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F or Release on Delivery

Statement by

Philip C. Jackson, Jr.

Member, Board of Governors of the Federal Reserve System

before the

Subcommittee on Financial Institutions Supervision, Regulation and Insurance

of the

House Committee on Banking, Currency and Housing

U. S. House of Representatives

January 22, 1976


T hank you fo r the opportunity to appear on behalf of the Board
of Governors to take part in the hearings on your Committee's con­
sideration of possible reform s in the structure and perform ance of
the nation's financial institutions.

Our comments on the implications

for the residential mortgage and real estate markets of Title II of the
FINE "D iscussion Principles" will build on the testimony presented
earlier today by Governor Holland on Title I dealing with depository
Before going into the details of the Discussion P rinciples, I
would like to make two general points.

The first is that inflation

continues to be the chief enemy of the mortgage and housing markets
in our country.

Inflation not only increases the cost of financing, but

it also disrupts the supply of funds.

It not only escalates the p rice of

homes, but it may also reduce the income, after allowing fo r other
necessary expenses, which consumers have available to acquire new
o r better housing accommodations.

Unless the forces of inflation can

be contained, it is doubtful that any financial restructuring could produce
a mortgage market which will appropriately meet the housing needs of
the American public.
The second general point is that in recent years the private
sources of home mortgage credit have become concentrated in the nonbank



thrift institutions. These particular lenders traditionally borrow short
and lend long and thus are highly vulnerable to the effects of inflation
and variations in general credit conditions. In 1960 thrift institutions
held approximately 52 percent of home mortgages outstanding. By
June 30, 1975, this proportion had grown to 60 percent.

In contrast,

life insurance companies dropped during this same period from 18 percent
to 5 percent. Commercial banks, on the other hand, increased their share
from 14 percent to 18 percent.

Federal credit agencies and mortgage

pools grew from 5 percent in 1960 to 12 percent in mid-1975.
This trend was confirmed in 1975 by the volume of new home loans
extended. Over the first three quarters of last year, savings and loan
associations and mutual savings banks together accounted for 61 percent
of total long-term home mortgage acquisitions. In comparison,
commercial banks supplied 15 percent, with Federal credit agencies
and related mortgage pools accounting for nearly all of the balance.


other source of savings capital made a significant contribution to the
home mortgage market.
When we consider the problem of inflation as well as the con­
centration of housing credit in institutions with volatile inflows of funds,
it is small wonder that home buyers have been plagued not only by
volatility in the price of mortgage money, but also by a periodic scarcity


of money at any p rice .


There are two overriding considerations, then,

that should be kept in mind insofar as housing finance is concerned.


is the need to further dampen the inflationary forces in our econom y that
contribute to such erratic fluctuations in both the demand fo r and the
supply of housing credit. The other is to broaden and strengthen the
sources of funds available to finance housing at a variety of investment
The expansion of investment powers of the nonbank thrift
institutions and the rem oval of ceilings on deposit rates — as proposed
in Title I of the Discussion Principles — would make fo r greater stability
in the operations of savings and loan associations and savings banks, and
produce a more even flow of mortgage funds from them.

Even though

the proposed expansion of deposit powers at thrift institutions may well
encourage a larger share of total savings to be funneled through them,
it is uncertain whether there might be some decline over the longer run
in the supply of mortgage funds at institutions which becom e m ore

The result may be that the cost of mortgage credit would

rise relative to yields on other investments.

In that event, other types

of lenders would be encouraged to move more funds into m ortgages.


shift would lessen upward mortgage rate pressures to some degree and
help to reduce short-run fluctuations in the cost and availability of
mortgage credit in the future.

-4 -

Some of the FINE Study proposals in Title II are designed
prim arily to moderate the possible impact of more competitive pricing
on mortgage borrow ers. As these proposals are considered, it is well
to rem em ber that sim ilar measures are already in effect in other form s.
Of these, the principal one is our system of Government mortgage
insurance and guaranty through HDD's Federal Housing Administration
and the Veterans Administration. Such programs make mortgage term s
more advantageous for borrow ers by pledging the faith and credit of the
government in addition to that of the home buyer who is seeking funds.
The Federal Home Loan Bank Board loan proposal in Title II
is sim ilar to the GNMA tandem plan now in operation. T o this extent,
the proposal would essentially duplicate an existing program which
provides below-market interest rates to home buyers and utilizes a
government-related source of funds. It is not clear from the Discussion
Principles whether the proposed new role for the Federal Home Loan
Bank Board would eliminate the authority of the Federal Home Loan
Banks to make advances to thrift institutions in order to cover either
takedowns of earlier mortgage commitments, o r deposit withdrawals,
in the event of unexpected reversals in their overall flows of funds.


our view, such advances would still be needed, at least on a transitional
basis, so as to provide necessary flexibility to this class of depository

-5 -


Although the FINE Discussion Principles would allow

depository institutions access to the Federal Reserve discount window,
discount borrowings have traditionally taken the form of very short­
term credit designed prim arily to cover temporary reserve deficiencies.
Thus the discount window operation would not duplicate the FHLBB
medium-term advance program now in effect.
The proposed m ortgage-interest tax credit and the mortgage
reserve credit features of the Discussion Principles would undoubtedly
be of some help in ameliorating any adverse impacts on consumers of
more competitive pricing of mortgage money. Yet the degree to which
they might do so in unclear.

A progressive m ortgage-interest tax

credit would probably offer only a relatively modest investment incentive
for com m ercial banks and insurance companies. Neither type of credit
would encourage pension funds to invest in mortgages.
M oreover, it is uncertain how much of the benefits from these
plans would be passed through to low er-incom e consum ers.

If applied

retroactively, the tax credit and reserve credit plans would obviously
provide windfall gains to lenders on mortgages already held in their
portfolios — benefits that would apparently not be transmitted to any
low er-incom e households that had borrowed prior to the inception of
the program s.

The proposals in Title I would encourage more diversification
by financial institutions which are now specialized.

In contrast, the

incentive programs in Title II would encourage specialization in one
type of asset, typically with long maturity and limited marketability.
It is even possible that the progressive tax credit proposal might
lead to a concentration of low - and m oderate-incom e mortgages in
a relatively small number of lending institutions.
The proposed mortgage reserve credit plan to aid low - and
m oderate-income housing raises a number o f important additional
issues which I would like to summarize:

The institution of a reserve credit plan would set an
unwise precedent for extending sim ilar preferential
treatment to holdings of other types of assets deemed
to be of pressing social m erit. The list of favored
credit instruments of this type could becom e longer
as time passed, thus diluting the initial advantage
enjoyed by qualifying m ortgages, and tending to segment
private credit markets even further.


-7 -

A reserve credit on one type of instrument — such
as a mortgage — would encourage financial institutions
to change the form of their lending simply to take
advantage of this kind of subsidy. T o that extent, the
mortgage reserve credit would not stimulate more
housing investment.

Lenders would have an incentive,

for example, to offer loans secured by real estate in
lieu of consumer loans to be used fo r non-housing

The mortgage reserve credit plan would affect the
pricing of qualifying mortgage assets, and could
accordingly limit their marketability.

On a given

mortgage loan, a reserve credit — particularly when
accompanied by a m ortgage-interest tax credit — would
produce a different effective yield at depository institutions
holding different proportions of assets in qualifying
mortgages relative to their deposits.

A yield distinction

would also exist between institutions qualifying for the credits
and those, such as pension funds, which do not. T o the extent
that these yield differentials would prevail, depository instituions


would either have to take low er profits or larger losses
than, they otherwise would be obliged to absorb on the
sale of loans to nondepository purchasers, and would thus
be discouraged from broadening the secondary market for
such loans.
The mortgage reserve credit plan would require lenders
to identify loans on "low - and m oderate-incom e housing"
held in their portfolios.

This ongoing identification process

would be difficult, particularly since qualifying characteristics
of borrow ers, properties, and even neighborhoods can
change either up or down over the life of a given loan.

Of even greater importance, a mortgage reserve credit would pose
a more fundamental problem for the monetary authorities. The mortgage
reserve credit plan would weaken the capacity of the Federal Reserve to
control the growth of reserves at depository institutions in order to
maintain a rate of expansion in the monetary aggregates consistent with
the needs of our economy.

Federal Reserve decisions would be complicated

by the addition of a new element to the already complex relationship between
the reserve base and the money stock.

This new element — stemming

from the asset side of lender balance sheets rather than the liability side —

-9 -

would require the Federal Reserve for the first time to predict changes
in holdings of qualifying mortgage assets by a large number of diverse types
of com m ercial banks, savings banks, savings and loan associations, and
credit unions.
To the degree that the proposed financial market reorganization
resulted in higher average mortgage borrowing costs over the long run,
low - and m oderate-incom e households would be affected the m ost.

F or

these consum ers, the cost of shelter, along with other basic necessities,
usually absorbs a relatively large portion of their incom e.

In that case,

considering the imperfections of both the m ortgage-interest tax credit
and the mortgage reserve credit approaches, one or m ore alternative
methods of housing assistance may be regarded as desirable for low and m oderate-income groups.
In addition to the FHA, VA, and GNMA mortgage credit program s,
an elaborate system of other Federal housing aids is currently in place.
Many of these plans already provide some support, directly or indirectly,
to low er-incom e households. Altogether, Federal aid to housing takes
such varied form s as tax incentives to homeowners, landlords, and builders;
cash subsidy programs to produce new and substantially rehabilitated
housing; secondary mortgage market support; and direct lending.


the complexities of the present system , now may be an appropriate time

-1 0 -

for the Congress to evaluate its overall cost and benefits, and the
interrelationships among the various form s of subsidy, before proposing
any further significant change.
Even in the absence of a comprehensive review of this sort,
there are several ways in which Federal assistance to homeownership
could be directed at the low er-incom e portion o f our population where
the need is greatest.

Unfortunately, portions of our present system now

apply the largest subsidy to consumers most able to pay without public
One possibility would be to revise the present system of income
tax deduction tor mortgage interest and real property taxes so as to
allocate tax benefits m ore heavily toward the lower end of the income

Another possibility would be to provide periodic supplements

to the income of low er-incom e households.

Both of these approaches

have the advantage of directly assisting those least able to pay, rather
than doing so indirectly through incentives to financial institutions.
In conclusion, the Board of Governors believes that the restructuring
of depository institutions proposed in Title I of the FINE Discussion
Principles may well hold the possibility of greater stability for our
specialized depository institutions, and ultimately fo r the mortgage and
housing markets.

If the Congress should decide that additional support

is necessary for low - and m oderate-incom e housing over the longer run,


the Board believes that direct aid to qualified home buyers and renters
is a more efficient use of public resources than program s designed to
reduce the cost of housing credit through subsidies to lenders.