time before the flurry is over and the 34-percent Treasury rate is firmly established as a going rate or better.

When that does occur, the 42-percent insured-guaranteed mortgage rates should also prove reasonably marketable. It should be noted, however, that the spread between a basic 34-percent and a 42-percent mortgage rate is not as favorable for mortgage financing as the spread between around 22 percent and 4 percent that prevailed a few years ago. Unless there are new influences in the picture that did not exist then, it would be unlikely that the present relationship between the two rates would be such as to put FHA and VA loans in quite as attractive positions as once prevailed. At best, therefore, the market may still be relatively tight.

Will a tight money policy be continued?

Although it appears that the present money market may be tighter than the Treasury had planned for, the fact remains that, for the time being, tight money is quite compatible with current administration policy. The administration is consciously using debt management as one of the means for restraining a level of activity which it considers to threaten another inflationary push.

With automobilies, appliances, factories, commercial buildings, houses, public works all being produced in large volume, the idea of a little restraint now to prevent a sharp drop later is not indefensible. So long as the Treasury and the Federal Reserve are convinced that the wind is blowing from the side of inflation, they will try to protect the economy from that direction. When they are conscious of a shift to the other side, there are a number of actions that can be taken: Greater willingness to finance the debt through the banking system, less concern with attracting long-term investors, lowering of the Federal Reserve discount rate, lowering of member-bank reserve requirements, support of the bond market by Reserve-bank purchases, tax reduction.

As long, however, as business is as good as it is now, such actions are not likely to be taken. This is one way of saying that money is likely to stay hard to get until some of the demand for it slackens off.

The outlook for building

What has the tight money policy meant to building? So far it may have reduced the rate at which construction activity might otherwise have expanded, but it certainly has not reduced the volume of activity in comparison with past years.

The total amount of construction during the first third of the year was nearly 6 percent more than in the first third of 1952—a rise that was shared in by all types of private and public building except industrial, hospital, farm, publichousing, and conservation projects. Life-insurance companies were investing as much money in mortgage loans as they were a year ago, and savings and loan associations considerably more. Even residential building, which has been affected by the interest-rate problem more than any other kind of construction, has been going ahead at an average annual rate of about 1,170,000 new family units.

In other words, so far there has been enough money to assure another topvolume year. The outlook is that there will continue to be. Demand also appears to be so strong that construction borrowers will be willing to pay what it takes to keep up with last year's record. NORMAN P. MASON,

Chairman, Construction and Civic Development, Department Committee. Mr. NEEL. There are also one or two other items I would like to insert in the record as a matter of giving the committee a chance for examination. I do not have a copy for each committee member, but I have a sample letter which I will put in the record, addressed to the members of our association, to show you the kind of work we have been doing in this field with reference to educating our members about this whole program and trying to put in the record things that have been happening under the program. It is a copy of a letter which the president of our association addressed to the membership shortly after the May 18 directive came out, dated May 23, which I would like to offer.

(The letter above referred to is as follows:)

LETTER TO MEMBERS OF THE MORTGAGE BANKERS ASSOCIATION OF AMERICA, CHICAGO, ILL.

No. 27-53
Issued May 23, 1953.

DEAR MEMBER: A long and difficult struggle on the part of our association has at last culminated in Government action to increase interest rates in FHA and GI mortgages.

Everyone in our industry knows of the large backlog of loans made at former rates but not yet placed and the desperate effort being made to place such loans. We also are well aware of the fact that investors have heavy outstanding advance commitments for closed as well as unclosed loans. Many of the latter have been committed for on a discount basis but subject to the effective interest rates at time of closing.

Many investors in the face of this situation are deferring announcements of policy with respect to price on mortgages carrying the new rate until the market becomes more settled. Some, of course, have sought to continue as long as possible the purchase of loans at heavy discounts.

While these facts are well known to us, they are not generally understood. The public, veterans, and even many of us erroneoulsy assumed that the rate adjustment was all that was needed to immediately restore the market to a healthy condition and prices to par. Acting on that false conclusion, some builders have pressed for immediate resumption of production at previous levels and some originators have jumped the gun with a renewed high volume of offerings in an apparent competitive effort to meet the builders' demands.

As a result, if the present tendencies of the mortgage bankers are pursued, we will very shortly find ourselves at the place where we came in. We will further

burden and glut an already demoralized market before it has a chance to recover. The evils of the discount system which we have fought so hard are likely to remain with us as long as we continue to invite them to do so. An institutional investor even though opposed to the discount practice and willing to pay par cannot announce such a policy in the face of continued voluntary offerings at a discount. There are several such investors to my personal knowledge who are faced with this problem today.

We have often said, “There is nothing wrong with the GI loan that a 41⁄2 percent, rate will not cure." We can now say, "There is nothing wrong with the FHA and GI loan markets that a reasonable amount of self-imposed individual and collective discipline will not cure.'

We as mortgage bankers, builders, and investors, together have an obligation now to the veteran which in all good faith must be kept. Compliance with the recommendation regarding the interest rate in which all of us have joined has been granted although it was certainly ill-advisedly delayed. The new VA schedule of fees and charges which has followed the interest rate adjustment prohibits all discounts and contemplates a par market, except to the extent that the primary lender is willing to forego expressly approved compensation for his services.

Any primary lender who attempts now to continue to maintain previous levels of business by resorting to the discount system or unrealistic service fees at the expense of further market demoralization is following a short-sighted policy. Under these circumstances we may hardly expect soon to have a sound program which will function to the advantage of the veteran or nonveteran home buyer. As responsible mortgage bankers we should all welcome the new VA rules and regulations which clearly define the limits of the collection of fees and charges and thus eliminate the previous questionable heavy discount practices. In attempting to operate under the new rules and at the new rates however, we should nevertheless take a firm position with respect to our own requirements just as the VA has done in commenting upon its schedule of maximum fees and charges as set forth in its bulletin of May 18. The thought expressed in the following paragraph from this bulletin of the VA is especially worth reading:

"It is recognized as being entirely possible particularly in the unsettled immediate condition of the loan market, that a particular builder or project may have difficulty in going forward under the tightened rules. It is hoped that this condition will prove of short duration and that their ultimate ability to obtain par marketings of GI loans will improve rapidly as a consequence of the firming effect of the new rules. But if the disability is of long duration in the case of specific builders, projects, or localities, it must be recognized that the

law contemplates, in directing that appropriate limits be prescribed, that those who cannot operate within those limits are thereby barred."

In making that statement VA officials doubtless realize, but if not, they are likely soon to do so, that the rate adjustment was too long delayed. It came at a time when there was a heavy backlog of loan offerings and at the beginning of the spring building season. Furthermore, it would be quite clear to all that the monetary and fiscal policy of the Government at present, as well as the trend of the general market for competitive high grade securities is such as will likely continue for at least some months to come to put pressure on any fixed interest rate for mortgages. The failure of only one or two operators in any given area to follow prudent policy can now easily demoralize the market for that area and one section of the country, as we know by recent experience, can upset the apple cart for the country as a whole.

Nevertheless, if we take a sound and firm position at this time, and particularly if both primary and secondary lenders assume their share of the responsibility to see that the program works, it seems to me that what we are now witnessing is not without promise and that when the disruptive events in the money market settle down, as they will in my opinion within a reasonable period, we may all look forward to a creditable, if somewhat curtailed, volume of FHA and VA mortgage lending at or very close to par in most sections of the country.

Very sincerely yours,

MORTGAGE BANKERS ASSOCIATION OF AMERICA,
BROWN L. WHATLEY, President.

Mr. NEEL. There are some papers which Mr. Colean and myself and Mr. Robert Morgan on behalf of the association presented to the American Legion Housing Committee when they were considering in a conference with the VA the interest rate, which I would also like to offer for the record-an article prepared by Mr. Colean, who is an economist dealing in housing matters employed by the association as an economic consultant, discussing the question of why, in our opinion, what he calls "rigid interest rates" won't work. Particularly it has reference to the VA loan rates. It is a reprint of an article which appeared in House & Home magazine. (The matter above referred to is as follows:)

[From the magazine of building-House & Home, March 1952]

RIGID INTEREST RATES WON'T WORK-HOW LONG MUST THE GOVERNMENT'S PRESENT CHEAP MONEY POLICY FAIL BEFORE WE REALIZE THAT NO ONE BUT THE VETERAN STANDS TO LOSE BY IT?

(By Economist Miles L. Colean)

The only way to assure that a mortgage system will work is to provide it with a market rate of interest. Yet as the Government gets itself deeper and deeper into the mortgage business the idea grows that

1. Mortgage interest rates can be set by law at a level thought beneficial to special groups of borrowers and

2. Lenders ought to adhere to the prescribed rate as a matter of social obligation without reference to the state of the money market. (Note: this point of view ignores the obligation the lending institution has to people whose funds it handles.)

Because veterans deserve special consideration, Government sets special interest rates for guaranteed loans to veterans.

Because cooperatives ought to be encouraged, Government makes special rates for FHA insured loans for cooperative housings.

Because defense workers shouldn't pay high rates, Government sets special rates for their loans.

These "becauses" may be worthy, but they don't influence the market one iota. What is the result of rigid interest rates?

It took years to learn the answer because for a long time the conflict between these welfare concepts and market concepts was concealed by the Government's cheap money policy which forced the whole structure of interest rates down. The special rates were low but not below the market rate of interest. Since

1946, however, market rates have gradually risen until the fixed rates are no longer attractive in the market.

The veterans' guaranteed loan unquestionably has a lot to recommend it: The investor faces practically no risk.

He need not be concerned with waste.

In case of foreclosure he collects promptly, in cash.

Naturally these guarantees add up to a lower interest rate than would accrue to ordinary loans. But that's not the whole story. It doesn't mean that a rate which satisfied the market yesterday will satisfy it forever. This holds true of all types of investment: Government bonds, for instance (if investors are to hold on to the ones they own and buy more).

What a flexible rate does

Short of setting up a politico-economic dictatorship, there's only one way to decide who's going to get the money and at what rates. That is, let borrowers bid for a share of the invariably limited funds available. Even a dictator would think twice before he fixed rates for one class of loan and left the rest to compete freely. If he were to guess wrong and fix too low a rate, his protected loans would just starve for funds and higher bidders would get the money. To offset this there are two avenues open: (1) allow the rates to move or (2) support a fixed rate by pouring in Government credit. To do the second of these in a time of deficit financing is to pave the way to dangerous inflation.

How the rigid rate started and where it went

Deep-seated though the fixed interest idea seems, it is new. A maximum rate was put into the FHA Act merely to prevent usury. Even so, some FHA originators thought it a mistake to mention interest rates at all, felt that the market and State usury laws were safeguards enough. The rate for the first FHA loans -5 percent plus 2 percent mortgage insurance, plus 2 percent annual service charge, making an effective rate of 6 percent-was fixed only after a careful check of the market. This proved satisfactory in spite of tight money conditions still prevalent at the end of 1934. But after that FHA activity reflected the gradual decline of the whole structure of rates. First, competition for loans drove out the special annual service charge.

Then lenders began to pay premiums for FHA loans.

Here was an unexpected development: the premium rate rarely went to the actual borrower. The builder might get it from the bank or mortgage company to which he brought the business. Or the original lender got it from another bank or insurance company to which he sold the loan. The borrower generally paid the prescribed 5 percent interest. What this meant was that the FHA maximum interest rate was not actually above the market rate. So FHA authorities pulled the maximum down to 41⁄2 percent.

Many people still think homeowners could have obtained lower rates on FHA loans if there'd beeen no maximum. Their argument: the stated rate made it easier to persuade the borrower to pay the full rate, no matter what. Their evidence: rates on uninsured loans did move down with the market, created no premium problem.

FHA followed the market

FHA revised its rate only when it was inescapably clear that the market had changed. It didn't try to lead or coerce the market, nor claim sanctity for particular rates. Following this principle, it later lowered the rate to 44 percent. And its announced policy still is that it will reverse itself whenever it is convinced that the facts call for change.

VA rate not intended to be untouchable

Probably the same sort of thinking applied when the veterans' guaranteed loan system was set up. But the 4 percent maximum was so low in the easy money days of 1944 it was doubtful that it would turn out to be a going rate. However, as long as the Federal Reserve Board arbitrarily maintained a low yield on Government bonds, the 4 percent VA rate remained relatively popular. But even in active times, the 4 percent rate proved vulnerable. In the first place substantial premiums didn't develop (as they had with FHA). And, in 1948 there was a rapid shift from guaranteed VA mortgages to investments that yielded more although the general interest rate structure rose only slightly. The shift was so decisive that in Autust 1948 Congress authorized VA, with the

concurrence of the Treasury, to up its maximum rate to 42 percent. What Congress evidently had in mind was to keep the VA guaranteed loan in competition with other investments in a tighter money market. Clearly it took the view that the rate was not untouchable.

But the rate was not changed. Trouble began to mount as VA loans continued a drug on the market. To cope with it: In October 1949 the power of FNMA to buy VA loans was greatly liberalized so that 4-percent money would be channeled through private hands.

In April 1950 Congress went further still, authorized the VA to make loans directly at 4 percent where private money had not been made available.

Now for the first time, the dogma of the sanctity of the 4-percent rate was enunciated; and the facts of mortgage financing ceased to be considered.

The rigid rate theory breaks down

Liberal operation of FNMA coupled with the Federal Reserve Board's 1949 resumption of an easy money policy and the scare buying caused by the Korean crisis quieted the interest rate problem during the lush year 1950.

Finally, in the teeth of inflationary excesses, FRB faced up to the situation with its historic money-tightening action of March 4, 1951. Result: the flow of funds for VA loans not already committed upon was reduced to a trickle. At the time it was widely thought that when the shock was over and the huge volume of outstanding commitments had been "digested," the rapid accumulation of new savings would cause lenders again to seek VA loans at the 4-percent rate. During the late summer of 1951, yields on long-term Government and corporate bonds slowly declined, giving some hope for this solution. By mid-October, however, the bond trend had once more swung upward and at the year's end new highs were reached.

Even credit restrictions failed to lower the demand for mortgage money for conventional loans and the volume of industry loans exceeded anticipations. Borrowers needed more money than lenders had to give them.

A new factor promised to keep demands of corporate borrowers at a high level: the excess-profits tax.

What the tax does to the money market

1. It absorbs earnings that would otherwise go into capital expansion (ordinarily earnings are used more than borrowings for this purpose).

2. It makes new equity financing impracticable.

3. It actually makes borrowing profitable for firms in the excess-profits category. It follows that a larger share of corporate financing in 1952 will probably be done by borrowing than has been the case in previous years. Nor will the borrowers be deterred by a high rate, as recent corporate issues carrying interest as high as 34 percent indicate.

VA refuses to face facts

In the face of this situation, all that VA did was to protest the advantages of its system (about which few would argue) and insist that consequently 4 percent was a proper rate to which the market did not respond. Hope that conditions would ease grew dimmer. The future of a privately financed VA program depended on the dubious chance of its conforming to market conditions that grew steadily more adverse.

It's the veterans who lose

Veterans are promised the benefits of low downpayments, long amortization periods and a specially favorable interest rate, but the promise is illusory unless the benefits are available at all times. If the officially established rate is so rigid that it prevents the system from working when money is tight, he gains nothing. The veteran (unlike other borrowers) becomes the victim if the deprivations of the counter-inflationary policy fall disproportionately on his shoulders. No one but the veteran loses by the present policy. The lender has no trouble making loans to higher bidders. The builder is still able to sell all the houses for which he can get the necessary materials.

But the veteran is not permitted to obtain the VA advantages promised him by paying one-fourth to one-half percent more than the present rate of interest (about 14 to 27 cents per $1,000 per month). Instead he must make both the higher downpayment required in the conventional market and also pay 5 percent interest or higher. A similar situation is dogging the financing of the FHA rigid 44 percent mortgage in defense areas.

35186-53