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Synthetics and Substitutes:
Challenge to Agricultl:f re .
The Quality of Mortgage
Credit: Part I •
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Synthetics and Substitutes:
Challenge To Agriculture
l)y
Gene L Sw(lc:klw111er
THE beginning of history, man has
struggled to develop food production capacity to sustain world population. In much of
the Western world the job has been done well,
with hum8.n nutritional needs being more than
satisfied. However, in many of the developing
nations, maintaining nutritional levels adequate
for survival remains a major undertaking. By
the year 2000, world population is expected to
increase to 6 billion- double the current level.
Obviou sly, demographers expect these people
to be fed- that is implied in the population projection- but diets may be barely adequate for
many.
The challenge to traditional agriculture is
immense. The next generation must duplicate
the food production record achieved since the
dawn of history. Consider the magnitude of this
demand. Can it be done?
Making an adequate nutritional diet available to an expanding world population is a
challenge to man's ingen uity ; meeting human
diet and living needs with sy nthetic products
that substitute for natural agricultural products
is a challenge to traditional farming. These two
challenges are opposites- one is a promise, the
other is a threat; both are not generally well
F
ROM
Monthly Review • March 1969
understood . The purpose of this article is to
condense relevant esonomic and research information on synthetics and substitutes. A diverse
assortment of literature was reviewed in an attempt to enumerate as accurately as possible
the major markets in which synthetics are
found and to discuss the economic impact of
synthetic substitutes in these markets.
In a literal sense, synthetics are artificial
replacements for natural -fo rm products. Substitutes arc replacements, too- automobiles and
tractors substi tuted for horses, plastic buttons
substitute for pearl buttons, and rayon and nylon are substitutes for cotton and wool and for
each other and other synthetics. If left at this
point, a description of the mix of synthetics and
substitutes and the raw material and end-use
product markets affected would be hopelessly
intertwined. Therefore, to better describe the
nature of competition from synthetics and to
assess their competitive impact, further delineation is made.
In thi s article, sy nthetics arc defined as raw
or semiproccssed materials, derived only from
nonagricultural sources. Substitutes are materials which partly or totally replace a naturalform component in resource combinations and
3
Synthetics and Substitutes:
Measuring ersa tz competition for th e whole
array of resource a nd product markets would
be a major effort beyond the purpose and
scope of this research, yet the need for some
es tim ates of current m arket share, value of
product, and potential development is very
great. The proliferation o f sy nth etic subst itu tes
in o ur economy during the past two decades
has been astounding. Many markets have been
affected . Both farm and urban families have
benefited from the technology of our age, but
adju stments have b ee n necessa ry as production
and m a rket environments change. In a study
of 12 agricultu ral m a rkets , it was estimated
th a t synthetic had captured 10 per cent of the
value of th e curre nt market for agr icultural
products. 2
Some es tim ates of ma rket share illustrate the
co mpet ition faced by crop a nd lives tock products. Of more than 600 million pairs of shoes
manufactured annually, 75 per cent have nonlea th er soles and 20 per ce nt have no nlc ather
urpers . Synthetic fruit fla vo rs and produ cts
accou nt for more than 5 per ce nt of fruit beverage sales; substitutes acco unt for an add iti nal 25 per cent. Artificial swee tene rs, riding
a soft drink boom, have continued to gain a
larger share of the sweetene r market and now
represent an ann ua l sugar equivalent of about
800,000 tons , compared with about 3 million
tons of annual beet sugar output. Wool and cotton contin ue to lose markets to synthetic and
cellulosic substitutes , which claim about 64
per cent of the dollar volume spent by the textile indu stry and over 40 per cent of the pound
volume . Urea competes with natural -protein
suppl eme nt a ni mal feeds· th e fore try products
indu. try finds the furniture, housing, and pap r
market cha ll enged by chem ically de rived plastics-even Christmas trees, mi stl etoe, and holly
a re not immune to the permeation of science.
The food industries have been less influenced by
synthetic substitutes, but face potential competition from agriculturally derived product substitute a nd other new foo ds. B ecause current
expe riments with protein a nd energy sources
have such awesome implications , a later section
is devot d e ntirely to food .
1
In an attempt to generalize this review of syntheti cs , a
preference was given to generic and scientific names
over trade names. Occasiona l use of a t rade name
is not an endorsement of one product over anot her,
but an effort to avoid unnecessa ry technicality.
~William S. H oofna gle and Ray S. Corkern, " In formation Needed fo r Decision Making," Syn th etics and Sub stit utes for Agricultural Products (Institute of Food and
Agricultural Sciences, University of Florida, Publication
No. 1, May 1966 ), pp. 89-95.
end-u se products. A substitute may originate
from either agricultural or nona g ricultural
so urces, but sy nthetics will be limited to nonagr icultural so urces. Thus, a synthetic substitute
is a product derived from nonagricultural
so urces th at substit utes for an agriculturnl
product.
Con ider the following illu trations: nylon ,
sacchari n, urea, artificial flow ers, a nd synthetic
leather' arc typical synthetic s11bstitutes. Each
is derived from non agricultural raw materials
a nd competes w ith agricu ltural products. offee
wh iteners, meat a nalog , rayon, glyce rin , and
fill d milk arc agricultural s11hstit11tes. These
prod uc ts arc eit her who ll y derived from agri c ultur,1 1 raw mate rial s ( soybeans, vegetable o il s,
reg nerat d c llul o e, tc.) or may represent
a combination of sy nthetic a nd natura l-form
materials. Resource substitutes repre ent a third
classification, including such substitutions as
m echanical and electrical power for m anua l
labor, tractors and trucks for horses, inorganic
commercial fertilizers for organic fertilizers,
commercially prepared a nim al feeds for grasses
and legumes, a nd agricultu ral chemicals for
tradit ion al fie ld c ulture . Although these types
of displacements have been dynamic and are
st ill co ntinuing, only occa io nal reference will
be made to them.
THE MARKET IMPACT OF SYNTHETIC
SUBSTITUTES
4
Federal Reserve Bank of Kansas City
Challenge To Agriculture
Table 1
ANNUAL GROWTH ATE IN CONSUMPTION AND
MARKET SHARE OF NATURAL-FORM AND
SYNTHETIC SUBSTITUT S
Markets
Growth Rates
Year
Rates Year
(Per
Cent)
----
All Fibers
Cellulosic
Noncellulosic
1949-65
Soaps and Detergents
Agri cultura l sources
Nonagricultural
1945-65
Ethyl Alcohol
Ag ricultural sources
Nonagr icultural
Market Sh are
Share Year Share
(Per
(Per
Cent)
Cent)
1949
l 00.0
97.2
2 .8
l 965
l 00.0
67.2
32.8
3.4
- 5.9
17.0
1945
100.0
96.3
1965
l 00.0
19.3
80.7
1946-65
4 .0
- 6.2
8.4
1946
100.0
61 .3
38.7
1965
l 00.0
16.2
83 .8
Swoot n r
Ag ricultura l so urces
Nonagricultural
1958-65
1.9
1.6
9.3
1958
100.0
96.3
1965
100.0
93 .8
6.2
Oilseed Protein Feeds
Oilseed meal
Urea
1955-64
6 .3
5.8
10.4
1955
l 00 .0
1964
l 00.0
Glycerin
Natural
Synthetic
1945-65
3. l
-1.5
13.0
1945
2.8
.4
19.0
3.7
3.7
91.3
8 .7
100.0
89.7
10.3
87.8
12 .2
1965
100.0
42 .8
57.2
SOURCE : Compiled from Ra y S. Corkern, " Synthetic Substitutes in Agri -
cultural
Markets,"
Marketing
and
Transportation
Situation,
No.
166
(Washington : U. S. Departm en t of Agriculture, Augu st 1967), pp . 21 -28.
A ummary of estimated market shares a nd
growth rate, for se le ted markets is prese nted
in Tab le I. These data show the directions a nd
magnitudes of change for . ynthetic and n at ural form products. Agriculturally derived product
show a dec lining annual rate of growth in t he
soap and detergent, ethyl alcohol, and glyceri n
ma rkets and a declining share of total vol um e
in all six markets. Further analysis will be made
of the factors influ encing competition betwee n
sy nth etics a nd agricultural products in individu a l markets .
Fibers
The label "fibers" encompasse num ero us
textil e, apparel, carpet, and fabric markets subclassified a cotton , wool, cellulosic (rayon and
some acetates) and noncellulosic (nylon, polyester, acry li c, spandex, textile glass, etc.) synMonthly Review • March 1969
thetic subst itutes . On a per capita con umption
basis, their re lative sha re of the total U. S. fib er
market is estim a ted to be: cotton, 47 per cent;
wool, 6 per cent; cellulosics, 15 per cent; and
none llul osics, 32 per cent. In individual m arkets, of cour c, these e timates will ary c nsiderab ly. Woo l's share of th e $28 billio n texti le
appa re l m a rk e t may rise to 10-1 I per cent ,
while nylon's share of the carpet market a pproaches 50 per cent.
Synthetic substitutes arc fabr icated to fill
voids in agri c ultu ral markets that resu lt from
supply shortages, volati le price fluctuation s, in consiste nt qua liti s, and lack of va ri e ty. Mo st
fib ·r s ub stitut es ha ' be ·n t,1ilnrcd for spc ·ifi ·
mark e ts r ·q uirin g ce rt ain a ttrihut ·s not found
in natural fib rs, ye t fcw sy nth et ics arc perfect
substitutes. Natura l products often have unique
adva ntage that encourage the u e of syntheticna tural blends such as the polyes ter-cotton ,
wr in kle-resistant, permanent-press fa brics.
The 19 per cent average annual rate of
growth for noncellulosic fibers between 1949-65
(Table 1) understates the current rate, estimated at 24 per cent since 1960. Further e ncroachment by synthetic substitutes into fiber
mark ts can be expected.
steady str am of
research and deve lopm nt expend itures by
m ajor chemica l firm s co ntinues to yie ld new
products ("spunbonded" no nwove n materials,
o lefin s, etc.) with market potential.
Fats and Oils
The role of animal fats and vegetable fats
and oils in soaps , detergents , and paints has
steadi ly declined. The use of petroleum-derived
a lco hols, l ignin sul fo nates, phosphates, a nd latex mul ' ions and alkyd (p a ints) ha rapidly
in creased. Although the ga in s made by yn thetic ub titutes s uch as organic detergents have
been impress ive, nonfood markets for ag ricul tural fats a nd oi ls w ill continue to be ex ten sive
becau e of a multiplicity of end-product use .
In many cases, lo t agricu ltural markets h ave
been recovered or rep laced. Inedible tallow5
Synthetics and Substitutes:
used in soap-peaked at 1.5 billion pounds in
the early l 940's, compared with .7 billion
pounds in the 1960's; however, the loss has
been more than offset by use of tallow in animal
feeds a nd fatty ac ids . ln other cases , export
market g rowth has compcn ated for los
f
domestic market hares.
Alcohol, Glycerin, and Adhesives
Ethyl alcohol ca n be produced from agricultural carbohydrates ( corn and barley grains)
and from ethylene gas- a sy nthetic substitute .
On the ba is of 372 bu shels of corn and 83
bush Is of barley malt yi ldin g 1,000 gallons of
ethyl alcohol it is stimated that sy nthet i ·s now
ac oun t for ov ' r 85 per cnt of th market
(Tab l I ). Glycerin , a byproduct of animal and
vegetable fat process ing in ·oap and indu st ri al
product manufacture, has been increasingly
synthesized from petrole um sources. The 13 per
cent annual rate of growth for synthetic glycerin
probably indicate further decline in natural
glycerin production.
The lumpine s of home-made, flour-andwater pa te is long remembered. Starch , dcxtrin , ca ine, and other agricultural materials
have long been used to make adhesives. l ncrcascd u c of lamination and pressure bindings
f heterogeneou s sub tanc s, however , has r suited in the development of sy nth etic adhesives that substitute for agriculturally derived
products.
Forestry Products
In an increasing number of markets, there
are products that look like wood . They h ave
a natural-looking color and grain, the "carvin gs"
arc prcci c, and they so und authentic t the
rap of a knuckle, but they arc pla tic. Shrinkpro f, hea t-re i tant pla tic furniture that i.
imperviou s to moi ture and scratches and will
not warp is a rea li ty. Pia tic consumption by
the furniture industry-estimated at $85 million in 1968-will probably double in the next
few years.
6
A grow in g market for disposable products
ha e ncouraged pulpwood production, technology, a nd a ea rch for new raw material
sources-such as Kcnaf, a promising an nu al
paper pulp crop-but plastics arc likely to
dominate the fi eld. Low-co t production of
poly tyrcnc ( coffee cup , egg carton ) ub titute for cardboard and polyurethane (hightemperaturc in . ulation and crush-rcsi, tant packaging) replaces other paper products.
Of all wood u cd, lumber comprises 60 per
cent; paper, 30 per cent ; and other pr ducts,
IO per c nt. I ncrcas d economic activity, a
1 rowing popula tion , ,ind improved timber tec hnolo •y h,1vc II ' lpcd cxp;md th e use of for st
products in the .1ggrcgat , th o u 1 h per capita
use of many individual products is declinin g.
Use of pulpwood for paper and paper products
ha s shown a trong upward trend approaching
480 pounds per capita per year-triple 1920
usage. Plywood, particle board , a nd paneling
likewi e have a n upward trend , although per
capita consumption of lumber and many wood
products continues to decline.
Oilseed Protein Feeds and Roughages
vcn th o ugh urea ( an organic h mica! of
45 per cent nitrogen at feed gra de) is limited
to use by ruminant , and has techni al limit in
mixed feeds, over 400 ,000 tons were used in
feeds la t year. Total urea production was 2.8
million tons- one-half of which was us d as
fertilizer. Because of cost advantages a nd favorable results from feedi ng trials , continued substitution of urea for high-protein agricultural
sources is expected. Assuming a maximum
technical limit of one-th ird of the protein in
ruminant ration , urea con umption may soon
d ublc.
The replacement of fi eld-grow n roughag in
ruminant ration s by oyster hell. granite, sawdust, sand, pla tic pellets, and other ub tancc
has produced a controver y. Rcga rdlcs of the
ultimate resolution by nutritioni st , the likelihood of further fc ding of low-roughage or " no"
Federal Reserve Bank of Kansas City
Challenge To Agriculture
rou ghage rati ons see m ass ured . ew knowl edge
about toxi c ity , vita min suppl ementation , and
utiliza tion of ccllul a es will undoubtedl y lead
to developme nt a nd use of new sy nth etic a nim al
feeds.
Leather Products
ynth e ti cs have made a bi g dent in to the
$400 milli o n U. S. shoe-upper m a rk t. Onl y
abo ut 71 pe r cent of th e no nrubbc r foo twea r
ma nuf acturcd thi yea r will co nta in all or pa rt
lea the r. A cce pta nce o f poromcric mate ri als,
even with o ut lea the r's porosity, has res ulted
p rim a ril y be a usc f ustomer app recia tion o f
easy 1rn1intena n ·c and lo ng li fe ,ind th e foo twea r indu stry's I 's ir · for raw materia l of uni fo rm thi ·kn css a nd rrcatcr pr ice stab ility. Oth ' r
new m a te ri als suc h a. po lyvi nyl chl o ride, featuring low cos t, ea y fabr ica tio n, sim ul a ted
lea th e r des igns, cxtru io n inj ected soles and
uppers, a nd di electric hea t bo nd ing in tead of
titching a re cha ll engi ng tra d itio nal m ate ri als.
Po lyvinyl chloride use h as increased at a n impress ive 50 pe r ce nt ave rage annu al rate since
1962.
Pri o r to 1953 , th e U ni ted Sta tes was a net
impo rte r o f all ty) cs o f hi des and ski n.. in c
th en, th e Nati o n has beco me a net expo rte r o f
m re th a n $ I 00 mil Ii n of b vi ne hi d s and
, kin s a nnu a ll y. Th e tu rnaro und co uld n o t h ave
c me a t a bette r tim . Rapid grow th in the u c
of po romc ric , vinyl , and fab rics as sub t itutc
for lea the r in hoc m a nufac tu re and rap id expansion of livestoc k p rodu ction would h ave led
to a hide surplu s h ad the U nited States not
exported an annu al amo unt about equ al to the
domestic m a rket lo
to synthetic substitutes.
Even so , the o utloo k is u nce rta in .
THE FOODS WE EAT
he M a lthu ian th e is th at po pul a ti o n will
outdi ta nce wo rld foo d p rod uctio n has rec ivcd
renewe d interes t in rece nt yea rs. But the re arc
some impress ive argum ents to the effect th at
just as M althus ove rlooked the impact of techMonthly Review • March 1969
no logy o n food produ ction , current famine
ala rmi sts a rc m a king th e sa me error. F or exam pl e, con ide r the foll owin g deve lo pm ent : Food
produc ti o n in the Weste rn world adequ ately
su pports th e produce rs, their fa mili es, and m any
oth e rs. Utili zin g current tec hnol ogy, the W este rn wo rld has th e potenti a l to continue to upport its p pul a ti n grow th. In the nited Stat ,
co ntinu ed p rodu cti o n adv ances will occu r o n
few er ac re a nd w ith less labor. T he developing
na tio ns a lso co ntinu e to rcgi te r foo d produ cti o n achieve me nt as th eir to re o f knowledge
im pro ves. A va il ability o f fe rtil ize rs, new h yb rid
gra in s, a nd tc hn ic,il ass ista nce is eleva ting sevc nd to se lf-suffi c iency. O ur export ma rke t
wea kn ess since 196() has re fl ec t ·d to a C< nsid ·rn ble ex tent th e produ cti o n ad va ncement s o f
fo reign na ti o n .
Food deve lop me nts that will h ave grea t influ e nce o n ma n's fu ture a re mate ri a lizin g. These
biologica l a nd chemi cal advancements are a
threa t to traditio na l agric ul tu re but a promise to
hum a n well -be in g. A side from the scientific
kno whow that has generated fo od from p etroleum ( sin gle-ce ll protein- S P ), alga e, and
bacte ri a, new foo d concepts arc evo lving.
T o most peopl e, food is mea t, egg , and
po ta to's. T o the phys ica l sc ic nti t, foo d is
ene rgy (c~ lo ri c ), a nd to th nu triti oni st, foo d
is p ro tei n, ca rbo hyd ra te , li pids, a nd vitamin .
Fo r m a ny c ie nti t un associated w ith modern
agri culture, o ur N a ti o n's fo od o utput pe r input
uni t-env ied by wo rld agriculturi sts -is not
impressive. Wh y? Because they think in terms
o f energy-co nve rsion efficiency. On this score,
the gra in and lives tock industries, as protein
produce rs, co me in second-be t to microo rga ni sms. T oo, the re is th e roundabout way
in whi c h agri ulturc uses sun hinc (energy) and
wa te r a nd ph o tosy nthc is to produce an annuaJ
ene rgy equi va le nt per ac re equ a l to the ene rgy
o f just o ne d ay o f sun shine on th at sa me acre.
Irreleva nt? Yes, perh a ps so, but the development o f SC P a nd o the r synthetics described in
this section is a step in the direction of paten-
7
Synthetics and Substitutes:
tially producing food substitutes much more
efficiently than by use of many of the traditional
methods.
Protein Sources
Proteins , carbohydrates, and fats are the
fuel s of our bodies. All three supply energy,
but proteins aTc e ential building blocks for
growth because of the ami no acids they supply.
Although carbohydrates and fats are also important foods, they arc generally abundant
throughout the world in wheat, rice, potatoes,
and native foods, whereas protein-rich foods
(red meat, milk , fi sh) a rc not. Finding new
so ur s of in expc nsiv protein for developing
nations has hi 1 h priority and assuring ,In ad, _
quat food supply f r future ,e nc rations is
equally important. Becau e of th e critical rot
proteins play in human nutrition, mo t current
research is focused on this food, although other
considerations are also encouraging the development of new foods. (1) Special markets such
as for vegetarians, allergic adults and infants ,
regular ba by foods, low-cost nutritive diets for
the aged , developing nations, drive-in restaurants, and institutional feeding represent large
potential sales. ( 2) The natural advantage of
soybea ns with a better amino acid balance than
other major vegetable . ources and twice the
protein of beef" ha. encouraged intensive u. c
research. (3) Not the least of these factor is
the unending searc h for a more efficie nt , le s
costly method of food production.
Soybeans. Soybeans, an excellent protein
food source, h ave contributed substantially to
agricultural substitutes. Soy flour and grits used
in baking, soup mixes, cereals , baby foods , and
proce ed mea t already account for a 300million-pound, $20 million annual indu . try.
Soy protein concentrate is u sed in breads and
3
Proceedings of lntemational Conference 0 11 Soybean
Protein Foods (Washington: Agricultural R esearc h Service, No. 71-35, U . S. Department of Agriculture, M ay
1967), p . 24.
8
ground meats. Protein isolates, which contain
about 90 per cent protein , promise the grea test
potential, with sales exceeding 10 million
pounds ann ually. Available in powder, spun, or
extruded form, protein isolates are used to
make whipped toppin gs, fro stings, oy milks ,
sy nthetic meats, binders a nd emulsifiers; coffee
whiteners, and other food . Soy protein supplement i.- added to high -s ta rch diet in developin g nation s and is distributed by UNICEF at
approximately 12 cents per pound versus 41
cents for milk -prote in equivale nt. About 28
million to ns of soybea n oil arc produced annu ally in the United States for use as cooki ng
oils, food in 1 rcdic nts, and inclu stri ,11 products.
Other soyhca n-dcrivcd protein form s include
nzym e-n1 od ificd soy isolat (soy flak 'S a nd
a rtifici al egg albumin ) a nd e nzym c-activ m al
(white bread bleaching age nt) .
Although soy proteins are agricul tu ral substitutes rather than sy nthetics, their impact on
tradition al a nim al a nd vegetable protein sources
is substantial. With use expanding at a 20-28
per cent a nnu al rate during the past four years,
and more firms investing in new product development, the prospect for continued market
penetrati o n is good. In addition, new food
forms- suf u ( soybean cheese), m at analogs,
cntrc suppl e ments, ctc.- with unique characteris ti cs of their ow n w ill chall ngc tradi tional f odstuffs not only as ub titutc and
imitations but as origin a l alternatives.
Synthetic Foods. Two significant developments are accelerating the research of syn thetic
foods. First, the demands of population on
food supply are expected to intensify in many
areas. Second, the changing concepts of foods
and nutrition have provided nonagriculturally
related firms an opening into a dynamic new
field . Foremost among the discoverie of the c
effort has been S P- s ingle-cell protein.
Man ha used si ngle-cell agents-yeast and
bacteria- beneficially for years , but these micro-o rganisms never attained the status of acceptable complete foods. However, because of
Federal Reserve Bank of Kansas City
Challenge To Agriculture
the numerou SCP advantages-high-grade protein, high productivity, low cost, simplicity of
processing, packaging and shipping, fr edom
from seasonality and natural growing constraints, and multiple uses- a dedicated effort
now is being made to manufacture and ell
SCP.
The production potential of single-cel l proteins is fantastic. Production incrca cs exponentially so that a one-po und seeded culture
would multiply to two tons of edible food (ha lf
protein, half carbohydrates and fats) in 24
hour .4 The raw materia l for S P include an
organic carb n so urce (sulfite waste liquor
from pap r pulp manufa lure, molasses, or
p trol um and natur,11 gas hydroc.1rbons), ni tro 1 n, phosphorus, s ulfate, wat r, oxygen, and
certain trace clements. The SCP yield from
1,000 pounds of petroleum is approximately
1,000 pounds of edible product which compares with 500 pounds of catfish , 250 pounds
of dressed poultry, and 75 pounds of dres sed
beef per 1,000 pounds of feed! 5
Sea Foods. The sea has great potential as
a source of food. Although oceans compri e
much of the earth's su rface and are known to
be rich with many resources, knowledge of
ocean farming is just at the threshold. We have
ju t begun to realize the importance of o can
research .
Algae are 20-40 time more efficient in converting solar energy into food than arc field
0
crops. These prolific plant have shown production potentials of from 20-60 tons dryweight per acre per year, with proteins about
equal to yeasts in value and superior in vitamin levels. It is estimated that the per ton cost
of algae protein would be comparable to oybea n protein but could become cheaper with
advanced production techniques.
4
"Food from Petroleum ," SPAN, Standard Oil Company (Indiana) , Vol. VIH, No. 3 (Fa ll 1968), pp. 6-9.
5
/bid.
6
Kermit Bird , "Foods of the Future," Food Product
Development, December 1968-January 1969, pp. 26-32.
Monthly Review • March 1969
The harvesting of plankton has been suggested as a possible so urce of human food.
These lower-order forms of life live on nutrient in the shallow ocean above the continental
shelf. They are a source of food to shellfi h and
smaller fin fi sh. The grea tc t economy would
seem to lie in cultivating and harve ting the
shell and fin fi h that con umc the plankton,
rather than in trying to harvest plankton direct. The c fish use plankton more efficiently
than the hum an body would, and even those
species unde sirable a fresh foods ca n yield a
valuable supp ly of prot in in th form of
fi sh prote in co ncentra te (FP ). Such protein
so urc 's ha v air 'ady 1 ained ac cpta ncc as supplements to hi gh-s tarch and carbo hydrat diets
in protein d ficicnt nations.
The ultivalion of freshwater fish on a commercial b a i has attracted new intere t. Catfish farming has proved successful in landlocked Plains states because of improved technology in raising fingerlings, in achieving excellent growth rates, and in simplifying harvesting. Catfi sh have been found to be very efficient nutri ent converters with the capability of
producing about a pound of growth for each
pound of feed.
Although nutritiou s, many of the sy nthetic
foods and protein supplem ents arc not appealing in concentrated forms. To enh ance their orga noleptic acceptability and palatab ility, most
are used as supplements to native foods. Current research with synthetic proteins in animal
rations with synth etic flavors, and on extruding
simulated food textures shows promise of producing acceptable foods products.
Fruit Beverage Market
In 1955, synthetics and ubstitutes in the
fruit beverage market wer virtually unknown.
Now they acco unt for more than 30 per ce nt of
a billion dollar industry. Gaining market share
with each citrus freeze and con umer acceptance with product improvement and extensive
promotion, synthetic fruit beverages are a for9
Synthetics and Substitutes:
midable market force. Like many farm products, citrus suffers from weather irregularities
that cause abrupt supply changes , price fluctuations , and inconsistent qualities. The challenge
to citrus producers i to rega in competitive advantage through a superior natural product. In
th e words of researchers for the Florida Citru s
Commission, " ... competition from sy nth et ics
will not be permanently le sencd by antisynthetic legislation , regulation, adverti ing, and
legal and / or antitrust harassment . New product development utilizing natural fruit solid"
offers the b e t mea ns for combating competiti o n fro m sy nthetic " 1
Dairy Products
The m t dramat ic epi sode of s ubstitute vcrsu natural product took pl ace b tween butter
and oleomargarine. The stage was se t ea rly for
this incongruou s struggle . Even Gilbert and Sullivan in H.M .S. Pinafore wrote a lyrical prelude
-"Things are seldom what th ey seem, skim
milk masquerades as cream. " The parade of
state "Dairy Laws" began in J 885, followed by
oleo color mixing and a succes ion of court
cases. On e state required marga rine to be co lored pink. A 10 per cent Federal tax o n colo red
margarine wa voted in 1902. Federa l legislation remained in force until 1950 and interstate shipment of filled fluid milks are still
regulated.
The thrust of legislation was protectionistto keep " imitation" products from claiming
dairy association . The ram ifications of this historic legal confrontation are many and go far
beyond this one industry . Consider the word
"imitatio n." Courts have ruled th at imitation
implies inferiority, which may not be a correct
product de criptio n . M any sy nth etic and substitute have attributes superior to natural prod7
W. E. Black and Leo Po lopolu s, "Sy nth eti cs a nd Substitutes and the F lorida
itru s In dustry," Synth etics and
S11bstit11tes for Avic11/111ral Co111 1110di1ies, Insti tute of
Food a nd Agricu ltu ra l c iences (Gainesv ill e, Fla .. Un iversity of Florida, May 1966), pp. 2-11.
10
ucts, such as longer shelf life, adaptability to
freezing , or economy. Additiona lly , true synthetics may have individu al characteristics
placing th em beyond a substitute classification.
Other ramifications apply in reverse. Sometimes the industry seek ing protection became
so rigidly defined that innovative development
wa s stymied. The dairy industry did this with
butter- which i narrowly defined by grade and
stand ard and act of Congres . The re ult was
to ass ure market voids reflecting cha nging consumer preferences and to invite more competition. No o ne can doubt the delay in g effectivenes of such legis lat io n, though consumers may
rese nt it. In the case o f margarin e, per capita
consumption rose from 2 pound s in th e I 920's
to ov r IO pound , in the t 960's, while bull r
de lin ed one-half to abo ut 6 p o und .
Mo t dairy product substitutes are not true
synthetics. M arga rine h as a vegetable oil base.
Coffee whiteners are 5 to 10 per cent vegetable fats. Synthetic whipping creams contain
vegetable oils, as do fill ed evaporated milks and
mellorine fro zen desserts.
Substitutes for fluid milk are of two general
types: tho e with one or more milk components an d those with no ne . N either arc tru e
sy nth et ics. Milk substi tute , with so me milk ingredi ents, come under the regulatory jurisdiction of th e l 923 Federal
illed Milk Act,
whereas th latter group does not. To date , with
the exceptio n of Hawaii and Arizona, market
penetration by substitute milks has bee n limited,
even though they are lower--priced and nearly
equal nutritionall y.
Dairy indu stry representatives have estimated
that one-fourth o f their total m ark et has been
lost to sub stitutes du rin g the pa ·t 25 years. Coffee whiten rs cla im 35 pe r c nt o f the offce
cream market, substitutes from 65 to 80 per
cent of the whipping cream marke t, and mello rin c 5 per cent of the frozen de sert m ark et.
Sweeteners, Flavors, and Vitamins
Of an approximately 10-million-tons annu al
Federal Reserve Bank of Kansas City
Challenge To Agriculture
sugar market, nea rly 40 per cent is imported
from foreign countries and 60 per cent is domestically produced-3 million tons co min g
from sugar beets. On a sugar-equ ivalent bas is,
synthetic sweetener pro duction (saccharin and
cyclamates) is estim ated at 800,000 tons. The
growth of sy nth etic sweeteners has ri en rapidly during the past decade, as a we ight-consciou s public seeks low-caloric food . Sy nth etics provide no caloric value. One pou nd of 90
per cent cyclamate- 10 per cent sacchar in is
equivalent in sweetness to 57 pou nds of sugar.
Some of the suga r market has bee n lost to
low-cal rie sy nth etics, especially in soft drin ks
- th e la rgest single sugar outle t- bu t th e imr ac t has bee n less th an imagined beca use much
f th '' I w alo ri e" growth has been new bus iness.
Synthetic fl avor and vitami ns pre cnt an
intriguing challenge to chemists but not an es peciall y great threat to farmers. Enriched products have wide consumer acceptance. But the
success of synthetic substitutes depends greatly
on their resemblance to natural products .
SUMMARY OF AGRICULTURAL MARKET
LOSSES
A commend able effort to meas ure the loss
of agricultu ral ma rket to synthetic and agricultural substitutes was made by Co rkern and
Poats. 8 In T able 2, a um mary of their study,
the loss in J 967 alone was esti mated at $895
million- over 10 per cent of the total for the
markets analyzed .
Technology plays an important role in the
development of synthetic products. Sometimes
synthetics result fro m hours of painstaking experiments, but laboratory accidents p roduce
new ideas and products alma t as often. F requently, a proce s exists long befo re a useful
8
Ray S. Corkern and Frederick J. Poats, "Synthetics and
Agri cultural Su bs titutes in Food a nd N onfood M arkets,"
Marketing and Transportation Sit 11atio11, No. 17 1 (Washington : U . S. D epa rtment of Ag riculture, November
1968) , pp . 25-28.
Monthly Review • March 1969
product is merchandised, and quite often a myriad of produ cts flows from one di scovery.
Football on synthetic grass, leonardite (nonfu el part of low-rank lignite coal ) as a fertilizer,
freeze-dried and ir radiated food s, plastic flowers, bamboo as a fiber crop, and propylene glycol ( hi gh-energy) space food s are but sa mples
of new product markets not covered. Howeve r,
othe r iss ues need attention because ersa tz competiti on causes problems.
Di spl ace ment of any product by another is
painful , but in a market-oriented economy,
consum ers make the fin al decisions-not the
produce r . Co nsumer a re ass umed to behave
rati o nall y, but thei r alte rn at ives may be limited
by prod uct s lec ti o n and information avai lab il ity. Y et, r gard lcss of im pe rfecti o ns, no a mount
of pro t cti o n wi ll ave a pr duct once co nsum er tastes and prefe rences change. This is
the cold impersonal side of economics. But ag riculture has seve ral advantages that assure continued vitality. Food habits change very slowly.
Table 2
ESTIMATED LOSS OF TRADITIONAL AGRICULTURAL
MARKETS TO SYNTHETICS AND AGRICULTURAL
SUBSTITUTES IN SELECTED AGRICULTURAL MARKETS, 1967
Agricultural Product
or Market
Cotton
Wool
Cane and beet sugar
Oilseed meal
Fats and oils for soap
Drying oils for paints
Glycerin
Starch for dextrin
for adhesives
Soy meal and casein
for adhesives
Leather for shoe uppers
Citrus
Fluid milk
Total
Unit
Market Loss
Quantity
Value
(Millions)
Estimated
Total
Market
(Millions)
1,780
235
370
358
460
248
46
$456
176
76
30
31
32
7
$1,124
385
1,954
Mil. lb.
54
4
43
Mil.
Mil.
Mil.
Mil.
76
51
52
12
6
31
45
24
491
334
3,162
$8,196
Mil. lb.
Mil. lb.
Thou. dol.
Thou . dol.
Mil. lb.
Mil. lb.
Mil. lb.
lb .
sq . ft.
gal.
lb .
537
53
64
25
__
1
$895
SOURCE : Marketing and Transportation Situation, No. 171 (Washington:
ERS, U. S. De partment of Agriculture , November 1968 ), p. 26. For a
description of the estimating procedure, refer to Corkern and Poats
footnote 7.
11
Synthetics and Substitutes
Many synthetics serve new markets rather than
replacing agricultural products. With technological and managerial innovation, agriculture
has remained an efficient competitor. And , assuming synthetic food consumption increases at
a 10 per cent compound annual rate through
1975, synthetic substitute still would account
for no more than 1 per cent of the total. Furth rmore, some synthetic products are complementary rather th a n competitive with food
production.
Competition from synthetics and substitutes
will not lessen with time, nor will price advan-
12
tage alone hold an agricultural market. Agriculture's production orientation is both a
strength and a weakness. Failure to expand and
adequately fund marketing and research hinders
agriculture's ability to compete, yet the rewards
for innovation are great. A willingness to blend
the best of natural and ynthetic components
may have saved cotton, and product development breathed new life into the potato. Adaptability is of prime importance in meeting competition. Only willingness to discover new and
better techniques of production and products
will keep the industry competitive.
Federal Reserve Bank of Kansas City
Part I
The Quality of Mortgage Credit
By Robert E. Knight
;1nd co ntributing cha rac terisA tic of th e postw;1r
·conom ic expa nsi <)n has
SIGNIFI
/\
T
been the very rapid 1 rnwth of p, iv;1t e debt. In
1945, gove rnment in(kbtcdncss was n arly dou ble private debt , but toda y private d bt of over
$ 1.1 trillion is 2 1/2 tim es greater than government debt. Although credit would normally be
expected to grow with the economy, it has rise n
more rapidly than income th ro ughout the postwar period. As a res ult , the debt-income ratio
shown in Chart l has begun to ap proach the
historically high levels for periods of prosperity
attained durin g th e late I 920's. The e development have prompt d some observers to conclud not on ly that debtors arc becoming ove rexte nded but also that a decline in th e quality
of er dit has occurred .
The major components of pr iva te debt arc
corporate, mortgage, and consumer cred it. This
article will examine so me of th e economic factors which influence the quality of mortgage
credit. Nonfarm mortgage debt has increased
more than tenfold since 1945 and currently
represen ts the most importa nt clement in
hou se hold indebtedness. Although th e growth
rate of mortgage credit has been less th an that
f con um r credit, hous hold mortgage debt
is prnctically three time the volume of tota l
consumer credit and i only slightly less than
on -third of all private debt.
Consumer credit, which include in talment
loans, charg account , single payment loan s,
Monthly Review
March 1969
and s ' rvi cc cred it , is th e oth er major omponcnt of hou se hold d ·ht. ( onsumer credit h;1 s
recorded th e most rapid ga in s, but it still represe nts onl y about IO per cen t of tot,11 priv . 1te
deb t. Its rapid grow th rate is attr ibutab le partly
to the very small a mount o utstanding at the
end of the war. Corporate borrowings, on the
other hand , acco unt for nearly half of total
private debt. Howeve r, corporate indebtedness
has grown less rapidly than both types of household credit, despite an increase of practically
700 per cent since 1945.
Chart 1
RATIO OF NET PRIVATE DEBT
TO DISPOSABLE INCOME
Ratio
3 .5 , - - - - , - - - - . - - - - - r --
- - - - , . --
, . --
~-~-~-~~
3 .0
2.5
2 .0
1.5
1.0
.5
'30
'40
'50
'60
Source : 1969 Economic Report of the President.
13
'68
The Quality of Mortgage Credit
Household mortgage credit has also been
increasing more rapidly than income. (See
Chart 2.) Many developments have contributed to this growth. The shortage of housing
a fter World War I I forced m a ny families te mporarily to double up and created an un satisfied de mand. Since th e n the demand for new
hou sing has been further stimulated by a n increase in the number of familic , by the net
move ment of fami li es to rapidly growing suburbs, and by rising incomes which have permitted families to acquire highe r quality homes.
The cost of housin g ha s also increased greatly.
Estimates indicate that the cost of constructing a res ide ntial nonfarm ho me ha s more than
doubl ed since 1950 whil e th e cos t of ;1 typictl
building site ha s increased nea rly four tim es.
Th e progress ive casing of mortgage terms
ha s also facilitat ed th e growth of mortgage
debt. Sm a ll e r down payme nts and hi gher loan value ratios not only make more families able
to qualify for mortgage credit, but also increase the average debt they are likely to have.
The lengthening of th e average maturity of
mortgages has reduced the repayment rate,
tending to increase mortgage debt outstanding.
Although the ratio of mortgage debt to in come has grown rapidly throu ghout th e postTable 1
NET PUBLIC A D PRIVATE DEBT
(In billions of dollars)
1945
1968e
265.9
252 .5
443.6
292 .5
13.4
21.6
129.5
140 .0
1,103.8
586.0
Mortgage*
85.3
7.3
27.0
Commercial and Financial *
14.7
Public
Federal Government and Agency
Federal Financial Agency
State and Local Governments
Private
Corporate
Farm
Consumer*
Total
5.7
405.9
* Nonfarm
8 Estimated
Source : 1969 Economic Report of the President.
14
50.0
283.5
71.5
112.8
1,547.4
Chart 2
RATIO OF HOMEOWNER MORTGAGE
DEBT TO DISPOSABLE INCOME
Per Cent
50
40
30
Mortgage Debt on I- to 4-tomily
Dwellings os a Per Cent of
US D1sposoble Income
20
4
3
Schedul d Repoyment,; Homeowners
Mor1goge Oeb1 as a Per Cent of
US. Disposable Income
*
2
*Doto Not Available
I~~~~~~~~~~~~~~~~~~~~~~
1945
'50
'55
Sources : 1969 Economic Report
Industrial Confe rence Board .
'60
of
the
President,
'65
National
war period , dee pening o f mortgage credit has
been limited . 1 In 1950, about I I million non farm families ow ned mo rtgaged hom es. By
19 66, over 2 1 million ho mco wning famili s
had mortgages. If a typical family in 1966 had
the sa me ratio of mo rtgage debt to income
that a similar family had in I 950 , the increase
in homeowners with mortgages and the rise in
income combined would explain over 82 per
cent of the growth in nonfarm mortgage debt.
Deepening would account for an increase relative to income of about $ I ,500 on a typical
mortgage. Although there ha s been a tendency
for some deepening to occur s ince 1950, the
amount ha s not bee n grea t.
Desp ite the slight deepening in mortga ge
debt , the debt repayment burden for a typical
1
Deepening of credit refers to an in crease in the average
debt per borrower relati ve to income.
Federal Reserve Bank of Kansas City
'68
The Quali ty of Mortgage Credit
family does not appear to have increased since
I 950. Scheduled repayments of homeowner
mortgage debt for all families in l 950 accounted for an estimated l .9 per cent of total
United States disposab le income. By 1965,
the figure had ri en to about 3.5 per cent of
disposable income. The increase in the number
of families with mortgage debt could account
for the entire rise in th e ratio. It would appear
that the progressive lengthening of the average
maturity date of a typica l mortgage has largely
offset any tendency for family mortgage repayme nts to ri se relative to income.
However, a word of caution is in order.
;\lthou •h indicative of trends, these fi gures
which reLite to avcr,1ges can not be taken as
accurate guides to the total distribution of debt
or the repaym e nt burden. lcka lly , one would
wish to examine the debt rat io and repayment
streams for those in various income classes, but
satisfactory data covering the en tire postwar
period is not readily available. Limited evidence suggests that, relative to income, the
lower income families have a higher ratio of
mortgage debt and a higher repayment rate.
If the weight o f mortgage debt on lower income
families ha s grown over time, the burden of
the total debt could increase without being reflected in th e overall averages. Nevertheless,
there is little reason to believe the aggregate
statistics present a misleading picture of the
postwar trend s.
DETERMINANTS OF THE QUALITY OF CREDIT
The quality of credit may be a nalyzed from
several viewpoints. The ultimate indicator of
credit quality is whether the loan is repaid according to the initial terms of the contract.
Rising delinquency , default, o r foreclosure rates
would si11;nify that a decline in credit quality had occurred. To loan officers attempting to evaluate an application for a loan , on
the other hand, the likelih ood of repayment is
a paramount consideration and the officer
often mu st make many spec ific assumptions
Monthly Review
•
March 1969
in reaching his decision. If these should prove
incorrect or if unforeseen circumstances should
develop , a loan which initiaJly looked excellent may become questionable. Consequently,
the quality of a loan may change over its lifetime and the ultimate repayment or foreclo ure
may not be an accurate indication of probability of repayment at the time it wa granted.
Few loan officer will make loans they expect
to turn so ur.
Judgment about the quality of credit, moreover, may differ with the relationship of the
viewer. One of th e many aims of Congress
in in stitutin g the Federal Hou sin g Administration, and l,1ter the Veterans Administration,
w,1s to promote home ownership by increasing
the availability of private mortgage credit to
those who would normally have difficulty in
meeting lende r qualification . By insuring lenders against default, these programs have been
able not only to provide financing on liberal
terms , but have a lso largely removed the ri sk
to the lender. From the standpoint of a lender,
therefore, an FHA-insured or VA-guaranteed
mortgage may be of higher quality than a conventional mortgage, but the overall likelihood
of default is also o ften decidedly hi gher.
umcrou s factors interact to determine the
quality o f a loan . On the aggregate level, the
future course of income, employment, and asset
values directly affect th e probability of repayment. Many loans that would be repaid in
periods of high employment will be defaulted
if income is falling and unemployment is rising.
To use an analogy from a different financial
field, if the stock market ri ses to an unsustainably high level, loans to purchase stocks may
be of low quality I egardle s of the immediate
financial position o f the borrower.
The spec ific terms of the loan and the financial characteristics of the borrower affect both
his willingness and ability to repay. If debt repayments, for example, represe nt such a large
proportion of the borrower's income that there
is little margin for unexpected expenses, the
15
The Quality of Mortgage Credit
possibility of defa ult increases. Other factors
which m ay contribute significantly to the probabili ty of eve ntual foreclo sure are the age and
occupation of the borrowe r, hi s responsibility
for financi a l obligations, poss ible ma rital difficulties, a nd th e ma rk etability of th e collateral.
The death o f the borrowe r will often result in
a mo rtgage be ing defaulted .
In rece nt years most di sc uss ion o f the quality
of cred it has focused on the progress ive libera lizat io n of term s. Whil e know ledge of the effect
of loan te rm is vita l to th e individual lender,
aggrega te developments arc lik ely to be more
in strum e ntal in dete rminin g th e quality o f
cred it from th e sta ndpoint or the ent ire eco no my. During pe riod s or ri sing in co m · ;ind ;1ssct
va lu es, ma ny loa ns with ve ry easy ter ms will
prove successful.
Several of th e more impo rta nt genera l determinants o f th e qu a lity of cred it are di scussed in th e following section s. Since repayment of a debt al o depend s on numerous
circum stances affecting only the individual borrower, the list is not complete.
Acquired Equity
The borrower's equity in an asset is the difference between th e va lu e o f th e asset and o utsta ndin g debt plu , inte rest du e. Since th e re arc
generally costs associated with sellin g a hom e,
these arc so metim e subtracted in calcu lating
the mo rtgagor's eq uity. Since th e borrower's
eq uity represents his net investment in an asset,
it also represent s hi s financial loss in event of
foreclosure. Whenever the borrower's equity
is mall , the poss ibl e financi al loss from defaulting on a loa n is also sm a ll. Once considerable equity has been acqu ired , however, thi s
potential loss in creases a nd , apart from o th er
co nsidera ti o ns, th e borrower ha s a grea ter in centi ve to m a int a in debt repay ment s. If it
sho uld become imposs ibl e for him to co ntinue
the p ay ments, th e debto r will o ft en se ll th e
property, pay off the ba lance o n hi s loan, and
reali ze hi s equity. The hi gher the borrower's
16
equity , th erefore, the less likely is the chance
of his defaulting and the be tter is the quality
of credit.
Prior to the great depress ion of the 1930's,
few long-term loan s were fully amortized. While
the bo rrower wa n o rmally expected to m a ke
periodic repay m ents of intcrc t o n the principal, the great bulk of sin gle family mo rtgages
were written so tha t th e entire principal wa
due on the m aturi ty date, which was commonly
fiv e years from the time th e loan was granted .
If the mortgagor was un abl e to accumulate a
sum to re pay the entire principal, he would
repay what he cou ld and a new m o rtgage would
1 ' nera ll y
he writte n for the balance. Under
th ese arran 1 ement s, assuming no spec ulati ve
increases in th e va lues of ex istin g ass ts, the
va lu e of th e home wou ld depreciate over tim e
whil e the loan balance wo uld re ma in un c hanged . Although th e loa n-va lue r atio s on
first mortgages were conserva tive in the l 920's
compared to those offe red to day , second and
third mortgages were much m o re common. If
the combined loan-val ue rat io were hi gh or the
rate of depreciation rapid, th e mortgagor could
acc umulate a sizeab le n ega ti ve equity in hi s
ho me.
Most mo rtgage loa ns today arc amortized
so th a t th e mor tgagor m ake , periodic repayments no t o nl y o f interc t but also o f principal.
The rate at which a borrower acquires equity
is a function of the depreciatio n or appreciation on the asset and the te rm s of the loan :
initial down payment, the interest rate charged,
and the years to m aturity . The borrower will
accumulate equity more rapidl y the slower the
rate of deprec iatio n, the larger the down payment , the lower the interest rate c ha rged , and
th e shorter th e maturity.
Although pra cti ca ll y a ll mo rtgage loans a rc
now fully amo rti zed , th e loa n-va lue ratio has
in creased greatl y th ro ugho ut th e postwa r period . As a co nseq uence, loa n s m ade on very
lib eral terms accumul ate littl e o r no bo rrower
equity in ea rl y years. Th e Federal Hou sin g AdFederal Reserve Bank of Kansas City
The Quality of Mortgage Credit
mi nistration , for example, will insure a loan of
$14,500 on a new home costing $ 15 ,000. Unti l
the recent ri se in interest rates, the loan could
be made for a period of 35 years at an interest
rate of 5 ¼ per ce nt. If strai ght line depreciation of 2 per cent per year and a sa les commi sion of 5 per cent arc as umed, the borrower' equity i negative for the first 25 years
of th e mortgage. Since the mortgagor will accumulate equity less rapid ly wi th lower down
payments and length ening of the maturity of
the loa n, th ese factors tend to be associated
with a lowe rin g of credit standards.
Guttentag's studi es of the rostwar mortgage
m<1rk e1 su 1 gest th.it ch.ingcs in the minimum
req uired do wn pay111ent ,ire th ' most important
short-run determin an t of th e demand for mortgage credit. " If a small reduction in down payments permits mortgages to be obta ined by
many borrowers who otherwise could not
qualify under the relatively liberal term s offered by th e FHA or VA, the quality of these
loans is likely to be low . The effect on quality
of a longer maturity, however, is unclear. Although a longer term tends to reduce the buildup of equity, it al o reduces the required repaym ents rela ti ve to th e borrower's income. lf
paym ents req ui re a smaller frac ti on of th e
mortgago r's income, he is less li kely to encounter diffi culty in meeting the payments.
Chart 3 shows th e casing of terms on FHAinsured hom e mortgages which has occurred
throughout th e postwar period. In 1946 the
average period to maturity of mortgages insured for new homes was 21 years, but by
1967 thi s had risen to about 30 years. Briefly
dur ing the ea rl y l 960's the average term to
maturity exceeded 30 years. Loan-value ratios
similarly have trended steadily upward , incrca ing from 87 p r cent in 1946 to 95 per
cent in 19 66 . Despite a tripling in the median
"J ack M. Guttentag, "Some Studie~ of the Po!>t World
W ar II Residentia l Construction and Mortgage Markets ." ( Unpub li shed Ph.D. di ssertat ion . Co lu mbia Univers ity, 1958).
Monthly Review
•
March 1969
Chart 3
CHARACTERISTICS OF FHA-INSURED
HOME MORTGAGES
Per Cent
100
New
,,
2
___ .,/
2
,✓
3000
,-----
,,---;;,:;,:. Homes
H RM
or
MOR 1 GAGF
MORTGAGOR'S
INVESTMENT
*
2000
1000
1946
Source :
* Doto
No t Avollob le
'55
'50
Federal
Housing
'60
'65
'67
Ad ministration.
mortgage debt, th e average mortgagor's initi al
in vc ·tm ent, which co nsists primarily of th e
dow n payment and closing costs, has fallen by
nearly 50 per cent. In recen t years, however,
a sli ght reversal of direction has occurred. As
shown in the chart, the term s on FHA-insured
mortgages for existing hom es have experienced
an equally dramatic easing. Each of these postwar trends could be interpreted as a relaxation
in the quality of credit."
"E mpha sis on F HA mortgage c haracteri stics is based
bo th n the ready availnbi lity of co ntinuous se ries a nd
on the fact that the stntistical mode l devel o ped in Part
I I of this an ide utili1.es F l IA data . Statisti c~ for VA g uaranteed and conventional mortgages suggest th a t
!>imilar developmen ts have occurred for these types of
mortgnges also. G 1 mortgages since J 949 evidence an
even sharper decli ne in average down payments. Conventional mortgages, of course, are se ldom made o n
s uch libera l terms, but the terms exhibit a similar trend
toward relaxation.
17
The Quality of Mortgage Credit
Borrowers will also acquire equity rapidly if
asset prices are ri sing. The United States
em e rged from World W a r 11 with a n acute
ho using shortage. Th e sharply ri sing demand
a nd limited in c reases in th e supply produced
signifi ca nt increases in the prices of homes.
Until th e late I 9 50 's, it was o ften po sibl e for
a p erso n to sell a ho me purc hased o nl y a year
earli er for 10 to 2 0 per cent mo re than he
ha d p a id . Und e r suc h c irc um sta nces, a mo rtgago r in fin anc ia l diffic ulty wo uld o ft en sell hi s
ho m e, re pay th e mo rtgage, a nd rea lize hi s in c reased equity rath e r th a n ri sk its possibl e loss
thro ug h forec los ure . With a ri sin g de m and ,
se llin g a ho me co uld o ft en be acco mpli shed
qui ck ly a nd with re la ti vely littl e diffi cu lty. /\! th o ugh ho me pri ces were co mpa ra ti vely stabl e
du rin g th e la te I 95 0 's a nd ea rl y I 960's, th ey
have aga in beg un to ri se in recen t yea rs. T he
increased rate of family form ati o n, continuin g
m ovem ent to th e suburb s, sha r ply in c reased
costs o f con struc tin g new ho m es, an d the be li ef
that real estate investment r epresen ts a good
hedge aga inst infl a tio n have all been co ntributing fac to rs. A degree of spec ulatio n has a lso
been present.
Ju st as ri sin g asset pri ces te nd to reduce
defa ult a nd fo recl os ure rates, fa llin g rea l es ta te
va lues ca n remove acquired equity ve ry ra pi d ly
a nd in c rease th e ra tes. Estim a tes sugges t th a t
th e average price o f ow ner occupied homes declin ed by a bo ut 25 p er cent between 1929 and
J 9 34. In a ddi tio n to fa lling in co m e, th e for ced
sale of fore closed homes which accomp a nied
th e general scramble for liquidity, th e overbuilding o f suburb an a reas, and the fai lure of
pop ul a tio n to grow a s rapidl y as had been predi c ted we re pa rtl y res po nsib le for declinin g
rea l e ·ta te pri ces . U nd e r such circ um sta nces, it
beco mes alm os t im poss ibl e to se ll ho mes a t a
profit , pa rtl y remov in g th e in centi ve fo r th e
mo rt gago r to sell rat he r th a n pe rmit fo recl os ure. With littl e equity, indi vidu a ls m ay no t
eve n have suffic ient reso urces to cove r sa les
expenses . If a m o rtgagor did have uch re18
sources, he could usuall y brin g hi s loan current
and avoid threa te ned fo reclosure . Whil e perha ps not the most impo rta nt sin gle factor , falling rea l estate price co ntributed g rea tly to the
inc reased fo rec los ure ra tes whic h occ urred durin g the depress io n. Jf a settlin g in rea l estate
prices sho uld occ ur in the futur e, a n inc rease
in defa ult a nd for ec losure ra tes is very likely
to occur.
Regional and National Economic Conditions
A ltho ugh defa ult rates indi ca te a sli ght
sensiti vity to flu c tu a ti o ns in na tio na l in co me,
thro ugho ut the ros twar pe ri od foreclos ure
ra te:-. show li ttle re l.i ti on shir . H owever, bo th
ra lL:s appL:ar to rcac l qu ite sha rpl y to cha n cs
in loca l econo mi c co nd iti o ns.' Th e fa ilure o f
po pul a ti on to grow as rap idl y as had be n projected in F lo ri da d urin g th e ear ly I 960's p rodu ced a m a rked in crease in ho me m o rtgage
fo reclos ures. Fo reclos ure ra tes in a reas which
rely heavil y o n a si ngle indu stry are al so likely
to react stron gly to economic setbacks. In Kansas durin g the late J950's, fo r exampl e, th e
curta ilment of a ircraft employ m ent a t Wichita
and the deacti vatio n of a Navy in sta ll ation at
Hutc hin so n moved the sta te FHA fo reclos ure
rati o to one of th e hi ghes t in th e na ti o n. Defa ult a nd fo reclos ure ra tes in De tro it a rc qu ite
sensiti ve to th e leve l o f a uto mo bil e sa les and
to changes in p rod ucti o n and in co me.
Despite th e fact th a t defa ult a nd fo reclosure
rates evid ence little cy clica l movem ent over
busin ess cycles, aggregate bu sin ess co nditions
are clearly a n importan t determin ant of th e
qu ality of credit. Since m ost m o rtgago rs expect
to repay bo rrow in g fro m c urrent inco me, the ir
ability to mee t pay ment s i hi ghl y d ependent
o n in come and empl oy ment ex pected in the
futur e. If a m an in c urs a debt durin g a pe ri od
o f p ros perity and la te r beco m es un em ployed
1
'For suppo rtin g ev id ence see the studies in F H A M ortgage Foreclosu res. Hea rin gs before a s ub commi tt ee o f
the Com mittee o n Bank ing and C ur rency, U nited Sta tes
Senate, 88 th Congress, 2nd Sess ion , 1964 .
Federal Reserve Bank of Kansas City
The Quality of Mortgage Credit
in a recession , the likelihood of hi s being able
to meet each paymen t on schedul e is grea tly
reduced.
Since debt repay ments, on the other hand ,
tend over time to become a relatively small
drain on income, many low quality loan will
prove succe sful during periods of stro ngly ri sing incomes. Mos t workers expect their incomes
to rise annually . If borrowers expect to meet
debt repaymen ts in part from the anticipated
growth in income, lack of grow th or th e curtai lment of inco me can produce losses. As long as
inco me rema ins hi gh and grow ing, se rious problems with th e quality of credit arc not lik ely
to he encountered .
Financial Characteristics of Mortgagor
For th e economy as a whole, debt will impose a rea l burden if repay ments become so
great th at debtor arc forced to curtail spending on curren t output. Aggregate figures, however, suggest this is not an immediate concern
for mortgage debt. Despite the fac t that mortgage debt has been rising much more rapidly
than di sposa ble in come, the progressive lengthening in mortgage maturities has offset the
tend ency for th e ratio of sc heduled mortgag
repa yments to di sposab le inco me to ri s gr ally. chedul ed mortgage repay ments currentl y
account fo r less than 4 per cent of U. S. di sposa bl e in co me.
The ability of borrowers to maintain debt
repayments in times of economic hardship is
partly dependent on the debtor's net worth and
holdin gs of liquid assets. If the borrower's income declines he may continue to repay hi s
debt by drawing on holdin gs o f liquid assets.
In th e long run he may also dispose of some
nonliquid assets. Total liquid assets of co nsu mer have grow n ve ry rapidly throughout th e
postwar period, and thi s ha s occas ionall y been
cited a ev idence that th e increases in private
debt need not warrant co ncern. evc rth eless
th ose applying for mortgage loa ns do not appear to have shared in th e ri se in liquid asset
Monthly Review
•
March 1969
Table 2
AVERAGE LIQUID ASSETS OF PURCHASERS
WITH VA PRIOR APPROVAL HOME LOANS
Year
Amount
1954
1955
1956
1957
1958
1959
1960
1961
1962
1963
1964
1965
1966
$1,996
1,777
1,970
2,215
2,020
1,720
1,725
1,530
1,665
1,845
2,040
2,350
2,085
So ur ce : 1966 Stati stical
Urbon D ovc l opmcnt.
Yourbook , D porlm n l of H o u si ng cand
holdin g . Desp ite ignifi ca nt in creases in scheduled mortgage repayments, liquid as et holdings for purchasers of homes with V A-guaranteed prior approva l loans have shown almost
no increase since 1954. (See T able 2.) This
also could be interpreted as a decline in the
quality of mortgage credit.
THE RECORD
The foreclos ure rate on nonfarm rea l estate
since 1950 is show n in
hart 4. The foreclos ure rate per I ,000 mortgaged st ru ctures
was 2. 17 in 1950, but under th e eco nomi c impact o f th e Korean War, it declined to 1.55
in 195 2. Thereafter the foreclosure rate rose
for six years, reaching a rate of 2.46 in the
recession year of l 958. After a brief pause in
1959, the upward climb resumed. By 1965
the fo reclos ure rate at 4.93 was more than
double th e very low rate of 1950 and practically tripl e th e rate of 195 I. Since 19 66 the rate
has declined slightl y, but it remain s hi gh by
ea rl y po twa r stand ard s.
I. . HA-in sured and V A-g ua r a n te e d home
mortgage forec los ures have shown even more
pronounced upward trends. Since 195 I the
FHA fo reclosure rate has increased over 10
times and th e VA ra te over fo ur times . While
19
The Quality of Mortgage Credit
Chart 4
NONFARM MORTGAGE FORECLOSURES
Rote per 1000 Mortgaged Units
14
12
10
8
6
4
2
0
6
4
2
0
1950
'55
Source : Fede ra l Hou sing Adm inis trat ion,
ti on, Fede ra l Hom e Loa n Ba nk Boord .
'65
Veterans
'67
A dmi ni st ra -
r isin g forcclosurc rate arc a cau se for concern
durin g times o f ri in g income, the postwar
rates arc not p articularly hi gh when viewed
over a longer pe ri od. lt ha s been estimated ,
for example, that the foreclosure rate in 1926
was over twice that of the peak postwar figure in 1965.
Since the three series in the chart have
been constructed from different sources th ey
are not directly compa rable . Nevertheless , the
fi g ures tend to show that FHA-in sured and
VA-g uaranteed mortgages have a mu c h hi gher
in cid ence of foreclosure than do conventional
20
mortgages . Thi s suppo rts the argument that
mortgages granted with very libera l financing
term s evidence hi gher rates o f for eclosu re. The
relationship , ho wever , is not perfect. Many
FHA and VA m ortgages appear to have been
made with no down payments, yet the foreclosure ra te o n F HA mo rtgage is much hi gher
than o n VA mortgages .
An interestin g fcat ure of th e cha rt is that
fo reclos ures show littl e sen sitivity to changes
in aggregate business co nditi o n s. Alth o ugh the
foreclosure rate rose in th e recessio n yea rs of
1954, 195 8, and 1960, even sha rper in creases
in fo rec los ures were reco rded in period s o f
relati vely hi gh e mployment. This is due partly
to th e relati cly mild busi ness cycles o f th e
postwar period. Some studie s, o n th e o th er
hand, ha ve co nclud ed that suc h no neco nomic
reaso ns a death, illness, marital difficulties ,
excessive u se of credit , improper rega rd for
obl igations, and di ssati sfaction with the home
ex plain as man y foreclosures as do changes in
income and employm ent. :;
Al so contributing to the poor relationship is
th e fact th a t a long and variabl e lag m ay be
enco untered between initi a l delinquency and
fo rcclo ure. Some lendin g in stituti o ns wi ll initiate fo reclosure proceeding o n delinquent loans
mo re rapidly th a n o th e r . If th e mo rtgagee
sho uld gra nt fo rebeara nce, m a ny mo nth s m ay
pass before foreclosure is finally begun . State
laws also differ great ly o n th e lengt h o f time
required to fo reclose.
While the initial postwar leve l was ex tremely
low, the foreclosure rate has ri sen steadi ly and
significantly through most of th e postwar period . By thi s sta nd ard, the fi gures leave little
doubt that some dec line in the qu a lity o f credit
did occ ur.
"F o r example, sec th e s tudi es ci ted in footno te 4.
Federal Reserve Bank of Kansas City
@FedFRASER