The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.
HOUSING AND MONETARY ______ POLICY Certain m onetary, fiscal and institutio na l changes are essential to the future health o f the housing industry, says Mr. Balles. A disciplined m onetary policy over time means a reduction in the inflation rate, and in turn a reduction in the level o f m ortgage and other interest rates. A disciplined fiscal p o licy means m uch less crow ding-out o f home purchasers from credit markets. And various institutio na l changes should help keep home prices from rising at a m uch steeper rate than the general level of prices. ‘‘By im plem enting such proposals, we should see m uch more stability in cred it flows available to the housing market, and thus the end o f the vast swings in hom ebuilding activity which have driven up housing costs so severely." In my conversations with business leaders th roughout the West, I’ve frequently been told that the problems of your industry can be laid directly at the d oor of the Federal Reserve System. For that reason, I’m grateful fo r the opportunity to state the Federal Reserve’s case — namely, that w hile the Fed may be part of the short-run problem, it is a m ajor part of the long-term solution. The d ifficulties of the forest-products industry of course reflect the problems of the housing industry, and the latter in turn reflect a host of fiscal, m onetary and institutional problem s that have developed over the past 15 years or so. I’d like to review fo r you today the developm ents in each of those areas, and wind up w ith several proposals designed to ease the housing industry's problems. But first, le t’s consider the present state of the industry. Problems Afflicting Housing Dem ographic figures show that household form ations have been running at alm ost two m illion units per year, while annual housing starts are running at around one m illion or less. On the surface, this indicates the existence of a severe shortage. However, the housing industry’s problem s are related to the volatility of housing activity; in the 1973-75 slump, and again in the 1978-81 dow nturn, housing starts declined by half or more. Indeed, we are now com pleting a third straight year of declining starts, so that 1981 may be the lowest housing year since World War II. We must not forget, however, that the present slump follow ed a trem endous upsurge in housing activity. The housing stock increased 28 percent (to 88.3 m illion units) during the 1970’s, compared w ith an 1 1 12-percent rise in the total / population (to 226.5 m illion). Because of this and the housing boom of earlier decades, the num ber of persons per household dropped sharply over this period. The quality of the housing stock also improved considerably, measured by increases in flo o r area per occupant or by improvements in such amenities as garage space or central air-conditioning. In fact, the average new home today is twice as large as its counterpart of the early post-W orld War II era, and the typical m obile home today is as large as the typical single-fam ily home of that earlier period. Moreover, housing increased its share of credit flows during the past decade — accounting for 21 percent of the total in the 1970’s, as compared w ith 19 percent of all credit flows in the 1960’s. Also, m ortgage-credit flows were several times greater in 1979 than they were a decade before. But by the middle of this year, less than 14 percent of total-credit flows was going into housing — in dollar terms, 36 percent less than housing claimed at the 1978 peak. This reflects once again the vast fluctuations in credit flows that have always afflicted this feast-or-famine industry. This problem, in turn, reflects the severe structural problem s now confronting the m ortgage-lending industry. Over the years, th rift institutions built up large p ortfolios of long-term fixed-rate m ortgages, but financed those investments w ith short-term deposits such as passbook accounts and savings certificates. Today the th rifts are paying more than 15 percent on 6-m onth m oney-market certificates, although 60 percent of the m ortgages on their books carry yields of less than 10 percent. Thus, as w e’ve seen, the industry is having severe earnings problems. Let’s also consider the problem from the hom ebuyer’s standpoint. A fam ily earning the median income in 1980 had to pay over 33 percent of its income to buy the 1980 m edian-priced house. In contrast, the ratio was only 15 percent of income back in 1965. This drastic change partly reflects the fact that housing prices have risen faster than inflation, spurred on by dem ographic factors and the preferential tax treatm ent of housing. A more im portant factor, however, is the combined effect of inflation expectations and the conventional fixed-rate mortgage. Expected inflation requires that lenders be compensated for the expected deterioration in the purchasing power of money. Moreover, the conventional fixed-rate m ortgage requires that payments be spread evenly over the duration of the mortgage, so that dollar payments remain constant. Today s conventional m ortgage thus imposes a significant cash-flow problem fo r the homebuyer, especially the first-tim e homebuyer. In this context, then, reducing inflation is a crucial part of the fig h t to restore the health of the housing industry. In 1981, of course, housing is severely depressed, at least partly because m ortgage rates have been running 4 to 5 percentage points above the supposed threshold of 13 to 131 /2 percent for potential homebuyers. Interest rates of that m agnitude mean im possibly high m onthly payments fo r most people, especially when they are tied to fixed-rate mortgages many years into the future. But remember that interest rates are only one fa cto r in the high price of housing. As I’ve just noted, the com bination of inflation expectations and institutional barriers (especially the fixed-rate mortgage) makes it prohibitively expensive fo r first-tim e homebuyers to break into the m arket today. The core of the problem is inflation, which means that we can only bring down interest rates if we are successful in our overall fig ht against inflation. This year, we have begun to see some progress in the form of declining inflation — and declining interest rates. Although that progress has been slow and halting, it does suggest that the worst may be about over. Interest Rates and Policy Interest rates are determ ined by many factors — including, but not mainly, the actions of the Federal Reserve, w hich can control only the supply of money and not the demand. Certainly the Fed has some effect on rates in the short run, because of its efforts to control the am ount of reserves in the banking system and the amount of money in the hands of the public. However, business-cycle conditions also influence rates, as credit demands rise and fall with the cycle. And above all, price expectations heavily influence rates, frequently offsetting other m arket influences. Today, fo r example, if people expect prices to rise by (say) 10 percent a year, lenders w ill demand that 10-percent inflation premium plus some “ real” underlying interest rate of perhaps 3 to 4 percent to protect themselves against an expected loss in the purchasing power of their money. In the realm of anti-inflationary monetary tactics, the Federal Reserve shifted its operating procedures tw o years ago to emphasize money-growth control rather than interest-rate control. Our experience has clearly dem onstrated that during periods of heavy (private plus government) credit demands, attempts to dampen rising interest rates result in rapid money growth. And history has also shown that rapid money grow th eventually leads to inflation — accom panied by high interest rates. By the same token, history shows that reductions in m oney-supply growth definitely reduce the inflation rate over time, usually with the lag of a year-and-a-half to two years. This suggests, then, that the Fed should continue to fo llo w the path of gradual deceleration adopted in O ctober 1979. The evidence fo r 1981 indicates some progress against inflation, despite a third-quarter price upsurge created by an acceleration of food and (especially) housing prices. The consum er-price index, which increased by 12 1 percent during /2 1980, has been rising on average at about a 10-percent rate to date in 1981. The broader GNP price index (deflator), follow ing its 10-percent increase during 1980, has been rising at about a 9-percent rate over the first three quarters of 1981. The battle, of course, remains as tough as ever, as we can see from the past quarter’s price upsurge. Yet, overall, I have no doubt that a policy of gradual deceleration in money growth w ill mean a fu rthe r deceleration in inflation over the next several years. Technical Problems The Fed’s policy task is com plicated, however, by technical questions of measurement, as the newspapers have been pointing out in recent months. In an era of financial deregulation and innovation, different m onetary measures have been giving o ff different signals. The narrow measure of the money supply — currency plus transaction (check-type) accounts, known as M1-B — decelerated slightly in each of the past two years, and sharply thus far in 1981. Recently it has been running considerably below the bottom of the 1981 target growth range, as set by the Fed, of 31 to 6 percent, after adjustm ent for /z shifts of savings into check-like NOW accounts. To com plicate matters, the actual M1-B measure — before adjustm ent fo r shifts of NOW-account funds — has been running roughly in the middle of that 31 /2-to-6 percent range. Moreover, a broader measure — prim arily currency plus all depository in stitu tio n s’ deposits (except large CDs) and money-market fund shares, known as M-2 — has been running near or above the top of its 6-to-9 percent target range, although below last year’s actual growth. Other broad measures of money and credit also have been expanding rapidly. The difference in growth trends can be traced ultim ately to the effect of high interest rates on household and business cash-management practices. High rates have m inimized the use of traditional transaction balances included in the M1-B measure, and have stim ulated the growth of money-market mutual funds and other com ponents of the broader monetary aggregates such as M-2. These technical questions, abstruse as they may seem, reflect some hard political and econom ic decisions. As the Wall Street Journal recently observed, w ith M-2 above its target and adjusted M1-B below its target, the Fed’s critics have the option of blam ing the Fed fo r creating money too rapidly and causing inflation, fo r creating money too slowly and causing recession, or perhaps fo r both at once. Some critics recently have argued fo r an anti-recession acceleration of adjusted M1-B grow th, to bring it w ithin its growth range. However, this would require accelerated money growth, at about a 12-percent annual rate, fo r the rest of this year. A grow ing body of evidence now indicates that the unadjusted M1-B figure is a better measure than the adjusted figure. Briefly, it appears that the attraction of high interest rates has considerably reduced the demand fo r currency and check-type deposits in relation to income. If this is true, we would be mistaken in policy terms to accelerate money-supply growth in coming months, because that would only create more inflationary tin de r at a tim e when we have made definite progress against inflation by getting money growth under control. In that case, we would only repeat our earlier experience, when we appeared to have licked inflation in the m id-1970’s because of a moderate monetary and fiscal policy, but then threw away our hard-won gains in the overexuberant atmosphere of the late 1970’s. Fiscal Policy Problems The d isinflationary money path follow ed by the Federal Reserve in the 1980’s is a necessary reversal of the inflationary money grow th of the preceding decade-and-a-half. That policy can be successful, however, only if it is accom panied by an equal reversal in the field of fiscal policy. The Congress and the A dm inistration have made some progress along this line this year. But w itho ut further progress, we would be faced w ith the prospect of large deficits in relation to the n ation’s savings potential, w ith its inevitable im plications fo r financial markets and for housing and other sectors dependent on credit. The harsh fact is that the past track record has not been encouraging. The Federal budget has not recorded a surplus since 1969, and in fact, has been in deficit in all but one of the past 21 years. In most years also, deficit forecasts have become larger and larger w ith each new estimate, giving m arket participants grounds for increasing skepticism. Budget deficits also have affected the markets more directly. After adjustm ent fo r capital-consum ption allowances — that is, the am ount necessary to maintain the present stock of business investm ent and housing — the nation generated about $185 b illion of savings in fiscal 1981, largely in the form of business-retained corporate earnings, household savings, and state and local pension-fund contributions. That amount represented the funds available to add to our plant and equipm ent, to inventory, to housing — and to finance the Federal Government. But Federal d eficit and off-budget financing, when com bined, totalled over $80 b illion — nearly one-half of the n atio n ’s total savings. Now, you could argue that our budget deficits are relatively small by international standards, when measured in relation to total production. This is true, but unfortunately our savings are also small, and it is the relation between the two that is crucial. For example, in the last half-decade, U.S. net savings amounted to less than 5 percent of the n ation’s total output. In contrast, the savings ratio was more than twice that large in most m ajor European nations, and almost fo ur tim es that large in Japan. Now, any econom ist w ill tell you that the effect of budget deficits on the econom y and capital markets should be judged differently at different stages of the business cycle. There is little danger of "cro w d in g -o u t” in a period when we have high actual savings, falling investment demands, and low interest rates. But surely, that is not the situation confronting us today, when com peting demands clash so strenuously in the marketplace. Thus, we see the Federal Government crow ding-out other borrowers — households, hom ebuilders, farmers, small businesses, and state and local governments — who cannot afford to pay the interest rates that the Federal Governm ent is w illing and able to pay. Surely, this massive Federal presence in credit markets must be considered a m ajor cause, along w ith high inflation, of the high interest rates now underm ining the housing market. Policy Proposals Let me summarize my argument, therefore, by making several policy proposals, beginning with the continued need fo r a disciplined monetary policy. The path of wisdom calls fo r a policy that w ill keep all of the m ajor monetary aggregates from straying too far off course. For the remainder of 1981 — according to Chairman Volcker’s latest Congressional testim ony — the Federal Reserve thus is w illing to hold adjusted M1-B growth near the bottom of its range, and M-2 growth near the top of its range. For 1982, the Fed tentatively has again reduced its projected growth range fo r M-1 (a single narrow /2 aggregate) to between 2 V2 and 51 percent, w hile m aintaining a 6-to-9 percent range for M-2. Thus, by carrying out our “ game pla n ” of reduced money growth in 1981, and projecting sim ilar discipline next year, we should add credibility to the n atio n ’s anti-inflation program and help to reverse long-standing expectations of continued high inflation. Next, we must make every e ffort to reduce Federal d eficit-financing pressures on the markets, and thereby reduce the crow ding-out of borrowers. I’ve been impressed this year by the jo in t Adm inistration-Congressional efforts to reduce taxes and spending in tandem. However, we are still left w ith the prospect of substantial deficits in fiscal 1982 and subsequent years. In passing, I m ight note an estimate that if half the funds required for financing the fiscal ’81 deficit had gone instead into housing, we would be back again at the 1978 peak level of hom ebuilding activity. I believe, therefore, that a vital “ phase 2” w ill be needed to ensure further reductions in Federal deficits. W ashington policy makers are now actively discussing ways of accom plishing this goal, through both further expenditure cuts and tax measures. With regard to expenditures, many observers believe that Congress should take a hard look at various entitlem ent programs, since large budget deficits in recent years have mostly reflected the inflation-indexed upsurge in payments for Social Security and other such programs. With regard to tax measures, the Adm inistration has proposed some increases in taxes other than on income, and in particular, some Congressmen have discussed deferring the income-tax cuts now scheduled for mid-1982 and mid-1983. It may be necessary to work on both expenditure reductions and added tax-revenue measures to head off a very unhealthy surge in the Federal deficit. Third, we should support various m ortgage-financing innovations which help first-tim e homebuyers leap the hurdle to homeownership. These innovations — such as the variable-rate mortgage, the graduated-payment mortgage and the shared-appreciation mortgage — mean that both borrowers and lenders share the risks and the benefits of inflation. But this approach also enables mortgage borrowers to obtain more housing services over tim e — especially because initial payments would be lower than they are under the terms of fixed-rate mortgages. Finally, we should elim inate the various state and local restrictions which have made housing prices rise even faster than the general rate of inflation in recent years. These include local building codes, lim itations on land use, and other restrictions w hich drive building costs up at a substantial rate year-in and year-out. Some observers believe that we also need a Federal override of state-court decisions which p rohibit enforcem ent of due-on-sale clauses in mortgages and w hich thus perm it homebuyers to assume low-rate m ortgages on existing homes. Realtors and buyers of existing homes may welcome this assum ability feature, but it has aggravated the th rift institutio ns’ problem of m aking funds available fo r new housing construction, and also of im proving the return on th eir m ortgage portfolios. Too many pressures as it is are forcing th rift institutions away from their basic responsibility of financing housing. Thus, I would welcome any action which would ease the th rifts ’ task of carrying out their basic hom e-financing role. In sum, I believe that these monetary, fiscal, and institutional proposals are essential to the future health of the housing industry. A disciplined monetary policy over tim e means a reduction in the inflation rate, and in turn a reduction in the level of mortgage and other interest rates. A disciplined fiscal policy means much less crow ding-out of home purchasers from credit markets. And the various institutional changes I have suggested should help keep home prices from rising at a much steeper rate than the general level of prices. By im plem enting such proposals, we should see much more stability in credit flows available to the housing market, and thus the end of the vast swings which have driven up housing costs so severely. And needless to say, by accom plishing those goals, we should be able to reduce the vast swings in building activity w hich have driven up your industry’s costs in turn.