Speech

EFFECT OF HOUSING FINANCE ON FEDERAL RESERVE POLICIES STATEMENT PREPARED BY MARRINER S. ECCLES, MEMBER OF BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM, AT REQUEST OF SENATOR J. WILLIAM FULBRIGHT, OF ARKANSAS, AND PLACED IN CONGRESSIONAL RECORD OF MARCH 15, 1950 Under Title III of Senate Bill 2246—the Hous­ able market than the obligations of other Govern­ ing Act of 1950—the obligations which would be ment corporations, such as Federal Land Banks, issued by the proposed National Mortgage Corpo­ which are not protected in the same manner, and ration for Housing Cooperatives would compete would be in effect the same as guaranteed Govern­ directly with Government securities in the money ment securities. The competition which would market. They would be purchased largely by arise in the market between Government securities banks and other investors, which otherwise would and obligations of the Corporation would, there­ probably hold Government securities. As a result, fore, be very direct. Most of the buyers of the either the Federal Reserve would have to purchase debentures would be banks, institutions, and other additional Government securities, thus creating investors that would probably otherwise hold Gov­ new bank reserves, or prices of Government securi­ ernment securities. ties would decline, i.e., interest rates would rise. As the bill stands, the Corporation would have a Although the protective aspects of the Corpora­ great deal of discretion about the gross interest rate tion’s obligations authorized by the bill are de­ to charge borrowers and the mortgage maturities signed to be similar to those of FHA mortgage to permit. The Corporation would probably be insurance, there are important differences between able to borrow at slightly above the long-term the two. Apart from the original capital of the Government rate, and the lowest gross rate to Corporation, the funds extended by the Corpora­ borrowers might be little over 3 per cent, although tion would be private funds, but the ultimate it would have the authority to charge higher rates lender, i.e., the purchaser of the debenture, is more and build up reserves. On the other hand, by adequately protected against difficulties and risk of issuing short-term debentures, the Corporation loss than is the mortgagee or holder of an FHA- might get its money as low as 1 1/4 or 1 1/2 per cent, insured mortgage. If the Corporation defaults on which might permit a gross rate much lower than a debenture, it itself makes the exchange for a 3 per cent. guaranteed debenture, whereas if an FHA mort­ If the Corporation were to obtain funds for long­ gagor defaults on his mortgage, FHA makes the term mortgage lending by borrowing substantial exchange of the mortgage for a guaranteed deben­ amounts on short-term obligations, it would not ture after the mortgagee has foreclosed and ob­ only run the risk of adverse market fluctuations, but tained title to the property. It would be reasonable it would in all likelihood obtain these short-term to expect, moreover, that the Corporation would funds largely from expansion of bank credit. This have less occasion to issue guaranteed debentures could be undesirable in a period when general credit because, while FHA issues guaranteed debentures policy was directed toward limiting expansion of for every individual mortgage which is foreclosed, bank credit. the Corporation would not have to issue guaranteed In view of the safeguards with respect to capital debentures in exchange for its other debentures of the Corporation and insurance reserves against until a very large proportion of its mortgages had the debentures included in the law, it is unnecessary gone bad and its capital, surplus, and reserves had to add the undesirable feature of what is in effect been impaired to a point where the Corporation a direct Government guarantee of the debentures. could not meet its obligations. The Corporation should be able to borrow on terms For these reasons and because of the other safe­ just as favorable as the Federal Land Banks and guards, the Corporation’s debentures issued to the Home Loan Banks, which now have no such obtain new funds should have an even more favor­ guarantee. The debentures then would be more [1] Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis EFFECT OF HOUSING FINANCE ON FEDERAL RESERVE POLICIES truly of the nature of private obligations and com­ Subcommittee report pointed out,1 “the essential pete less directly with Government securities. characteristic of a monetary policy that will promote The practice of issuing securities guaranteed by general economic stability is its timely flexibility.” the Federal Government was abandoned many But Federal Reserve policies cannot be varied in years ago because such issues came to be viewed response to changing needs without affecting in­ as practically the same as direct Government obli­ terest rates. For the Federal Reserve to endeavor to gations and were an indirect means of keeping the maintain a rigid level of interest rates would mean expenditures out of the budget. Issuance of guar­ supplying all credit demands in time of expansion anteed obligations has the same effect as an increase and absorbing all of the unused supply of credit in the public debt. Investors buying the new secu­ in times of contracting demands. Such policies rities might sell direct obligations of the Govern­ would tend to create instability, because they would ment. Either the prices of Government securities tend to reinforce both the expansion and the con­ would fall and interest rates rise or the Federal traction phases of economic fluctuation. Reserve would have to support the market by buy­ Another general point which should be kept in ing securities, thus creating bank reserves. mind is that there are many interest rates which Action by the Federal Reserve of this nature reflect, on the one hand, varying degrees of risk might at times be inconsistent with major aims and and liquidity involved in different obligations and, statutory obligations of the Federal Reserve. An ex­ on the other hand, the supplies of funds that may cellent description of the appropriate aims and pro­ be seeking relative safety and liquidity at the sac­ cedures of Federal Reserve policies is given in a rifice of higher return or vice versa. For example, recent report of the Subcommittee on Monetary, the Treasury can borrow at between 1 and 1 1/4 per Credit, and Fiscal Policies of the Joint Committee cent on short-term obligations and at less than 2 1/2 on the Economic Report, after conducting a com­ per cent on long-term bonds, while business bor­ prehensive inquiry under the Chairmanship of Sen­ rowers at banks pay from 1 1/2 to more than 6 per ator Douglas. This description may be sum­ cent, depending on the size and risk of the loan, marized and paraphrased approximately as follows: and consumer loans carry higher interest charges. The role of the Federal Reserve in our economy These differences in the structure of interest rates is to supply the banking system with adequate must be taken into consideration in the determina­ lending power to support a growing and relatively tion of Federal Reserve policies. stable economy and to exercise restraint upon exces­ What bearing do these observations have on sive credit expansion that will lead to instability. housing finance and housing legislation? An impor­ This task has been made exceptionally difficult by tant aspect of most of the housing legislation of the the tremendous wartime growth of the public debt, past two decades has been to make it possible for the pervasive distribution of Government securities among many holders, and the tendency of these lenders to tap money markets at lower rates of in­ holders to view their securities as liquid assets read­ terest and on more favorable terms than were pre­ ily convertible into money to be spent or otherwise viously available. These were and are, on the invested. Attempts to sell these securities, unless whole, desirable aims, as institutional arrangements buyers are readily available, tend to lower their in the mortgage market have had much need for prices, which means a rise in interest rates. In the improvement. Particularly during periods of de­ absence of a demand by other investors, declining pression and substantial unemployment it was most prices can be prevented only by Federal Reserve helpful to facilitate the flow of available investable purchases. But any expansion of Federal Reserve funds into the mortgage market at reduced rates of credit has the effect of supplying banks with addi­ interest. It is quite another matter, however, to tional reserve funds, on the basis of which the bank­ adopte measures which will lead to the creation of ing system by lending or investing and relending new money to finance construction at a time when can expand bank credit, and the volume of money, activity is already fully utilizing available supplies by many times the amount of the reserves supplied. This process of monetary inflation can be 'some­ 1 “Monetary, Credit, and Fiscal Policies”, Report of the Subcommittee on Monetary, Credit, and Fiscal Policies of what restrained by limiting Federal Reserve pur­ the Joint Committee on the Economic Report, January 23, chases of Government securities. As the Douglas 1950, p. 19. [2] Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis EFFECT OF HOUSING FINANCE ON FEDERAL RESERVE POLICIES of material and labor and prices are higher than a by the Federal Reserve. In the case of the first large portion of potential buyers can afford. alternative, the benefits of lower interest rates ex­ The aim of many of the measures adopted and pected by the sponsors of the measures to provide proposed has been to lower the cost of housing by cheaper housing would not be fully realized and, obtaining low interest rates on mortgages—an im­ in addition, all other Government securities would portant cost of home ownership. This is generally decline in price. In the latter case the inflationary done by attaching some sort of Government insur­ policies might result in higher prices. Whether ance or guarantee to the mortgages or to the obliga­ such a result ensues depends upon the general tions of mortgage lending agencies or by providing economic situation at the time. facilities for increasing their liquidity. One result It is because of these possible consequences that is that these obligations can tap sources of lendable the Federal Reserve has a particular interest in funds that would otherwise not have been available housing finance and in the various legislative pro­ to them. The lower rates and increased availability prosals that have been made. Their effects on the of funds tends to stimulate borrowing. economy, and perhaps their success in accomplish­ Obligations guaranteed or insured by the Federal ing their objectives, will in the final analysis in­ Government are to a considerable degree competi­ fluence, or be influenced by, Federal Reserve tive with Government securities; therefore an in­ policies. crease in such obligations is likely to result in a While the monetary consequences of financing decline in prices of Government bonds, i.e., a rise in the amount of debentures proposed under the interest rates. In the absence of a large unused present bill might be slight, the principle, however, supply of loanable funds in that sector of the mar­ is one which, if adopted in a moderate amount for ket, the only way a general rise in interest rates one purpose, might well be extended in magnitude could be avoided would be by Federal Reserve and scope. It is difficult to provide special privi­ purchases of Government securities, which would leges to one group and deny them to others. This mean the creation of new money. principle, if widely adopted, could unduly stimulate Thus the issuance of additional amounts of obli­ housing construction at lowered interest costs and gations directly or indirectly guaranteed by the eventually undermine the values of existing houses Federal Government would have the effect either and of mortgages outstanding against them. It of depressing the prices of Government securities would be at first an inflationary factor and ulti­ or of requiring creation of supplies of new money mately lead to a deflation of values. I 3 ] Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis

Marriner S. Eccles (1950, March 14). Speech. Speeches, Federal Reserve. https://whenthefedspeaks.com/doc/speech_19500315_eccles

@misc{wtfs_speech_19500315_eccles,
  author = {Marriner S. Eccles},
  title = {Speech},
  year = {1950},
  month = {Mar},
  howpublished = {Speeches, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/speech_19500315_eccles},
  note = {Retrieved via When the Fed Speaks corpus}
}