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HOUSING FINANCE AND THE ECONOMIC RECOVERY VICE CHAIRMAN PRESTON MARTIN BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM WASHINGTON, D.C. SEPTEMBER 2 8 , 1983 The increase in mortgage interest rates recorded since mid-1983 has raised doubts about the ability of the housing sector to contribute to an economy moving from recovery to expansion. Although rates have drifted down in recent w e e k s , the effect of interest rate levels on housing activity is still an understandable c o n c e r n . its classical Housing has played role in the recovery p e r i o d , leading the upturn and having positive effects upon building materials and consumer d u r a b l e s . The sensitivity of housing to interest rate changes was once again demonstrated in the timing of its r e c o v e r y , following the substantial de- creases in rates on both fixed- and adjustable-rate mortgage contracts that occurred throughout 1 9 8 2 . It would be a m i s t a k e , h o w e v e r , to expect an iteration of past housing cycle patterns and old relationships between interest r a t e s , housing s t a r t s , and home s a l e s . The Changing Housing Finance System Institutions which finance housing are different this time. In one r e s p e c t , housing is even more interest sensitive t o d a y , because of the much closer tie between yields demanded by institutional invest- ment managers considering mortgage-backed securities and the variations in interest rates evident in the capital m a r k e t s . Aggressive and inno- vative managements at the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation are helping to bring additional sources of capital to bear upon h o u s i n g . On the other h a n d , many thrift i n s t i t u t i o n s , particularly savings and loan a s s o c i a t i o n s - s o m e using their new title of "bank"-- are aggressively marketing a d j u s t a b l e - r a t e mortgages so that consumers have the opportunity to qualify for loans at initially a t t r a c t i v e rates -2- despite the firming of market returns on fixed-rate m o r t g a g e s . The shift to adjustable-rate mortgages is n a t i o n w i d e , with some regional exceptions, and represents a substantial move by the thrift industry to restructure the asset side of its collective balance sheet while remaining specialized in the financing of h o u s i n g . An important thrust in continued housing expansion comes from the unusually large number of first-time h o m e b u y e r s , and their acceptance of adjustable-rate mortgage contracts is n o t e w o r t h y . T h u s , analyses of the probability and extent of a continued housing contribution to economic expansion must rely more than in the past on the acceptability and rates on the new types of m o r t g a g e s , rather than on the stated or nominal rates which are fixed and can be interpreted as cutting off housing expansion to an unrealistic degree. The housing expansion may also be influenced by other sweeping changes taking place in our financial s y s t e m , changes away from restrictive laws and regulations and toward a system in which financial tions largely pay market rates for their savings or d e p o s i t s . with these changes on the liability side institu- Associated are the new empowerments thrift institutions which w e n t on the books about a year ago for permitting thrift managements to consider the development of commercial loan capabilities and to shift portions of their assets into many new lines of a c t i v i t y , some of which have little to do with housing. Indeed, some observers have begun to view the financial industry as though the thrift institutions already have transformed themselves m a g i c a l l y into commercial banks. This may be part of the tendency many of us have to regard the passage of legislation as producing i n s t a n t , structural effects. -3- The factual situation is somewhat different. Certainly a small number of- thrift institutions have convinced their respective boards of the merit of asset shifts and have actively recruited executives ana staff with commercial banking experience. A n d , of c o u r s e , New England thrift i n s t i t u t i o n s , mainly savings b a n k s , have had some statutory authority in this regard for a number of years a n d , in many c a s e s , hold a small percentage of commercial estate loans on their b o o k s . non-real Yet in the vast majority of c a s e s , the shift away from mortgage assets which occurred in 1981 and 1982 apparently has been largely c o m p l e t e d , and mortgage l o a n s , participations in mortgage l o a n s , and mortgage-backed securities represent the preponderance of new assets being placed on the b o o k s . Prior to the late 1 9 7 0 s , large cyclical movements in mortgage and housing activity partly reflected the impact of various artificial constraints on the "availability" of mortgage credit. When short- and long-term market rates r o s e , the flexibility of depository institutions to respond was constricted by state laws imposing ceilings on the mortgage rates and federal laws establishing ceilings on the interest rates which could be paid s a v e r s . When market rates f e l l , the inflows of savings tended to produce the upswing and recovery for which the housing sector was well k n o w n . As we wit- n e s s e d , intermediation succeeded disintermediation which succeeded reinte m e d i a t i o n . The jungle of laws and regulations at both state and levels-artificial federal constraints on credit avai 1 abi 1 i ty--are no longer a significant force limiting the m a r k e t s . I n d e e d , on October 1 , all ceiling restraints on time accounts of over 31 days will disappear. -4- Under the prompting of the Depository Institutions Deregulation Committee, numerous new deposit instruments with varying degrees of transactions and savings characteristics have taken s h a p e . Today's financial institution is capable of raising funds in its community and in the capital by a variety of m e a n s . markets T h u s , in large p a r t , rate considerations and borrower qualifications have succeeded funds availability as primary management concerns. Though the broader powers provided thrift institutions in the Garn-St Germain Act of a year ago have not transformed mortgage lenders into commercial b a n k e r s , the potential utilization of these powers has been attractive to the Wall Street investment c o m m u n i t y . The transformation which has occurred has been the conversion of many large mutual institutions into stockholder-owned ventures which in the process of conversion have accumulated substantially larger e q u i t i e s . A fair number of institutions have augmented their equity positions by $100 million or more--a phenomenon of massive capital infusions that has not before characterized the mortgage industry with the exception of the period of experimentation with the real estate investment t r u s t s ; in the latter s i t u a t i o n , h o w e v e r , the thrust of the REITs was toward commercial real estate and less toward h o u s i n g . The deepened equity base and the pressure for earnings upon a m a n a g e m e n t whose skills are concentrated in the financing of housing are factors that should be taken into account in evaluating the continued contributions of housing in the expansion phase of this c y c l e . The secondary m a r k e t for mortgages and mortgage-backed ties and the effectiveness of two quasi-governmental mortgage securi companies -5- FNMA and F H L M C , are also factors to be reckoned w i t h . The m o r t g a g e - backed s e c u r i t y has come into its own after a 13-year s t r u g g l e . "swap" p r o g r a m s of FHLMC and FNMA have contributed to thrift p r e s e n c e and s t r e n g t h in the m o r t g a g e m a r k e t s . i n n o v a t i v e in several The institution Both a g e n c i e s have been regards as illustrated by the c o l l a t e r a l i z e d mort- gage o b l i g a t i o n s m a r k e t e d by the F H L M C - - s e c u r i t i e s divided into classes w i t h varying m a t u r i t i e s such as 5 y e a r s , 1 2 - 1 / 2 y e a r s , and 30 y e a r s . And o t h e r s e q u e n t i a l - p a y i n g type bonds are beginning to a p p e a r , utiliz- ing pools o f mortgage-backed s e c u r i t i e s , in c o n t r a s t to pooling o f the mortgages themselves. It is o b v i o u s that d e e p e n i n g s e c o n d a r y m a r k e t s and m o r t g a g e - b a c k e d s e c u r i t i e s are not s i m p l y m a t t e r s o f financial legerdemain. These m a r k e t p r o c e s s e s e n c o u r a g e and s t i m u l a t e thrift i n s t i t u t i o n s n o n t h r i f t s to stay in the m a r k e t . and Some i n s t i t u t i o n s are o r i g i n a t i n g u n p r e c e d e n t e d v o l u m e s o f m o r t g a g e loans in this r e c o v e r y , s e l l i n g the bulk o f t h e m , and r e t a i n i n g p a r t i c i p a t i o n i n t e r e s t s . T h u s , some thrift m a n a g e r s have j o i n e d t h e i r m o r t g a g e banker c o m p e t i t o r s in d e v e l o p i n g a substantial f l o w - t h r o u g h of funding w h i c h finds its w a y to the homebuyer. The c u r r e n t c o n s i d e r a t i o n by the C o n g r e s s o f a d d i t i o n a l vate v e h i c l e s pri- for the p o o l i n g o f m o r t g a g e s and the sale o f o b l i g a t i o n s secured t h e r e w i t h is to be a p p l a u d e d . The P r e s i d e n t ' s H o u s i n g Commis- sion in 1982 r e c o m m e n d e d c h a n g e s in tax laws and o t h e r s t a t u t e s w h i c h w o u l d g r e a t l y e x p a n d the i s s u a n c e o f m o r t g a g e - b a c k e d s e c u r i t i e s by nongovernmental mortgages corporations-the (TIMs) proposal. c o n s i d e r e d by the Senate. s o - c a l l e d trusts for i n v e s t m e n t s in This is one o f the p o s s i b i l i t i e s now being -6- Monetary and Fiscal Policy The wide variety of institutional changes which underpins the housing expansion does n o t , of c o u r s e , remove housing's unusual vulner- ability to rate c h a n g e s , although this vulnerability has been greatly mitigated. It is still true that interest rate sensitivity is greater in the housing sector than in most other components of our domestic economy largely because housing is a high-priced item that requires financing at long t e r m , often by buyers with limited financing alternatives . Monetary policy that is designed to facilitate expansion of the economy without regenerating inflationary pressures should lead to lower interest rates over t i m e , with attendant benefits for housing and other credit-dependent private s e c t o r s . To get the most out of t h i s , h o w e v e r , there must be complementary fiscal p o l i c y . T o d a y , the prospect of federal budget mega-deficits looms ahead even as the economy e x p a n d s , suggesting a serious imbalance arising from fiscal p o l i c y . That concern is widely held in the financial markets and in the public at l a r g e , and the prospect of intensified "crowding out" of private demands in 1984 and beyond in competition for the available supply of credit appears at least partly responsible for the m a i n t e n a n c e of high "real" interest rates on longer-term i n s t r u m e n t s . Concerns abound that mega-deficits will only place heavy demands on the credit markets but that they will not thereby create pressures for excessive monetary e x p a n s i o n , causing the battle against inflation to become c o n s i d e r a b l y more difficult. C l e a r l y , the fundamental outlook for interest rates and housing activity does not lie in the hands of the Federal Reserve a l o n e , because -7- federal budgetary decisions will have an important effect on both the level of interest rates and the distribution of the available supply of credit among private and governmental sectors. in financial markets and financial deflect the b l o w . Institutional changes institutions s o f t e n , but do not Market confidence in the success of monetary policy must be supported by continued commitments and decisions in both the Congress and the Administration to reduce the large structural federal deficits that threaten to place heavy pressure on our financial sources as the economy g r o w s . re- Complementary monetary and fiscal poli- cies will foster the easing of inflationary expectations that are essential to sustained expansion in homeownership and its potentially positive effects on productivity itself.
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