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Remarks by
Henry C. Wallich
Member, Board of Governors of the Federal Reserve System
to the
Pacific Coast Builders Conference
San Francisco, California
June 28, 1980

Remarks by
Henry C. Wallich
Member, Board of Governors of the Federal Reserve System
to the
Pacific Coast Builders Conference
San Francisco, California
June 28, 1980

It is a pleasure, and an honor, to be on this panel together with
Jay Janis and Herman Smith, under the guidance of Marvin Gilman, to talk
about federal economic policy in today's housing picture.
As we move into the second half of 1980, we are looking at the
beginning of a new housing cycle.

Housing starts are likely to bottom out

Permits have already turned up, although I would not give too much

attention to data for a single month.
Today, housing construction is severely depressed in most parts of
the nation.

Housing has been the victim of the surge of inflation, as has

happened several times before.

As we look to the future and formulate our

policies, we must be guided by the need both to restore the immediate health
of the housing industry and to forestall continuation of this typical cyclical

How We Got Here
Let me review how we got to where we are.

In recent years, the role

of housing and its finance in the American economy has become more important
than ever.

Home ownership now represents the single most important

-2asset of American families, totaling $2.2 trillion.

The dollar value of

new housing units constructed in 1979, close to $100 billion, was nearly
three times its level 10 years ago and two times its level five years ago.
The volume of home mortgages issued last year was of the order of $110

This accounts for 28 percent of all the credit raised by non-

financial borrowers in the economy.

The total stock of 1 to 4 family home

mortgages outstanding amounts to $872 billion, equal to 23 percent of the
total debt of nonfinancial borrowers outstanding, or about equal to the
debt of the federal government.

The wealth of the American people increasingly

has come to consist of their homes, their saving has increasingly been done
for them by the rise in the price of their homes, and they have increased
their mortgage indebtedness in order to liquify accumulated housing equity.
The evidence shows that people today are willing to devote a much
higher fraction of their income to homeownership than in the past.


nearly 46 percent of home buyers in 1979, housing expense exceeded 25 percent
of household income, against 38 percent in 1977.

The pressure to acquire an

inflation hedge seems to be as strong among the unmarried as the married.
In Washington, D.C., the percentage of home buyers who were single rose
from 20 percent in 1977 to 40 percent in 1979.

Housing A ids

Behind this love affair of the American people with their homes
are forces that have been constructive and others that have been distinctly
not so.

Housing in the United States is supported by a variety of incentives

and subsidies, many of which are not available in other countries.


tax deductibility of mortgage interest, without imputation of implicit rent
to the owner's income, seems to be an almost unique feature of the housing

scene in the United States.

Deductibility of interest is far more limited,

where it exists at all, in Canada, Germany, the United Kingdom, France, and

The government for many years has offered to insure and guarantee

homeowner mortgages, and in recent years, we have created a pipeline from
the bond market into the housing finance market, through a variety of mortgagebacked passthrough securities.

An effort has been made, ill advised in my view,

to hold down mortgage interest rates by not allowing thrift institutions and
banks to pay a market-oriented interest rate to small savers.

The flow of

small savings has been diverted to mortgage-oriented thrift institutions by
allowing them to pay a slightly higher deposit rate than their commercial
bank competitors.

This is only a partial list of the public policies we have

employed to help channel resources into housing.

Price vs. Volume
Aided by strong demographics, measures like those I mentioned have
strengthened the demand for owner-occupied housing.

Rental construction has

fared far less well, again largely because of public action such as rent

But the supply of new housing has shown itself to be not very

elastic in response to mounting demand.

Construction capacity is limited,

and high activity has led to higher production costs.

Limitations on the

supply of land mandated by nature have been aggravated by man through regulation
of all sorts.

Much of the demand, therefore, has gone into higher prices rather

than increased volume.

Over the last 5 years, the price of owner-occupied homes

has risen by 69 percent for new and 64 percent for old homes, contrasted with a
rise in the consumer price index of 47 percent.
contributed to general inflation.

Thus, housing prices have

They have also made homeowners affluent

-4while inflation was destroying the value of savings in thrift institutions,
in bonds, and in common stocks*

And meanwhile potential new home buyers, who

had no existing home to sell at a profit, were increasingly driven out of the

Recent survey data indicate that from 1977 to 1979 the share of first­

time buyers among all home buyers dropped from over one-third to about onesixth.

I n f l a t i o n and I n t e r e s t R a te s
Meanwhile i n f l a t i o n was r e l e n t l e s s l y d r iv in g up i n t e r e s t r a t e s .
Both borrow ers and le n d e r s , e x ce p t f o r sm a ll s a v e rs and s to c k h o ld e r s , have
in c r e a s in g ly le a rn e d to defend th em selves a g a in s t i n f l a t i o n .

L end ers know

t h a t th ey must g e t an i n t e r e s t r a t e a t l e a s t eq u al to th e r a t e o f i n f l a t i o n ,
and more i f th ey a re t a x a b le .

Borrow ers have le a rn e d th a t r i s i n g p ro p e rty

v a lu e s and r i s i n g incomes w i l l com pensate them f o r h ig h e r i n t e r e s t r a t e s ,
and i f th ey a re t a x a b le , th ey w i l l s t i l l be ahead o f th e game.

U n t il l a t e

l a s t y e a r m onetary p o l ic y , in i t s e f f o r t to m oderate th e r i s e o f i n t e r e s t
r a t e s , only made them h ig h e r in th e end by t o l e r a t i n g more i n f l a t i o n .


g o vern m en t's huge d e f i c i t s added to demand in c a p i t a l m arkets and to r i s i n g
in te r e s t r a te s .

F o llo w in g th e p o lic y changes i n s t i t u t e d l a s t O c to b e r, w hich

were d esign ed to g iv e th e Fed b e t t e r c o n t r o l over a g g re g a te flow s o f money
and c r e d i t , m arket i n t e r e s t r a t e s ro s e f u r t h e r and many m ortgage le n d e rs
te m p o ra rily withdrew from th e m a rk e t.

E f f o r t s to Avoid D is in te r m e d ia tio n
T hu s, i t was no t a la c k o f demand t h a t s tr u c k h o u sin g , b u t
p r in c ip a lly th e u n a v a i l a b i l i t y o f f in a n c in g ,o r a v a i l a b i l i t y on ly a t v ery
h ig h i n t e r e s t r a t e s .

T h is has been th e e x p e rie n c e a ls o o f th e e a r l i e r

b u s in e s s and housin g c y c le s e x p e rie n ce d by our economy.

I n th e exp an sio n

-5that came to an end early this year, special efforts were made by the
Federal Reserve, the Federal Home Loan Bank Board, and other agencies, to
shield housing against a recurrence.

The six-month money market certificate

was introduced, perhaps the most "successful" financial instrument of all

I put the word "successful" in quotation marks advisedly, because

in the end it only helped to postpone the day of disintermediation for the
thrift institutions to a time of still higher interest rates and so helped
to substitute a serious earnings problem for what might have been mainly a
liquidity problem.

Regulation Q ceilings were shifted around and the

monetary aggregates allowed to expand excessively to avoid what were con­
sidered premature increases in interest rates.

All this represented well-

intentioned efforts to shield the thrift institutions and their principal
customer, the housing industry, against disintermediation.

But all that

was achieved was to postpone a little the day of reckoning and to make it
more severe when it came.
The measures of March 14 that had to be instituted late in the day,
in order to keep accelerating inflation from exploding, also took special
account of the needs of the housing industry.

The credit controls imposed

at that time sought to avoid the need to slow the inflation mainly by high
interest rates*

Given the tax shelters enjoyed by most borrowers, even the very

high nominal rates reached in the mortgage market were still severely negative in
real terms for many borrowers.

Moreover, the controls and restraints

imposed by the Federal Reserve specifically exempted small business and
especially home builders from limitations on bank credit expansion.


small banks with high loan ratios were given special rediscount privileges,
a measure addressed primarily toward the needs of agriculture but also helpful
to housing.

Reserve requirements were imposed on money market mutual funds



to slow the drain of money from local banks and thrift institutions into
money market centers.

All this, together with a series of actions taken by

the Federal Home Loan Bank Board, has helped to ease the situation of financial
Interest rates have come down dramatically since March under the new
procedures instituted by the Federal Reserve which focus on a rigorous pursuit
of a money supply target.

Treasury bill rates are down about 8 percentage

points from their peak, and so is the prime rate.

Mortgage rates have come

down about 4 points, and the supply of funds is building up.

The condition

of thrift institutions has improved, and if there were concerns earlier they
have been removed.

The financial system has weathered the strain of the last

few months in good condition.
We must now lo o k toward th e f u t u r e .
two t h in g s :

As I s a id b e f o r e , t h i s means

to resume m oderate speed in hou sin g and in th e economy g e n e r a ll y ,

and, seco n d , to work toward av o id in g a r e p e t i t i o n in f u tu r e y e a rs o f th e booman d -b u st c y c l e .
The f o r c e s th a t w i l l tu rn housin g and th e economy around a r e a lre a d y
a t w ork.

Lower i n t e r e s t r a t e s , g r e a t e r a v a i l a b i l i t y o f money, and an im prove­

ment in th e b a la n c e s h e e ts o f hou sehold s and b u s in e s s a re underway.

T h ese

developm ents do n o t need any s p e c ia l s tim u la tio n from a ta x c u t o r an
a c c e l e r a t io n o f m onetary grow th.

Such m easures would have t h e i r e f f e c t s to o

l a t e to a f f e c t th e p r e s e n t s i t u a t i o n and would o n ly g u aran tee us a resu m p tion
o f a c c e l e r a t in g i n f l a t i o n a few q u a r te r s down th e ro a d .
I t i s p r e c is e ly toward th e c o n t r o l o f i n f l a t i o n t h a t fu tu r e
m easures need to be geared a t th e F e d e ra l R e s e rv e .

I f i n f l a t i o n were to

keep r i s i n g , I would s e e l i t t l e hope f o r th e fu tu r e o f our economy o r o f
th e h ou sin g in d u s tr y .

I n f l a t i o n has ravaged our s a v in g s , our p r o d u c tiv ity ,


the value of our dollar at home and abroad, and will continue its grisly
work if we do not fight it resolutely even at some cost.

The costs of

letting inflation run are vastly greater than the costs of fighting it.
That is true even if housing could to some extent be shielded by
imaginative new :leviccs such as variable-rate and rollover mortgages.
The Federal Reserve supports these techniques, as it also has supported Federal
preemption of state ceilings on home mortgage rates, the broadening of the
asset and liability powers of thrift institutions and the gradual phasing
out of Regulation Q which have now been mandated by Congress.

But without

an end to inflation, these measures cannot restore the lasting health of the
housing sector or of our economy.
Nor should we deceive ourselves by prematurely declaring victory
in this struggle and going home.

The consumer price index has exaggerated

the rate of inflation on the upside, owing to the heavy weight given to home
prices and mortgage interest rates.

It will soon begin to exaggerate success

in bringing inflation down, as housing prices slow and lower mortgage rates
are incorporated in the index.

It will take much longer than a few months

to wring out an inflation that has taken 15 years to build up.
not delude ourselves as to the difficulties of the struggle.

We should
But neither

should we entertain illusions about the fate that awaits this economy if it
yields to the temptation of trying to live with inflation.
outcome, all our efforts must be united.

To avoid that