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For release on delivery

Statement by

Arthur F. Burns

Chairman, Board of Governors of the Federal Reserve System

before the

Subcommittee on Priorities and Economy in Government

of the

Joint Economic Committee

December 7, 1972

I appreciate this opportunity to discuss with you measures for
moderating cyclical swings in the availability of credit for housing.
In a report submitted last March, the Federal Reserve Board set forth
recommendations to accomplish that objective.

Before reviewing those

recommendations, it may be useful to comment on recent developments
in the markets for housing and mortgage credit, and to assess prospects
for the year ahead.
The flow

of savings into the thrift institutions that specialize

in mortgage lending has shown extraordinary strength for more than
two years.

Commercial banks and other financial institutions have also

been abundantly supplied with funds for lending.

As generally happens

in times of ample credit availability, housing credit and construction
have expanded rapidly.

In fact, residential mortgage loans have grown

at an unprecedented rate.

Growth in the first three quarters of this

year was at an annual rate of $46 billion, compared with $36 billion
in 1971 and less than $20 billion in most other years.
Savings and loan associations and mutual savings banks
accounted for about two-thirds of the expansion in residential mortgage
loans in 1971 and 1972.

Life insurance companies have continued to

reduce their investment in mortgages on 1- to 4-family dwellings.
On the other hand, commercial banks have been able this year to

accommodate business and related loan demands and at the same
time expand their portfolios of residential mortgage loans at a
record annual rate of $10 billion.
Homebuilding began to respond vigorously to easier credit
conditions during the second half of 1970, and thereby provided a
much needed stimulus to general economic activity.

This year

housing starts will probably reach a new peak of more than 2. 3
million units, not counting mobile home shipments, which should
exceed 550, 000 units.
Interest rates on home-mortgage loans are now only a little
higher than they were earlier this year, and the rise has been
associated in part with more liberal non-rate terms on conventional
loans and larger loan amounts.

In October rates for conventional

loans on new homes averaged about 7. 60 per cent, up 10 to 15 basis
points from their recent low last Spring, but still somewhat below
their August 1971 level and some 90 basis points below their peak
in the summer of 1970.
Further expansion in overall business activity in 1973
might put upward pressure on short-term interest rates.

There is,

however, no imminent threat of a substantial diversion of savings
flows from mortgage-oriented thrift institutions into market
securities.

In recent years, these institutions have managed to

increase appreciably the proportion of their liabilities taking the
form of longer-term deposit certificates with attractive yields.
Moreover, minimum denominations of Treasury bills and various agency
issues have been raised, and this too should help to moderate deposit
withdrawals.

Deposits should thus continue to grow at a good rate,

even if the recent phenomenal pace is not sustained.

And supplementary

support can be expected from FNMA, the Federal Home Loan Banks,
and related sources when and as needed.
Since backlogs of demand have been filled and vacancy rates
are now rising in some areas, production of housing in 1973 may be
below this year r s record level.

But with funds for mortgage credit

continuing in relative abundance, the pace of residential construction
should continue ahead of that required to meet the national housing
goal established by the Congress in 1968.
Encouraging as these developments are, we should not lose
sight of the need to make the mortgage market less vulnerable to the
storms by which it has been buffeted periodically in the past.

On a

sunny Autumn day, the prudent commuter gets out his snow tires.
Chances are he will need them some time during the winter, and it
is best to get them on before the snow falls.

It is comforting to

know that this committee is mindful of the need to help others
prepare for winter weather.

Past experience indicates that at certain stages of the
business cycle, forces develop that diminish the availability of funds
for home loans.

Mortgage credit for housing is typically in short

supply when the demand for credit from other sectors rises rapidly.
In a briskly expanding economy, business demands for credit from
banks and the public market normally increase to finance additions
to plant, equipment, and inventories.

Interest rates then tend to

rise, and the supply of credit available for other borrowers is
squeezed.

The shortage of credit may be intensified if the aggregate

demand for goods and services threatens to exceed the nation's
productive capacity.

For in that event monetary policies designed

to restrain demand and to curb inflation will further restrict the
available supply of credit to borrowers.
The difficulties experienced by the housing industry stem in
significant measure from the fact that homebuyers depend heavily
for credit on institutions that are in a poor position to compete for
funds when market rates of interest rise sharply.

Their deposit

inflows then shrink, and so does their ability to sustain the flow of
mortgage credit.

Legislative and regulatory limits on mortgage

interest rates also constrict the flow of funds to housing in periods
of general credit restraint.

Other classes of borrowers, particularly business firms,
are less affected by general credit restraint.

Established business

enterprises not only enjoy preferred status as customers of commercial
banks; they often also have access to alternative sources of credit in
money and capital markets.

Thus in periods when the aggregate demand

for goods and services becomes exuberant, the share of new loan funds
absorbed by business tends to rise, while that for housing falls.
While it may not be possible or even desirable to eliminate
cyclical fluctuations in the supply of credit for housing, the feast-tofamine swings that we have experienced in the past have clearly been
excessive.

In its report to the Congress submitted last March, the

Board made several recommendations for smoothing out these cyclical
variations in the supply of housing credit and hence in housing
construction.

I will summarize the reasoning behind these recom-

mendations briefly.
First, the Board believes that the main thrust of new initiatives
should strike directly at the sources of fluctuation in housing credit.
Accordingly, the Board recommends removal of a number of
legislative and regulatory constraints that at times discourage
investment in mortgages.

Interest-rate ceilings on FHA and VA

loans, intended as protection for homebuyers, have meant in

practice that this form of financing periodically dries up, or becomes
available only if the seller is willing to pay several ''points" as a loan
fee.

Recognizing this fact, the Congress has allowed greater

flexibility in these ceilings by authorizing their adjustment by
administrative action.

Even so, the ceiling rates often lag behind

market developments.

If Congress abolished the ceilings, or tied

them directly to market interest rates, it would encourage the States
to take similar action with regard to usury laws, which have also
served to block the flow of funds into mortgages.
Other changes in Federal legislation would be helpful.
The Federal Reserve Act should be amended to permit the Federal
Reserve Banks to lend to member banks on the basis of sound
mortgage collateral at the regular discount rate.

The statutory

restrictions on real estate loans by national banks should be
eliminated so that mortgage lending by these banks may be
governed mainly by considerations of safety and soundness, tested
by examinations, as other types of loans are.

When that is done,

the Comptroller of the Currency should however be authorized to
establish safeguards through such regulations as may seem necessary
from time to time.

Removal of the geographical restrictions on

conventional mortgage loans of Federal savings and loan associations

would help free funds for investment where the need is greatest.
As in the case of FHA and VA rate ceilings, such actions at the
Federal level could lead to similar liberalization of State laws.
Steps should also be taken to strengthen the ability of
depositary institutions to attract and hold consumer savings when
yields are rising on market securities.

The thrift institutions

that specialize in mortgage lending are particularly vulnerable at
such times because of the disparity between their assets, which
consist of long-term loans with fixed yields, and their liabilities,
which are short-term.

When market rates rise, savings tend to

be diverted from thrift institutions into market securities because
the institutions are unable to raise their rates to meet the
competition.

And when deposit inflows shrink, the supply of

mortgage credit also declines.
The sharp swings in deposit inflows and in loan activity at
these institutions could be moderated somewhat by lengthening the
average maturity of their deposits.

Some progress has been made,

and is being made, in this direction but more could be done, perhaps
by adjusting deposit rate ceilings to allow greater incentives for
savers to invest for longer periods.

-8-

Some benefits would also accrue from shortening the average
life of the earning assets of thrift institutions, although any sizable
move in this direction should come only after careful consideration
of the potential impact on the supply of mortgage credit in the long
run.

Some benefits can probably be gained by encouraging the

specialized mortgage lenders to put a modest portion of their
earning assets into consumer loans.

Then their earnings would

respond better to changes in market interest rates, and they would
be in a somewhat better position to adjust the rates they pay on
deposits so as to maintain savings inflows.
Another step well worth considering would be to enable all
depositary institutions to offer mortgages with variable interest
rates and attendant safeguards, side by side with the traditional
fixed-rate mortgage.

Since the variable-rate mortgage would

result in more flexible average earnings rates, the institutions
could compete more effectively for deposits.

Steadier deposit

inflows, in turn, would mean greater stability in the availability
of mortgage credit during business cycles.

Moreover, this

greater stability could be achieved without affecting adversely the
long-run supply of mortgage funds.

Along with these benefits would come some costs.

The risk

of interest rate fluctuations would be a complicating factor in the
planning of homebuyers

who chose a variable-rate mortgage.

But

this difficulty could be kept within reasonable bounds by putting limits
on the amount that the rate could vary, and by providing that the
monthly payment would normally remain fixed, with rate changes
affecting only the term to maturity.

To protect borrowers and

facilitate rational choice, the lenders should be required to make
full disclosure about variable-rate and fixed-rate mortgages.

And

needless to say, the contract should provide for adjustments both
ways-~to reflect reductions as well as increases in interest rates.
It would probably take ten years or more for variable-rate
mortgages to become a substantial element in the portfolios of
depositary institutions.

But they have the potential, in time, of

playing a key role in smoothing out flows of funds into home loans,
and their encouragement therefore deserves serious consideration.
For the immediate future, the best hope for greater stability
in housing lies in continued progress in controlling inflation, and
particularly in better management of our fiscal affairs so that less
reliance would need to be placed on credit policy to stabilize the
overall economy.

By making greater use of fiscal tools, sectors

-10-

of the economy that are relatively immune to monetary policies
could be made to bear their share of restraint during periods of
excess demand.
Specifically,

the Board recommends flexible use of the

investment tax credit as a means of achieving greater stability
in outlays by lousiness firms for machinery and equipment.

These

expenditures are large, cyclically volatile, and relatively insensitive
to monetary policy.

During periods of credit restraint,

expenditures

for machinery and equipment have repeatedly drawn on resources
that otherwise would have been available for housing.
If the investment tax credit were lowered in boom times and
raised in slack periods, we would experience more stability in
business demand for external financing, and therefore also in market
interest rates and in the flow of funds for housing.

This tax

flexibility could be achieved by authorizing the President to vary
the investment tax credit within prescribed limits, perhaps from
zero to ten or fifteen per cent.
become effective,

Before a change in rate could

a sixty-day waiting period should be allowed

for disapproval by either House of Congress, analogous to the procedure for reorganization plans.

-11-

Among the recommendations in its report, the Board believes
that first priority should be given to the proposed variable investment
tax credit.

Establishment of machinery for flexible use of the

investment tax credit would yield benefits more quickly than can be
expected from the other recommendations, and the benefits would be
substantial, not only for housing but also for other sectors that are
sensitive to fluctuations in credit conditions.
In closing, let me commend this Committee for drawing
attention to the need to improve credit arrangements for housing.
We should take advantage of the breathing spell we are now enjoying
in order to prepare for problems that may develop in the future.