1 Series discontinued; Moody's Aaa series runs fairly close to this series]

2 Not available.

V. Comparison of VA home loans closed and yield on long-term U. S. Government

1 Amount of loans closed during 1944 and 1945 totaled only $192 million. Quarterly figures are the total for the quarter.

2 Average yield during the quarter on taxable bonds, 12 years and over, beginning with April 1952; 15 years and over prior thereto,

In addition to this special analysis, there appeared on my desk yesterday an analysis of what the money policy means to the housing market, a letter put out by the United States Chamber of Commerce, which again I think would be of interest to the members of the committee as showing the relationship between the whole VA loan program and the general condition in the money market. Again I

think this is a matter which should be studied at your leisure and which I can leave on the table for your examination. (The matter above referred to is as follows:)

CHAMBER OF COMMERCE OF THE UNITED STATES, CONSTRUCTION AND CIVIC DEVELOPMENT DEPARTMENT, Washington 6, D. C., June 1953.

CONSTRUCTION MARKETS

WHAT MONEY POLICY MEANS TO THE HOUSING MARKET

The condition of the Government-bond market is a crucial indicator of the supply of mortgage funds and the terms on which they are obtainable. This fact is a new one to many builders and even to many mortgage lenders, who have assumed that the mortgage market was fairly independent of the general investment market. The last few years, however, have provided some pretty rugged lessons in the interdependence of the market as a whole.

The historical relationship

The diagram below vividly illustrates this interdependence by tracing the inverse relationship that has existed between the yield on long-term Treasury bonds and the volume of activity in VA guaranteed home-mortgage lending over the long period while VA unsuccessfully tried to prove the thesis that a mortgage interest rate is anything that an official agency decides it ought to be.

Since, under this policy, the interest rate on new VA loans could not vary with changes in long-term bond yields, activity varied quite drastically. When bond yields rose, VA mortgage activity fell; when yields softened, VA activity rose. If it had been possible to prevent all trading in VA loans at a discount, the variations in activity would undoubtedly have been even sharper.

Besides illustrating these important trends, the significant thing about the diagram is its demonstration that 4-percent VA mortgages have never been readily marketable (taking the national market as a whole except when the yields on long-term Treasury bonds were less than about 21⁄2 percent. The market's happiest days were those when there was more than a 11⁄2 spread in percentage points between the mortgage rate and the long-term Government bond rate. How the easy money market was maintained

Basic interest rates appear to move in long cycles. Prior to 1900 was a long period of declining rates. Between 1901 and 1920 yields climbed upward and stayed up during most of the 1920's, until another downward trend began, continuing until the end of World War II.

With the vast demands for funds after the war, yields on private bond issues started another upward climb. But the Treasury long-term rate was heldamid the growing discomfort of the Federal Reserve Board-by the inflationary device (which pushed construction costs up about 100 percent) of pumping new money into the economic system as the Reserve banks bought Government bonds at par.

The diagram also reveals the effects of changes in Federal Reserve policy on Government bond rates-and hence on mortgage money conditions. In 1946, when the Reserve banks stopped supporting the price on short-term Treasury obligations, not only did the rate on these issues rise (not shown in the chart) but the long-term rate also responded, with the most noticeable upward movement in many years. With continued support of the long-term bond prices, however, yields sagged again, ushering in a last feverish era of VA mortgage activity.

Then, early in 1951, the Federal Reserve Board, with the reluctant concurrence of the Treasury, made the decision to let long-term Government financing fend for itself. The result of this decision was to limit all long-term borrowing pretty much to the amount that could be obtained from actual savings. It also toned down inflation and made money tighter than anything most people could remember.

Why money stayed tight

With savings accumulating at new record rates, the situation might have eased had not the demands for money remained so strong. Steadily rising money costs, however, did not deter private borrowers to any marked extent, while the

Federal Government, faced with new deficits, had been forced to borrow irrespective of costs.

The Treasury, moreover, has had another problem. As part of the former administration's method of holding down the total amount of interest on the public debt, it had shifted more and more into short-term obligations, for which rates are generally lower than for long-term bonds. This shift not only caused the short-term rates to rise almost to what the long-term rate formerly was, but it also made it necessary for the Treasury to go into the market frequently, an upsetting thing for the whole market in a time of tight money.

Treasury moves into long-term financing

But

Facing these problems, the Treasury in April made the first offering of longterm bonds since the end of the war. It took a hard look at conditions and put a rate of 34 percent on the issues, in order to attract long-term investors. something went wrong in the marketing program. As had been expected, the issue was much oversubscribed; but unexpectedly-it was oversubscribed mainly by speculators anticipating a quick profit rather than by savings banks, insurance companies, and other permanent investors.

The result was an unhappy one for the "free riders" when they found that the long-term investors, quite content with the quotas allocated to them, did not rush into the market to buy more at above par, or at par, or at even slightly below. As the speculators sweated it out, the market developed a wait-and-see attitude. Effects on the mortgage market

Amid this atmosphere of uncertainty, the Federal Housing Administration and the Veterans' Administration took their long overdue action to raise the maximum permissible rates on insured and guaranteed loans. If this move had been taken a few months earlier, it probably would have readily restored these loans to a par position. Coming when it did, an unsettled market responded uncertainly.

Although the discounts at which FHA and VA loans had been selling fell markedly, they did not disappear; and although investors did some shifting of new funds from conventional to insured-guaranteed loans, the change was much smaller than expected. Mortgage money still remained tight.

The situation was most crucial among the large general investment institutions, like life-insurance companies and savings banks, which had so great a choice of bargains that nothing for the time seemed quite good enough. The consequences were most serious for the part of the homebuilding industry and the regions of the country most dependent on these sources of financing.

On the other hand, purely local institutions, particularly savings and loan associations, were less disturbed by the happenings in the general money market. Closely restricted by their charters to mortgage investment and dependent largely on local savings for their operating funds, they had fewer opportunities to benefit from the availability of bargain-counter investments. To many of them, guaranteed mortgages at 41⁄2 percent may look attractive, especially after so long a period of high building activity. Therefore, it is probable that savings and loan associations will not be deterred in making a fairly rapid response to the new rate. What's ahead

Aside from its purely local aspects, the mortgage market cannot be expected to settle down until the Government bond market itself attains greater stability. How long this will take is a question.

Looking at the Treasury's task-requirements during the second half of the calendar year of about $8.8 billion new money, plus perhaps about $3.5 billion to replace cash payments in refinancing operations-many analysts believe the Government will have to pay still higher interest rates. This opinion is supported not only by the continued demand for loans by business corporations but also by the huge volume of tax-exempt bonds being issued by State and local public bodies.

At the same time, influences that may be entirely temporary cannot be ignored. Among these are the current distress of the "free riders," the hesitancy of the big investors, and the necessity of corporations, individuals, and local governments to carry through with financing for which plans were already made. It is very possible that these temporary influences are of sufficient weight to have caused the drop in price of the new Treasury issue. If this is true, then it may be only a short