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Under Title III of Senate Bill 2246—the Housing Act of 1950—the obligations which would be
issued by the proposed National Mortgage Corporation for Housing Cooperatives would compete
directly with Government securities in the money
market. They would be purchased largely by
banks and other investors, which otherwise would
probably hold Government securities. As a result,
either the Federal Reserve would have to purchase
additional Government securities, thus creating
new bank reserves, or prices of Government securities would decline, i.e., interest rates would rise.
Although the protective aspects of the Corporation's obligations authorized by the bill are designed to be similar to those of F H A mortgage
insurance, there are important differences between
the two. Apart from the original capital of the
Corporation, the funds extended by the Corporation would be private funds, but the ultimate
lender, i.e., the purchaser of the debenture, is more
adequately protected against difficulties and risk of
loss than is the mortgagee or holder of an F H A insured mortgage. If the Corporation defaults on
a debenture, it itself makes the exchange for a
guaranteed debenture, whereas if an F H A mortgagor defaults on his mortgage, F H A makes the
exchange of the mortgage for a guaranteed debenture after the mortgagee has foreclosed and obtained title to the property. It would be reasonable
to expect, moreover, that the Corporation would
have less occasion to issue guaranteed debentures
because, while F H A issues guaranteed debentures
for every individual mortgage which is foreclosed,
the Corporation would not have to issue guaranteed
debentures in exchange for its other debentures
until a very large proportion of its mortgages had
gone bad and its capital, surplus, and reserves had
been impaired to a point where the Corporation
could not meet its obligations.
For these reasons and because of the other safeguards, the Corporation's debentures issued to
obtain new funds should have an even more favor-

able market than the obligations of other Government corporations, such as Federal Land Banks,
which are not protected in the same manner, and
would be in effect the same as guaranteed Government securities. The competition which would
arise in the market between Government securities
and obligations of the Corporation would, therefore, be very direct. Most of the buyers of the
debentures would be banks, institutions, and other
investors that would probably otherwise hold Government securities.
As the bill stands, the Corporation would have a
great deal of discretion about the gross interest rate
to charge borrowers and the mortgage maturities
to permit. The Corporation would probably be
able to borrow at slightly above the long-term
Government rate, and the lowest gross rate to
borrowers might be little over 3 per cent, although
it would have the authority to charge higher rates
and build up reserves. On the other hand, by
issuing short-term debentures, the Corporation
might get its money as low as 1 % or 11/2 per cent,
which might permit a gross rate much lower than
3 per cent.
If the Corporation were to obtain funds for longterm mortgage lending by borrowing substantial
amounts on short-term obligations, it would not
only run the risk of adverse marketfluctuations,but
it would in all likelihood obtain these short-term
funds largely from expansion of bank credit. This
could be undesirable in a period when general credit
policy was directed toward limiting expansion of
bank credit.
In view of the safeguards with respect to capital
of the Corporation and insurance reserves against
the debentures included in the law, it is unnecessary
to add the undesirable feature of what is in effect
a direct Government guarantee of the debentures.
The Corporation should be able to borrow on terms
just as favorable as the Federal Land Banks and
the Home Loan Banks, which now have no such
guarantee. The debentures then would be more


truly of the nature of private obligations and compete less directly with Government securities.
The practice of issuing securities guaranteed by
the Federal Government was abandoned many
years ago because such issues came to be viewed
as practically the same as direct Government obligations and were an indirect means of keeping the
expenditures out of the budget. Issuance of guaranteed obligations has the same effect as an increase
in the public debt. Investors buying the new securities might sell direct obligations of the Government. Either the prices of Government securities
would fall and interest rates rise or the Federal
Reserve would have to support the market by buying securities, thus creating bank reserves.
Action by the Federal Reserve of this nature
might at times be inconsistent with major aims and
statutory obligations of the Federal Reserve. An excellent description of the appropriate aims and procedures of Federal Reserve policies is given in a
recent report of the Subcommittee on Monetary,
Credit, and Fiscal Policies of the Joint Committee
on the Economic Report, after conducting a comprehensive inquiry under the Chairmanship of Senator Douglas.
This description may be summarized and paraphrased approximately as follows:
The role of the Federal Reserve in our economy
is to supply the banking system with adequate
lending power to support a growing and relatively
stable economy and to exercise restraint upon excessive credit expansion that will lead to instability.
This task has been made exceptionally difficult by
the tremendous wartime growth of the public debt,
the pervasive distribution of Government securities
among many holders, and the tendency of these
holders to view their securities as liquid assets readily convertible into money to be spent or otherwise
invested. Attempts to sell these securities, unless
buyers are readily available, tend to lower their
prices, which means a rise in interest rates. In the
absence of a demand by other investors, declining
prices can be prevented only by Federal Reserve
purchases. But any expansion of Federal Reserve
credit has the effect of supplying banks with additional reserve funds, on the basis of which the banking system by lending or investing and relending
can expand bank credit, and the volume of money,
by many times the amount of the reserves supplied.
This process of monetary inflation can be 'somewhat restrained by limiting Federal Reserve purchases of Government securities. As the Douglas

Subcommittee report pointed out,1 "the essential
characteristic of a monetary policy that will promote
general economic stability is its timely flexibility."
But Federal Reserve policies cannot be varied in
response to changing needs without affecting interest rates. For the Federal Reserve to endeavor to
maintain a rigid level of interest rates would mean
supplying all credit demands in time of expansion
and absorbing all of the unused supply of credit
in times of contracting demands. Such policies
would tend to create instability, because they would
tend to reinforce both the expansion and the contraction phases of economic fluctuation.
Another general point which should be kept in
mind is that there are many interest rates which
reflect, on the one hand, varying degrees of risk
and liquidity involved in different obligations and,
on the other hand, the supplies of funds that may
be seeking relative safety and liquidity at the sacrifice of higher return or vice versa. For example,
the Treasury can borrow at between 1 and 1 lA per
cent on short-term obligations and at less than 2 l / 2
per cent on long-term bonds, while business borrowers at banks pay from 154 to more than 6 per
cent, depending on the size and risk of the loan,
and consumer loans carry higher interest charges.
These differences in the structure of interest rates
must be taken into consideration in the determination of Federal Reserve policies.
What bearing do these observations have on
housingfinanceand housing legislation? An important aspect of most of the housing legislation of the
past two decades has been to make it possible for
lenders to tap money markets at lower rates of interest and on more favorable terms than were previously available. These were and are, on the
whole, desirable aims, as institutional arrangements
in the mortgage market have had much need for
improvement. Particularly during periods of depression and substantial unemployment it was most
helpful to facilitate the flow of available investable
funds into the mortgage market at reduced rates of
interest. It is quite another matter, however, to
adopte measures which will lead to the creation of
new money to finance construction at a time when
activity is already fully utilizing available supplies
1 "Monetary, Credit, and Fiscal Policies", Report of the
Subcommittee on Monetary, Credit, and Fiscal Policies of
the Joint Committee on the Economic Report, January 23,
1950, p. 19.


of material and labor and prices are higher than a
large portion of potential buyers can afford.
The aim of many of the measures adopted and
proposed has been to lower the cost of housing by
obtaining low interest rates on mortgages—an important cost of home ownership. This is generally
done by attaching some sort of Government insurance or guarantee to the mortgages or to the obligations of mortgage lending agencies or by providing
facilities for increasing their liquidity. One result
is that these obligations can tap sources of lendable
funds that would otherwise not have been available
to them. The lower rates and increased availability
of funds tends to stimulate borrowing.
Obligations guaranteed or insured by the Federal
Government are to a considerable degree competitive with Government securities; therefore an increase in such obligations is likely to result in a
decline in prices of Government bonds, i.e., a rise in
interest rates. In the absence of a large unused
supply of loanable funds in that sector of the market, the only way a general rise in interest rates
could be avoided would be by Federal Reserve
purchases of Government securities, which would
mean the creation of new money.
Thus the issuance of additional amounts of obligations directly or indirectly guaranteed by the
Federal Government would have the effect either
of depressing the prices of Government securities
or of requiring creation of supplies of new money

by the Federal Reserve. In the case of the first
alternative, the benefits of lower interest rates expected by the sponsors of the measures to provide
cheaper housing would not be fully realized and,
in addition, all other Government securities would
decline in price. In the latter case the inflationary
policies might result in higher prices. Whether
such a result ensues depends upon the general
economic situation at the time.
It is because of these possible consequences that
the Federal Reserve has a particular interest in
housing finance and in the various legislative proprosals that have been made. Their effects on the
economy, and perhaps their success in accomplishing their objectives, will in the final analysis influence, or be influenced by, Federal Reserve
While the monetary consequences of financing
the amount of debentures proposed under the
present bill might be slight, the principle, however,
is one which, if adopted in a moderate amount for
one purpose, might well be extended in magnitude
and scope. It is difficult to provide special privileges to one group and deny them to others. This
principle, if widely adopted, could unduly stimulate
housing construction at lowered interest costs and
eventually undermine the values of existing houses
and of mortgages outstanding against them. It
would be at first an inflationary factor and ultimately lead to a deflation of values.

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