 4 3
3 ,0 4 8
2 8 ,7 9 6
3 1 8 ,6 2 9
1 9 5,10 3
3 8 9 ,4 7 4
44,541
14 ,508
73
7 ,7 1 0
188

3 ,7 6 4
83 8
3 2 6 ,7 2 5
426
13 ,297
2 0 3 ,3 7 0
1 9 5 ,5 6 4
3 9 0 ,3 5 0
3 3 ,5 5 0
3 2 ,0 5 4
...

4 ,0 3 4
170

...

2 0 ,2 9 3

1 8 ,4 1 0

1 ,8 83

Less than $ 5 0 ,0 0 0 .
Source: Federal National Mortgage Association

and

mortgages

from

originating sources,

combine these mortgages into large blocks or
pools, and then issue bonds that are secured by the

the investor, GNMA guarantees the performance
of the servicing agent.
In addition, both FNMA and the FHLMC have

blocks of mortgages to public investors. The bonds

been

are guaranteed by GNMA. Pass-through partici

mortgages for their portfolios; but as of the

pations are issued by private financial organi

present time, only FHLMC has made any pur

zations and differ from mortgage-backed bonds in

chases. The FHLMC has also been given authority

several respects. Only FHA and VA mortgages

to issue conventional mortgage backed bonds, but

are eligible

back the participations,

thus

attenuating the risk of final default. The origi
nator

retains the

servicing of the

mortgages

authorized

purchase

conventional

these would not be guaranteed by GNMA and
would, therefore, be d iffic u lt to market.
The primary purpose of the new mortgage-

and passes the monthly mortgage payments, plus

backed instruments is to attract large investors,

any prepayments, on to the holder of the pass

such as pension funds, which traditionally have

through participation after deducting a nominal

been reluctant to invest in mortgages through the

service charge.7 As an additional protection for

secondary mortgage market and in some cases
prohibited from doing so. These securities elim i

7 The detailed treatm ent o f late payments and prepay

nate the paper work of handling individual and

ments varies among issuers.

highly diverse mortgages and through the GNMA

JULY 1971

Chart 1.

MORTGAGE DEBT O UTSTANDING
BILLIONS OF DOLLARS

END OF PERIOD

Last entry: 1970
Source: Board of Governors of the Federal Reserve System

guarantees meet the legal liquidity requirements
often

imposed

pension

funds.

new

new securities. FHLMC has fo r the most part

securities also have the characteristics of other

followed FNMA even though the FHLB and the

capital

market instruments, in

The

the more active innovator and participant in the

that they are

savings and loan associations deal almost exclu

conducive to active and frequent trading in the

sively in primary conventional mortgages. The

secondary market and can be held as long-term

interest of the FHLB and the savings and loan

portfolio investments.

associations in the development of the new bonds

Since FNMA has been primarily concerned with

and the secondary conventional mortgage market

FHA and VA mortgages, it was not expected to

would appear to be a reasonable expansion of

play an active role in the development of the

their previous operations.

mortgage-backed bond or a secondary conven
tional mortgage market. However, largely because
of the influence of HUD, FNMA has proved to be

THE MORTGAGE M ARKET SINCE 1965
General Trends. The ebb and flow of funds into
21

ECONOMIC REVIEW

TABLE II
Annual Rate of Growth of
Mortgage Debt Outstanding
Governm ent Guaranteed

Conventional

Total
1966
1967
1968
1969
1970
Average annual
growth rate

Federal Housing
A dm inistration

Veterans
Adm inistration

6.62%
6 .5 6
7.37
6 .9 9
6.06

7.62%
7.08
7.78
6.6 9
5 .9 0

5.38%
5.4 9
7 .0 0
8 .2 2
8.21

0.65%
3.9 2
4.4 0
5.4 2
4.2 8

6.7

7.0

6.9

3.7

Sources: Board o f Governors of the Federal Reserve System and Federal Reserve
Bank o f Cleveland

the

mortgage

market

since

1965 have been

at the end of 1965 to $451 billion at the end of

sensitive to changes in overall economic activity,

1970, at an annual average rate of 6.7 percent.

especially to conditions in the money and capital

During this period, the fastest rate of growth

markets.

occurred

During

periods of

limited economic

growth and declining interest rates, funds were
readily

available;

while

periods

1968 when total

mortgage debt

outstanding increased by 7.4 percent; the slowest

rapid

rate was 6.1 percent in 1970, considerably below

economic expansion, funds were scarce, and many

any of the preceding four years (see Table II).

lenders were completely out of the mortgage

Mortgage loans guaranteed by the Federal Govern

market despite high interest yields. Chart 1 shows

ment grew more slowly than the total between

the total volume of mortgage debt since 1965.

1966 and 1968, but FHA loans have grown much

Although

more rapidly than conventional loans since 1968.

this outstanding debt has increased

annually, the dollar volume of new loans has

However, at the end of 1965 and 1970, conven

fluctuated.

tional loans outstanding represented 69 percent of

The

proportion

loans

having

Government guarantees has also varied as money
market conditions changed. To a large extent,

total mortgage loans outstanding.
The trend toward greater Government partici

mortgage credit is a function of the volume of

pation in the mortgage market since the credit

savings flows into commercial banks and the th rift

crunch o f 1966 is also apparent in the volume of

institutions. The mortgage market cannot, there

new mortgage loans made. In both 1966 and 1969,

fore, effectively compete with the money and

savings flows at commercial banks and other th rift

bond markets for funds, because of the vulner

institutions fell sharply, causing a reduction in the

ability of the inflows to the spread between yields

volume of funds available for mortgage lending.

on savings accounts and other alternative invest

Although the data are incomplete and only show

ment outlets.

mortgage loans made by savings and loan associ

Since 1965, total mortgage debt outstanding in

ations, the trend is partially discernible from Table

the United States has increased from $326 billion

III, especially when it is recognized that nearly all

JULY 1971
TABLE III
Mortgage Loans Insured by the Federal Housing Administration and
Veterans Administration and made by Savings and Loan Associations
(Millions o f Dollars)
FH A

1965
1966
1967
1968
1969
1970

Savings and
Loan Associations

A m ount

Percent
Change

A m ount

Percent
Change

A m ount

Percent
Change

$ 8 ,6 8 9
7 ,3 2 0
7 ,1 5 0
8 ,2 7 5
9 ,1 2 9
11,908

+ 6.87%
- 1 5 .7 5
- 2.3 2
+ 1 5 .7 3
+ 1 0 .3 2
+ 3 0 .4 4

$ 2 ,6 5 2
2 ,6 0 0
3 ,4 05
3 ,7 7 4
4 ,0 7 2
3 ,4 42

- 6.81%
- 1.96
+ 3 0 .9 6
+ 1 0 .8 3
+ 7.89
- 1 5 .4 7

$ 2 4 ,1 9 2
16 ,9 2 4
2 0 ,1 2 2
2 1 ,9 8 3
2 1 ,8 4 7
2 1 ,3 8 7

-3 0 .0 4 %
+ 1 8 .8 9
+ 9 .2 4
- 0.61
- 2.1 0

-o -

Sources: Board o f Governors of the Federal Reserve System and Federal Reserve
Bank of Cleveland

TABLE IV
Total Residential Mortgage Debt Outstanding by Type of Lender
(Millions of Dollars)
Commercial Banks
A m ount
1965
1966
1967
1968
1969
1970

$ 3 2 ,3 8 7
3 4 ,8 7 6
3 7 ,6 4 2
4 1 ,4 3 3
4 4 ,5 7 3
4 5 ,6 4 0

Percent
Change
11.94%
7 .6 8
7 .9 3
10.07
7.57
2.3 9

Savings and
Loan Associations

Mutual Savings
Banks

Life Insurance
Companies

A m ount

Percent
Change

A m ount

Percent
Change

A m ount

$ 1 1 0 ,3 0 6
1 1 4,42 7
1 2 1,80 5
13 0,80 2
14 0,34 7
1 5 0,56 2

8.85%
3.7 3
6 .4 4
7 .3 8
7 .2 9
7.27

$ 4 0 ,0 9 6
4 2 ,2 4 2
44,641
4 6 ,7 4 8
4 8 ,6 8 2
4 9 ,9 3 7

9.89%
5 .3 5
5.67
4.71
4 .1 3
2.5 7

$ 5 5 ,1 9 0
5 9 ,3 6 9
6 1 ,9 4 7
6 4 ,1 7 2
6 6 ,2 5 4
6 8 ,6 9 3

Percent
Change
8.53%
7.57
4 .3 4
3.5 9
3.2 4
3 .6 8

Sources: Board o f Governors o f the Federal Reserve System and Federal Reserve
Bank of Cleveland

mortgage loans made by savings and loan associ

contrasts between the effects of the two periods of

ations are conventional in nature. In addition,

severe credit restraint on the mortgage market.

commercial banks normally make a substantial

Most striking is the behavior of FHA-insured

amount of conventional mortgages; but as Table

mortgages. Rather than allowing funds to dry up

IV shows, the increase in mortgages outstanding at

and the number of new loans made to decrease

commercial banks was extremely small in 1970,

sharply, as in 1966, FNMA increased its purchases

indicating that conventional mortgage loan origi

of FHA and VA mortgages. This stepped up FHA

nations probably decreased substantially from

activity in the mortgage market in 1970 increased

previous year levels.

the volume of insured loans to $11,908 m illion or

Comparing early 1970 mortgage market results
w ith

those from

1966 shows several marked

30 percent more than in the previous year. The
total volume of FHA mortgage loans outstanding
23

ECONOMIC REVIEW

increased to $72 billion in 1970.8

meet the enlarged demand for policy loans.10

FHLB pursued an aggressive "advance” policy

Interest Rate Effects. Generally, in choosing

in 1970; as a result, savings and loan associations

am ong

maintained the volume of mortgages made in early

commercial banks and life insurance companies, of

various

competing

uses

funds,

1970 better than they did in 1966. These institu

all the major mortgage lenders, have the fewest

tions closed $21 billion of new mortgage loans in

legal restrictions.

1970, only 2 percent less than in 1969 and 2.4

and mutual savings banks are limited by law to a

percent less than the 1968 cyclically large volume.

relatively narrow choice of investments.

Savings and loan associations
19

Further

In 1966, they had made only $17 billion of new

complicating the mortgage market is the depen

loans, a decline of 30 percent from 1965. The

dence of three of the largest mortgage lenders

strong market support action taken by the various

upon time and savings deposits for their funds. As

Federal

largely

alternative investment outlets w ith higher rates of

housing

agencies

probably

responsible for the relatively small percentage

return develop, the net flow of funds into these

decrease in housing starts in 1969 and 1970 and

institutions is likely to decrease, partly because of

the short duration of the slump in housing starts.9

"in fle xib ilitie s” on rates paid. As can be seen in

The three major sources of private mortgage

Chart 2, commercial banks experienced a net

funds—commercial banks, mutual savings banks,

outflow of time and savings funds in 1969.

and

life

insurance

companies—seem

have

Interest rate differences have a double effect on

curtailed their volume of mortgage lending more

the volume of mortgage lending. First, as rates on

severely during 1969-1970 than 1966, causing

competing investment instruments rise, suppliers

total mortgage debt outstanding to increase less

of funds tend to decrease their purchases of

rapidly in the more recent period (see Table IV).

mortgages. This is particularly true when mortgage

In 1969 and 1970, life insurance companies did
not have the freedom to choose freely among the

10Due to special circumstances arising from policy loans,
insurance companies made fewer mortgage loans than in

alternative uses of funds as did the other financial

the previous year from 1 9 66 through 1969. In 19 70, life

intermediaries because of contractural arrange

insurance companies increased their volume of mortgage

ments contained in their policies. A substantial

loans made to $ 7 .0 m illion from $ 6 .6 m illion in 19 69,
still well below the volume o f $ 9 .9 m illion in 1 9 65 and

share of their investment funds had to be used to

$9 .2 m illion in 19 6 6 . See The Tally o f L ife Insurance
Statistics, Institute of Life Insurance.

11
O
Unpublished data. Board of Governors of the Federal

For

life

insurance

companies,

this

includes

the

possibility of acquiring equity in the mortgage property.

Reserve System.

12 M utual
g

savings banks enjoy somewhat more freedom of

choice than savings and loans inasmuch as they are able to
"credit

hold U nited States, corporate, and municipal bonds, and

crunch” spans the second half of 1 9 69 and early 1970.

The

period

most

comparable

the

1966

corporate stocks as well as mortgages and consumer credit

The recent impact o f tight credit markets on mortgage

instruments. Savings and loan associations are generally

lending, however, was more intense during 1970 than

restricted to

1969.

graphic areas.

real estate loans w ithin fa irly small geo

JULY 1971

Chart 2.

NET SAVINGS FLOWS*
BILLIONS OF DOLLARS
40
CO M M ERCIAL BANKS

0
M U TU A L SAVING S BANKS

-1 0
—20
1965

'66

'67

'68

'69

'70

'71

END OF YEAR

Last entry: 1970
•C U M U L A T IV E T O TA L

Source: Board of Governors of the Federal Reserve System and Federal Reserve Bank of Cleveland

interest rates are held below the level of market

During periods of high interest rates, demand for

rates, often though artificial interest rate ceilings

new residential mortgages is also depressed because

(state

of the increase in the total cost of a home. As was

usury

laws). Second, as interest rates
at

true during 1969 and 1970, interest rate advances

commercial banks and other savings institutions is

and generally tighter mortgage terms frequently

retarded, and the available supply of loanable

occur during periods of inflation so that the costs

funds at these institutions is decreased. This

of property are higher, thus discouraging mortgage

second

borrowing.

increase,

generally

impact

time

deposit

magnified

when

growth

maximum

interest rate regulations on deposits, imposed by

It therefore appears that the primary mortgage

the various regulatory agencies, are effective. It is

market can be quite sensitive to monetary policy.

unlikely, however, that these institutions, because

In general, the market expands during periods of

of their long-term loan portfolios, could become

expansionary monetary policy, and it is one of the

fu lly

first and most strongly affected economic sectors

competitive

w ith

market interest rates.

ECONOMIC REVIEW

TABLE V
Federal Home Loan Bank Operations
(Millions of Dollars)

1965
1966
1967
1968
1969
1970

To tal
Advances
Outstanding
(End of Period)

Advances
Made

Repayments

A m ount

$ 5 ,0 0 7
3,8 0 4
1,527
2 ,7 3 4
5,531
3 ,2 5 6

$ 4 ,3 3 5
2 ,8 6 6
4 ,0 7 6
1,861
1,5 00
1,9 29

$ 5,9 97
6 ,9 3 5
4 ,3 8 6
5 ,2 5 9
9 ,2 8 9
10 ,615

Long-term
Advances
Outstanding
(End o f Period)

Percent
Change

A m ount

+12.61%
+ 1 5 .6 4
—3 6 .75
+ 1 9 .9 0
+ 7 6 .6 3
+ 14 .27

$ 2 ,9 2 3
1 ,9 29
401
392
85 5
7,5 34

+ 17.91*
- 3 4 .0 0
- 79.21
2.2 4
+118.11
+ 7 8 1 .1 6

Sources: Federal Reserve Bank of Cleveland and Federal Home Loan Bank Board

during

periods of restrictive monetary policy.

took additional steps to encourage the taking out

Although influencing the volume of total expendi

of long-term advances in the 1969-1970 period

tures in the economy is one of the goals of

(see Table V). To add greater support to the

monetary policy, spending for housing has social

recovery in the mortgage market in late 1970 and

value, which may partially exempt it from the

early 1971, the FHLB began to discourage the

desired results for the credit markets as a whole.

early repayment of these advances and to encour

Consequently, FNMA and FHLB have recently

age its members to make additional mortgage loans

been attempting to lessen the impact of monetary

instead.

policy on the housing industry and the mortgage
market.
The FHLB, through the issuance of short- and

The secondary market operations of FNMA
affect the overall availability of funds in the
mortgage market more directly than the FHLB.

long-term advances to member institutions, can

FNMA is capable of increasing the total amount of

affect their liquidity and, therefore, the ability of

funds

a given savings and loan association to make new

restraint through the purchase of mortgages in the

loans. Short-term advances are often taken out by

market and decreasing the amount of money

available

during

periods

monetary

FHLB members to compensate for seasonal varia

available during periods of rapid credit expansion

tions in savings flows and loan demand. Longer-

through the sale of mortgages. This action some

term advances, which require specific collateral,

what offsets the general effects of monetary

tend to increase the amount of money available to

policy. In addition, both FNMA and the FHLB

the mortgage market as a whole and, particularly,

finance a large portion of their support operations

to those regions of the country where the local

through funds raised in the bond market.13 This
T5

lending institutions may have insufficient funds to

U ntil the increase in the m inim um denom ination of

meet mortgage loan demand. Although the volume

these bonds in 1 9 70, apparently a substantial am ount of

of advances has always increased rapidly during

funds were being w ithdraw n from th rift institutions and
commercial banks to purchase the

periods when interest rates are rising, the FHLB
Digitized for 26
FRASER

bonds.

F N M A and FH L B

JULY 1971

Chart 3.

FNMA MORTGAGE COMM ITM ENTS OUTSTANDING
MILLIONS OF DOLLARS

END OF PERIOD

Last entry: January 1971
Source: Board of Governors of the Federal Reserve System

has the effect of drawing funds into the mortgage

percent and 8 percent, respectively; whereas in

market, where they may be more urgently needed

1966, the volume had decreased by 16 percent and

in terms of social values. In periods of tight credit

2 percent (see Table III).

conditions such as 1966 and 1969, total mortgage
sales by

FNMA

As would be expected, the volume of com m it

were extremely small, while

ments increased during periods of "tig h t" credit

purchases of mortgages were at record levels (see

and decreased as credit conditions eased (see Chart

Table I; Columns 1 and 4). Although the purchases

3). By providing mortgage companies and builders

are preceded by commitments, they do serve the

w ith funds in this manner, FNMA again helped

purpose of channeling funds—that would other

soften the burden of monetary policy on the

wise go elsewhere—into the mortgage market. The

housing industry.14 Since May 6, 1968, FNMA

sale o f a mortgage, however, constitutes a true

has been conducting a "free m arket" auction of

secondary market transaction and acts to absorb

commitments for the future purchase of eligible

excess available funds of mortgage lenders. In the

single fam ily FHA and VA mortgages, as well as

1969 period of increasing mortgage rates, FNMA

purchasing eligible FHA and VA mortgages "over

borrowed funds in the private bond markets to

the

counter."

Some

m ulti-fam ily

mortgages.

increase its purchases of FHA and VA mortgages
and to give support to the primary market. Largely

14Leo

due to this support, FHA and VA were able to

M arket, (Los Angeles: University of California, 1961) p.

increase their mortgage loan activity in 1969 by 10

138.

Grebler and Oliver Jones, The Secondary Mortgage

ECONOMIC REVIEW
however, are still purchased by FNMA through

improved the secondary market, but they have

stand-by commitments or at negotiated prices on

gained some acceptance and should continue to

an individual case basis.

increase the scope of the secondary market. So far,

The Secondary Market. Commercial banks and

$1 billion of mortgage-backed bonds have been

savings and loan associations in general do not

issued by

originate mortgage loans with the intention of

FHLMC.

selling

take

secondary market activity involving conventional

advantage of the existence of the secondary

mortgages. The slow start in issuing these new

them.

times,

however,

they

FNMA, and only $615 m illion
There

has

been

virtually

by
new

market to adjust their portfolios, both by selling

mortgage-backed securities is due at least partially

any oversupply

to the easing of money market conditions in 1970

and

purchasing additional

mortgages if the market conditions indicate that

and the adequate supply of loanable mortgage

new mortgages should not or cannot be made. Due

funds that has characterized the period since the

to the Government backing and standard high

introduction of the securities.

quality of FHA and VA mortgages, most of the

In general, during

periods of interest rate

stability, the yields on mortgages in the secondary

mortgages. These portfolio adjustment purchases

market are below those available in the primary

purchases

and

sales

involve

FHA

and

and sales are not based on prior commitments and

markets, an expected result of charges for servicing

therefore qualify as genuine secondary market

and other costs of origination. The yields on Aaa

transactions. In spite of the many efforts to

corporate bonds are also generally below yields on

develop a secondary market since the 1930's, most

F H A -in s u re d

of the purchases and sales of existing mortgages

secondary market. This spread between corporate

mortgages

purchased

the

are only marginal secondary transactions because

bond and FHA mortgage yields is due chiefly to

the initial loan, in most cases, would not have been

the well-established bond market mechanisms, the

made w ithout a commitment from the final

greater degree of competition in the bond market,

holder.

and the larger denominations of the bonds.16 It is

In order to draw new sources of funds into the

likely that the yield on the newly established

mortgage market, particularly the large private

mortgage-backed securities w ill be between the

pension funds, the GNMA pass-through partici

two, perhaps approaching the yield available on

pation was developed. Since the program became

Aaa corporate bonds.

operative in February 1970, 992 applications to

Throughout 1965, when interest rates were

form mortgage-backed pass-through participations

stable, the yields on the various instruments

have been received by

behaved as expected (see Chart 4). In 1966 when

GNMA, totaling $3.9

billion; of this amount, $2.3 billion have been sold

interest rates began to

increase steadily, the

and delivered, although commitments have been

secondary market yield increased relative to the

received fo r more.15 These new FHA and VA

conventional mortgage yield; it was substantially

mortgage-backed securities have not markedly
16 Risk

15
A ll data concerning m ortgage backed securities are as
o f J u ly 1 9 , 1 9 7 1 .

secondary
m ortgages.

not

considered

m ortgage

because th e

y ields are

based

data

used fo r

F H A -in s u re d

JULY 1971

Chart 4.

SELECTED INTEREST RATES
PERCENT

M O N TH LY

Last entry: May 1971
NOTE: Mortgage data based on FHA field-office reports for market areas of insuring office cities. For
"conventional," average interest rates are for first mortgages on new homes. For "FHA-insured," weighted
averages of private secondary market bid prices for certain new-house mortgages are converted to annual
yield. Breaks in FHA insured series indicate periods of adjustment to changes in contractual interest rate.
For corporate bonds, weighted average of new publicly offered bonds with at least 5-year call protection are used.

Source: Board of Governors of the Federal Reserve System

above the conventional
interest

rates

finally

mortgage yield
peaked

1970.

when

changing

m a rk e t

conditions.

Conventional

This

(primary) rates are usually set for given periods

probably resulted from the fact that the secondary

and require administrative action to change. In

market for mortgages is more competitive than the

times of increasing interest rates, this w ill lead to

primary market and is, therefore, more sensitive to

the market determined secondary rates increasing

ECONOMIC REVIEW
more rapidly, while the reverse is true during

directly by the impact of economic conditions on

periods of declining rates. In addition, during the

the housing construction industry than by the

most recent period of increasing interest rates,

yield structure of various alternative investments.

primary mortgage rates were restrained by state

To counteract the reduced participation of the

usury ceilings. Although there were fewer legal

life

restrictions on the secondary market yields, these

secondary

yields were constrained by Government pressure,

increased its participation. As is shown in Table I,

partly because of the social implications of high

FNMA became much more active in the purchase

mortgage rates. This permitted the yield spread

of FHA mortgages in 1966 than in any previous

insurance

companies

market,

the

and

others

Federal

the

Government

between Aaa corporate bonds and the secondary

period. In 1968, as conditions became increasingly

mortgage yield to narrow. In fact, the yield on Aaa

tight

corporate bonds was greater than the yield on

agencies

F H A -in s u re d

increasing the Federal agency share of total pur

mortgages

purchased

the

in the
also

mortgage

market, other

became

large

scale

Federal

purchasers,

chases from 7.7 percent in 1965 to 58.2 percent in

secondary market in late 1969.
One o f the most important changes in the

1968, and 46.5 percent in 1969 (see Table VI).

mortgage market since 1965 has been the relative

Although savings and loan associations are only

withdrawal o f the insurance companies (see Table

marginal

participants

the

FHA

mortgage

V I). As interest rates increased and the rates of

market, they did increase their volume of pur

return on alternative investments increased relative

chases in 1967 and 1969 when yields on FHA

the

yield

mortgages,

the

insurance

companies began to turn to other investment

mortgages climbed above those available on con
ventional home mortgages.

outlets. One of their frequently used alternatives
was the purchase of equity in the property being

CONCLUDING COMMENTS

fewer

Some of the improvements long sought by

mortgages, the insurance companies began to sell

experts in the secondary mortgage market have

o ff a larger proportion of their portfolios of

come about since 1968 or are currently in the

mortgages. In 1965, sales of mortgages equaled 7.1

planning stage. The most discussed improvements

percent o f those purchased, while sales were 23.6

relate to the development of (1) a market maker

percent of purchases in 1969.
banks, usually net sellers, also

and (2) a central mortgage bank.17
Most notable of the accomplished reforms has

tended to cut back their participation in the

been the institution of the "free market auction"

secondary FHA market between 1965 and 1969,

by FNMA that allows the yields which it receives

when

mortgage

on FHA and VA mortgages to fluctuate w ith

activity. On the buyer's side of the market, mutual

market conditions. The administered rates, which

mortgaged.

Commercial

banks

addition

generally

purchasing

reduced

all

savings banks were forced to cut back their
activity when savings flows declined. The smaller
buyers of FHA mortgages, such as industrial banks
and finance companies, also withdrew from the
market. Mortgage companies were affected more
30

17 For

mortgage

detailed

m arket and

discussion

o f the

suggestions fo r

secondary

expansion

and

im provem ent of the m arket, see Grebler and Jones, The
Secondary Mortgage Market.

TABLE VI
Total Purchases and Sales of Federal Housing Administration Insured Mortgages
by Type of Institution
(Thousands of Dollars and Percent Distribution for Year)
19 65

1966

1967

1968

1969

Type of
In s titu tio n

Purchases

C o m m e rc ia l banks

6 8 1 ,1 2 4
10.8%

Sales

Purchases

$1 ,01 4,23 4
16.1%

12 7,76 4

54 7,43 9
8.1%

Sales

Purchases

$1 ,07 8 ,9 6 9
15.9%

122,481

4 2 2 ,3 2 6

Sales

9.7%

7 6 2 ,7 7 0

Purchases

17.5%

3 1 0 ,4 1 8

Sales

4.1%

872,301

Purchases

11.8%

3 2 1 ,4 0 2

Sales

4.9%

8 9 2 ,6 9 5
13.6%

Savings and Lo an
A ssociations

31 4,05 1

5.0%
M u tu a l Savings Banks

$2 ,3 9 0 ,6 9 3

F ederal A gencies

37.9%
$1 ,4 6 1 ,5 9 8
23.2%
$ 2 3 1 ,8 6 8
3.7%
$ 4 8 4 ,4 3 4

O th e rs *

Insurance C om panies
M ortg a g e C om p a n ie s

7.7%

TO TAL

7 3 5 ,6 0 3
11.7%

$ 6 ,3 0 2 ,5 1 8

2.0%
$

169,191

2.7%
10 3,43 2

1.6%
$4 ,62 7 ,6 8 0
73.5%
$ 17 7,95 2
2.8%
$

80,531

1.3%
$ 6 ,30 2,51 8

26 0,868

3.9%
$1 ,78 3,35 0
26.4%
$1 ,35 1,70 0
20.0%
19 7,83 9
2.9%
$1 ,95 6,08 5
29.0%
$

65 7,339
9.7%
$6 ,76 2,31 3

4 4 2 ,9 1 5

1.8%

10.1%

1 3 8 ,592

1 6 6 ,6 7 3
2.5%
$5 ,01 7 ,4 8 9

$1 ,2 0 5 ,4 7 3
27.6%
$ 6 9 3 ,8 4 7
1 5.9%
$ 103,151

74.2%
2 3 ,1 7 2
0.3%
$ 2 1 2 ,7 1 6
3.2%
$6 ,7 6 2 ,3 1 3

2.4%
$1 ,0 2 9 ,0 6 4
23.6%
$ 4 6 7 ,4 1 7
1 0.7%
$4 ,369,701

2.1%
$

* Includes industrial banks, finance companies, endowed institutions, private and
state benefit funds, etc.
Source: U . S. D ep artm ent o f Housing and Urban Development

8 6 ,6 5 4

2.0%
$

1 0 7 ,7 3 2

2.5%
6 3 ,5 2 0
1.5%
$3 ,252,511
74.5%
1 0 ,9 3 0
$
0.2%
$

8 0 ,4 0 0
1.8%
$4 ,369,701

6 6 1 ,7 0 9

8.9%

80 ,9 2 7
1.1%

149,484

12.9%
$1 ,1 9 5 ,7 4 7
18.2%

2.3%
28 7,47 7

11 5,35 5

97 2,24 1

13.1%
585,631
7.9%
2 1 9 ,9 8 4

2.9%
$4 ,3 3 3 ,1 5 0
58.2%
$ 3 5 9 ,1 9 5

0.6%
5 5 ,839
0.8%
$3 ,853,611
52.0%
$2 ,4 2 2 ,6 1 6
32.7%
7 7 ,5 1 5
$

4 8 9 ,1 3 9
7.4%
$ 30 6 ,7 5 2
4.7%
$ 3 ,064,781
46.5%
$ 3 5 7 ,6 3 4

4.9%
$7 ,4 5 2 ,8 5 9

1.0%
$7 ,4 5 2 ,8 5 9

$6 ,590,901

$
$
$

45,751

8 4 9 ,3 0 3

5.4%

4.4%
1.8%
$4 ,349,561
66.0%
$ 701,761
10.6%
8 5 ,9 4 8
$
1.3%
$6 ,590,901

ECONOMIC REVIEW
had been used previously, tended to distort the

for doing business, and taxation of out-of-state

allocation

lenders.

process

the

market.

Potential

investors were faced w ith both the uncertainties of

addition,

competition

could

increased by the easing of geographic restrictions

the market and the additional problem of antici

on primary lending activity, allowing the flow of

pating the judgmental decisions of the admini

funds to go directly to the areas of the country

strators.

having the greatest need.

FNMA and the FHLMC are also moving in the

Improving the marketability of the mortgage

direction of developing a standardized conven

instrument, however, w ill serve little purpose if

tional

little

investor entry into the secondary market is not

progress has been made in standardizing state laws,

also improved. One possibility of increasing the

FNMA is in the process of developing a standard

confidence of potential investors in the market

mortgage contract fo r each state, w ith as much

ability of a mortgage is to establish Federally

homogeneity among states as possible. When this

chartered market makers or a central mortgage

project is operational, some national homogeneity

bank fo r conventional mortgages. These market

w ill exist, cutting down the current extent of

makers would act as central clearing houses for

mortgage

instrument.

Although

market segmentation. The primary purpose of this

purchases and sales of mortgages. Combined w ith a

program is to facilitate the purchase of conven

workable classification system and simplifed legal

tional mortgages by FNMA and FHLMC, but it

and administrative procedures, the market makers

w ill also help develop more reliable conventional

could increase the volume of secondary trading

mortgages and broaden the potential market for

and the scope of those participating. The results of
such a move would be similar to the advantages of

them.
Further standardization of statutory restric

trading a corporate stock listed on an established

tions would probably lead to increased compe

stock exchange over trading an unlisted stock. Not

titio n

only would the large institutional buyers enter the

among

the

various

primary

lenders.

Currently, the multitude of restrictions tends to

market,

but

confidence

marketability

isolate the various local markets from each other,

increases, smaller scale traders might also enter. A

discouraging secondary market transactions. A

central mortgage bank could also act as a clearing

more homogeneous product would also be brought

house fo r market information and provide the

about

environment needed to develop the secondary

the

adoption

of a uniform

code

concerning foreclosures, redemption periods, laws

mortgage market.