to chairman eccles from j. if. daiger

I

TO Chairman Eccles

FROM J. If. Daiger

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

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MEMORANDUM OS TK£ CONSOLIDATED O U ROF LEGISLATIONPROPOSED BY THE

HOKI 01 X)AN CORPORATIONFEDERAL HOUSING AEMINlSTfUTION

The proposed amendments to the N&tionel Housing Act

the Home OfflMtrs Lorn Corporetion Act contained in the consolidated

f the legislation r.bove referred to, ere set forth in Sec-

tions 2 to 31 '"-nd Sections 32 to 42, respectively. The reat

rity of these r-endnents : re si -.r:ly technical or clarifying

in nature end require no detniled oonMiit*

lag up first the proposed cnend&ents to the National

Housing /ct, the following rre those which to some degree Involve

Bubst&ntiYe c a in the present Btetvtti

« Section 6 luthorizes the /dministrrtor to insurein excess of eighty percent (30*) upon

roperties i \ed at net sore tbaa forty-fivehundred doil »,;00) i nd constructed rfter

:u: vy 1, 1936 hnd before July .!, 1937.

se of thii-; esenebMttt is to tu '. Bible need

- tion of construction cf homes for the lower

M groups* This is tcco iplishsd \y enabling tl nirtretor

to reduce the amount of the twenty , ercent (20^) cash et uity now

to such extent ae Bay be i t with

ind Lending ".ice. To thi? end the eraendaent expressly provider

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% ^ that the Ada

•gage

^ure thr-t aaount by which tiu. bt exc?

.%) of the appro L iue of tfre property. la ,

persons pitta is are not in . c—

cu«ulata twenty percent (20%) of the cost o ae for the -a»n

.it although their general credit standing or other collateral

resources t>re JO secure tbt n«

Thi »ould enable the AdmLnisti

to establish re under vhic eac& case of this character

could be handled u us, thu ; worthy borro

Le to atet ireaienta except that of a twenty percent (2J%)

down •)•. , Lid homes, the cost of which i^ within the

.jpe of their prc ted income*

It is not intended that the amendment should entiiii the

uiarestrictec 3; but that in ev^ry case, the

soundness of the transaction sould be carefully scrutinized sad a

loan in excu . cent (30$>) would be approved only where

the borrower L ition to support the excess, either b.,

ting up securi w other additional collat-

eral, by obtaining th imit jr &v\r ntee of his note

other ftimnotallj responsible person, or by othenfise c L i

regulations designed to raeke the excess loan secure.


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lartg£~. that with which they B io

•nt.

-

July 1, 1937 wou- LL

progr&M ju that program in coauaencing to roai the init.

rgaoisation una become really

wo not 01 bjuc-

>r t hich Cont

ictf but to unc

by the Fee ing Aaainistra-Lion toward th

eat housing a conditic action on no

basis o£ the hoa^ mort, I country.

It should bev°^lIl1:'ed out that th lousing

AQMinistrution aebentures by the riment reprefceata only a con-

oiiity upon which thei *ood oi' th rn-

ever . .jntingent liability tccbnicaliy

2(1 Dy ths OUT. .inL cue on AV . ,-,*- j - •

voulci haT auae default* o.veciosureii on practic .y

hone in %he country and t LOHS oi .ue in fty

in orjier to arrii biiity

-ike the amount ] nt^ci by the outstandin

ts on insured mort.

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run try

Lnistr^tion,

It

~ng

td cjnt: o in-

volved it jvernaent iousing amiii ion

del

ction :^ion .by proviciin^ in

rryingwhich C 7t

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.

oDigitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

of low income ould be x>roperly handled through the insurance

feature of Title II, and the primary purpose of this amendment

. Ay to cover, in sufficient legal detail, the intention ex-

pressed by Congress in a condensed and general form in enacting

such section*

In only two respects of any importance does the amend

differ from the original Section 207. They are as folloi

(a) An insurance fund separate hrid distinct frcn theMutual Mortgage Insurance Fund Is 3et up forlarge mortgages upon low cost housing projects*

The National Housing Act created a system of mutual

mortgage insurance. Mutual insurance is in essence the grouping of

similar ris^s. There is no similarity of risk and hence no mutu-

ality between a $1,000,000, corporate mortgage • nd a $16,000 home

mortgage; yet these risk3 are grouped together in one fund as the

Act now stand3» The proposed amendment takes the large mortgages

out of the small mortgage fund. Thus a condition preventing true

mutuality among the small mortgages is removed and the original

intent of Congress as shown by the Committee Reports, can be

realized*

(b) Provision is made for the insurance of debenturupon assignment of the mortgage to the Adminis-trator after default instead of upon conveyanceof the property after foreclosure.

The wisdom of putting the Government in the business of

oDigitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

c .closing mortfages against home owners haa been seriously ques-

tioned. With this in mind the Congress authorized the payment of

mortgage insurance only after the mortgagee had completed foreclo-

sure against the home owner and was in possession of the property*

This method of settlement *;s the Act now stands also applies to

large corporate mortgages under Section 207, but the considerations

prompting this method of settlement obviously do not apply to large

corporate mortgages. There is no reason, therefore, why mortgage

insurance should not be paid upon assignment of the mortgage in the

case of corporate mortgages*

In addition, this mwthod arould induce private capital to

finance large-scale housing at lower interest rate3 because it as-

sures the certain end speedy collection of the insurance. The

certainty of the insurance improves the mortgage security and

lowers the money cost. Low money cost is vital in housing low in-

come groups. The government is lso better protected because it

>f the property more promptly and thus main-

i the project as a going concern, safeguarding earning power

ana rty values by eliminating the possibility of waste and

milking.

The proposed amendment also clarifies the Adminis-trator^ right to insure mortgages covering housingfor sale as well as for rent.

The statute as it now stands, leaves some doubt upon

thi t. Under the amendment, the Administrator i3 given the


t to supervise an operation leading to a result already easily

xble through indirect methods. For, even assuming thct the

trator may only insure mortgages covering housing for rentt

the mortgagor in a given ca3e may by the simple expedient of re-

financing the mortgage without the insurance, proceed to sell off

the property.

It is felt that under the amendment, wide use will be

made of the insured mortgage device in the development of new sub-

divisi- garden apartments. These developments, however, in

order to obtain mortgage insurance must be planned according to

sound reel e3tate and housing practices, and the limited dividend

corporations or other agencies, public or private, undertaking the

projects, must submit to strict supervision designed to protect the

3 the risk which the government assumes. In this

the unbridled speculative practices of the past may be largely

The proposed amendment to Section 207 does not change

the classification of eligible mortgagors; the size or chf- acter

of ell the character or Kind of eligiole proper-

ties or the premium rate for insurance. In short, the proposed

i3nt merely perfects & vehicle for carrying out a policy to

the Congress is already clearly committed.

8


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C ^ on th narrow spread, it is essential that the

volume o. which may be done by the association

increased as much ie.

In view of the safeguards thrown about the operations of

National Mortgage Associi tionst there is no reason why

to 1 ratio should be inherently any less sound than a

ratio -» For judging this matter Ln practice, the

only evidence available is tht-t presented by the op&rbti

of certain European and South American institutions o

ce. These have operated soundly and conserva-

tively over a period of many years with ratios as high

to 1 and without any guarantee of underlying collateral.

C , Since every issue of debeaturea must be approved b A.d-

aini3trator and the total amount of all such debentures mubt

be supported by an equivalent amount of insured mortgages,

cash, or government securities, it is difficult to understand

how the increase of this ratio froa 20 to 1 can be attacKed

an unsound financial practice»

The purpose of capital stock in an institution selling its

obligations to the public is to enable that institution to

absorb li . xined on account of assets held as co

lateral to its public obligations, £hen such collateral is

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restricted to cash, government securiti insured mort-

gages which are eventu& lly guaranteed by the government, no

severe losses on account of collateral can be sustained by

the association. Any losses actually sustained can, further-

more, be offset by earnings, A cushion represented b

talization of 1 to 20 represents tm adequate safeguard i

Xc l collateral which cannot be met out of operating

revenue.

5. Section 2$. amends Section f>136 of the revisedstatutes, as amended, by providing that nationalbanks may subscribe or invest not exceeding 6

rcent of their paid up net capital stocksurplus of national mortgage associations.

This power has already been conferred upon commercial

banks operating under state laws in thirty-six states, upon

savings banks in thirty states and upon trust companies in thirty-

seven states, as a result of amendments to their applicable laws

sed since the adoption of the National Housing Act. Bailees

have been the chief source of the funds advanced to date under

mortgages insured under Title II, and their relationship to the

entire insured mortgage program is perhaps more fundamentally im-

portant than that of any other class of private lending insti-

The purpose of the proposed amendment is 3imply to


coonlete the integration of the functions of national banks ami

the Federal Housing Administration of mortgage financing by-

according to national banks the right already possessed by sttte

banking institutions.

National banks corapris. e substantial portion of the

institutions already approved and active &3 mortgagees under

Title II and their direct interest in giving to Injured mort-

gages as high B degree of liquidity or shiftability as possible

obriouSf and national mortgage associations were provided ior

by Congress for this express purpose* It is felt, therefore,

that national mortgage associations in which national banks have a

financial interest would be assured the most competent end res-

ponsible management that it is possible to give theft*

In view of the close governmental supervision to which

both national banks and national mortgage associations &re sub-

ject by l&wf it Lfl submitted that the authorization of national

banks to invest in the stock of national mortgage associations

cannot be attacked as an unsound or unwise innovation in

banking and financial practice.

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With respect to the proposed aaencbneats to the Home

Owners Loan Corporation Aet0 we submit the following coamentsgl a Section 33 authorizes the Home Owners Loan Corporation

Mto sake loans to individuals to enable them to buildhomes after this Act takes effect,, or to buy homesbuilt after this Act takes effect, or to improve homes0Properties dealt with under this section should notexceed $59000 in value and shall be for the occupancyof the persons securing such loans Such loans shallnot exceed 20$ of the appraised value • . • . but maybe made as '. part of or subject to loans by other lenderson such prr ertieso* Th- terns and conditions underwhich such -cans are to be made are to be prescribed bythe corporation,, an* the corporation is authorized toexpend $200o00090C r the purposes of this sub-sectiono

To this proposal the Federal Housing Administration is in

opposition for the following reasons?

ao The Borne Owners Loan Corporation was created as an

emergency organization to perform a specific tasko This

task has been admirably perfomed and is essentially com-

plete If ever the government expects to withdraw from

this type of direct lending operation it should do so

nowo The effect of this proposed legislation would be

to perpetuate the Home Owners Loan Corporation organiza-

tion consisting of some 283 offices with Ht,rly 20,000

employees^ It would project a paternalistic form of

government financial practice indefinitely into the

futur*o

b9 The wording of the proposed legislation is so broad and

general that i t is difficult precisely to understand the

14


type of operations which would be authorized^ As

f drawn6 the language could certainly be interpreted

to include the making of direct loans by the govern-

ment for the purposes of modernizing and repairing

existing properties* This type of loan is now being

made by private financing insti tut Ions insured by the

Federal Housing Administration under Title Z of the

National Housing Aoto The average TOluae of loans

insured for this purpose during the past 6 months- has

been over $26,000^000 per month through more than 6v000

private financial institutions.,

oThe direct lending of government funds for this purpose

would be a serious duplication and create direct competi-

tion on the part of the government with these private

lending institutlonso This legislation proposes to put

the government Into business at a tine when many repre-

sentatives of the administration have been indicating that

every effort would be made to take the government out of

business and out of competition with private business

wherever possible, From a political point of view, thert-

fore» this would seem to be an unwise proposalo

There is nothing in the proposed legislation to indicate

the nature of the security to be taken on these loans or

whether any security would be required,. It may be assumed,

however, that some type of mortgage security such as a

15


second or junior mortgage would be required; If such

advances are made on mortgage security, some sort of

inspection and appraisal of the collateral would be

required: Without then the operations would be impose

sibly hazardouso If the loans were made in any con-

siderable volume, these operations would necessitate

the creation or retention of an organization large

enough to handle all these Inspections and appraisals.;

Such an organization would be exactly duplicating the

functions cf the Federal Housing Administration

The costs of making the necessary inspections and

appraisals would be the same as those involved in

making any mortgage loan on properties, and there

would be no source of Income to offset these cost«0

When the average size of these loans is considered the

costs of making them would certainly be exorbitant

All the operations wo#ld have to be carried out directly

with all expenses paid by the government In contrast,

the Federal Housing Administration carries on no direct

lending operations but utilizes 8,000 private Institutions

which absorb these expenses and enables the Federal Housing

Administration to maintain a low expense ratio

do If the purpose is to make second mortgages, we believe that

it represents unsound financing, the perpetuation by direct

government activity of one of the most iniquitous features

of home financing practice,, that the policy represented would

be diametrically opposed to one of the basic features of the

1*Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

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National Housing Act* and that as a precedent it would be difficult if

not impossible to discontinue this activity

If the government made a loan on a siortgage junior to a prior lien,

in case of default on the first mortgage it would either forfeit its

loan or would be obliged to assume the liability of the prior lien©

Aa sum ing an average advance of $lp000» or 20$ of ths appraised value

on a $59000 house, and an underlying mortgage of 70$ of $3,500, the

total arrant advanced and the total contingent liability of the

government would be approximately $9009000»000©

If the government abandoned its claim against the property in case

of default on the first lien, the advance of funds represents a bonus

on which government losses might b« very greato

fhe abandonment of these claims would result In the ho .der of the

first mortgage obtaining properties at a price which would represent

at least 20$ less than the total loans against the propertyo

Ho interest rates or other limitations are proposed In this legis-

lation0 It aay be assumed that the interest rate would not be in

excess of the 5$ now charged by the Home Owners loan Corporation

In many cases the interest rate on underlying mortgages would be in

excess of Sjto The government would thus be placed in the anomalous

position of guaranteeing in effect the first mortgage which bore a

higher interest rate than its secondo

TSven though the Act restricted the Interest rate on advances on

prior liens to say 4$e the advance of government funds on second

1?


mortgages would be tantamount to a guarantee of the prior lien and

would create a great deal of confusion with respect to the government

program in connection with the guarantee of mortgageso

The government would be placed in the ridiculous position of operating

tin programs of mortgage guaranteeB one of which required the payment

of a premium and the other did noto

The government is now authorised to subscribe to 78$ of the stock in

Federal Building and Loan Associations, This proposed legislation

would authorize the overanent to advance 20$ directly above mort-

gages made by the Nations o Of the total amount lent in such

an operation, gover onds would represent 76*2£ of the entire

loan. Thus of ever. advanced to the borrower, $752 would be

government funds-

This program would be in direct competition with that of national

bankSo state banks,, members of the Federal Reserve System, savings

banks» life insurance companies* and building and loan associations

which are cooperating in the program of the Federal Housing Adminis=

t rat ion Under this program private lending institutions have ad*

vanced during the past six months an average of over $2295000000

per inonth and have reached a level of $7&000a000 per week with a

present rate of increase of nearly $loOGOnQOO per week These

private lending institutions cannot compete with the kind of prograa

proposedo The effect, therefore, would be to drive these institu-

tions out of the type of operation now represented by the program

of the Federal Housing Administration,


c would be to give an unfair compe-

titive advantage to the building and loen associations in

connection with their mortgage lending operations.

Federal fa g end loan associations can no» lend up to 75%

of the value of the property without mortgage insurance. If

a 20% loan is obtained under the proposed program, the tot

amount borrowed would represent 95% of the value of the property•

State building and lo< jciations can lend up to 66 or 67%;

and thus a borrower could secure through ,hem and through

the government loan up to 86 or 87% of the value of the property.

But national banksf state banks, members of the Federal Re-

serve System and life insurance companies are limited to

£ Ioan3 of 50 to 60% on uninsured mortgages> This amount

loan of government funds constitutes considerably leas

than the percentage of property value which can be covered

by lotus from Federal and other types of building and loan

associations under .graau

The program would be exceedingly difficult to administer in

3uch a way as not to exoose both the government and borrowers

to extraordinary risk due to shoddy construction, ov g$

I construction costs, and all the other bed practices

which are associated with second mortgage lending* In the

ograia of the Federal Housing Administration provision is

19


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made and an organization in trained to enforce regulations

designed for the protection of both borrowers and lenders

against these practices.

h* The proposal, though made as a temporary or emergency measure*

would have the effect of confirming private lending institu-

tions in the ancient practice of lending only $0% or 63% of

the value of the property on first iieaa. The government

would be in a position of perpetuating mortgage practices by

lending institutions which would encourage and almost compel

the use of secondary financing. This type of financing prac~

tice was vigorously condemned by the Chairman of the Home

Loan Bank Board in his testimony before the Senate Banking aad

Currency Committee in May 1934 i& the following words*

"But so far as it is humanly possible la the futureto eliminate secondary financing of that characterit ought to be done. It hf_s been done in othercountries to a Yery large extent end there is noreason why it cannot be done here."

i» It is doubtful whether the proposed program would result, as

suggested, la the stimulation of construetion# It ls more

likely that it would result in merely changing the channels

through which funds are made available for construction* .'-

Khile these funds are now coining from private sources in an

increasing volume, the effect of this proposal would be to

substitute government funds on second mortgage and reduce

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;rtg&ge.

^tive of the pur-

ch ce or the cost c tyf on a loan, a private

fin 3 ti tut ion and the borrower himself would xititurally

prefer & rtgage . -vermaent second mortgage to

! \% first mortgage from a private lender.

connection with every home under

$5, Ln con, • Ication would be made for

government loan.. The J00 fund would thus probably

be cfaickly ui in connection wi+h projects which will un-

doubtedly proceed ttitfoaut such fin&ncing, end additional funds

would be required to continue the program.

jo in sumiaary no proposal could be made th&t would

re successfully defeat many of the major objectives of the

->£ram of the Federal Housing Administration.

Section 3U authorizes tlie Home Owners Loan Corpora-tion to expend $3,000,000 "to promote cooperativethrift and home building, to assist in the rehabil-itation of mortgage lending institutions and gener-ally aid Ln the development of a sound home buildingand home ownership program throughout the UnitedStates."

It is difficult to foraul&te a precise judgment with

ect to thi 8 of the general term3 in v/hicht

the legislation is drawn. Inso rposes of this

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legislation are tp enable the corporatLon to 3 the est -

iish&ent ana development of federal saYin loan associations

we feel that it :3.

Th? , •. certai . .. dearth rids available for in-

vestment in Mortgage any gener icing facilities

tliroughout t r•.-..: > 8 whole. If 11 mcaded that there

^hich fundk are able, Feder 1

Sav.L ^Bpfiiationa can be created ;itted

case »ut thi liture 0J«

The Federal ,

of festively promoting the organisation of acrdi-

tional Federj ,, ociatio:_-. During a period in

Wiiic _ ' •. • | une

Reconstructio ^ieral Housing Adainis-• * ' •

tration hive bei , , interest rates, many of these

Federal ing high rates*

notwithstt- - i ent funds may be invested in

these institu >ereent of their total

Alt the*-general policy of the Administration ss

est; . . ,1 Housing Act is to insure mortgages upX

to 80 jereeni -. s of the property, these associfctioas

.fc io ijZed to aake loans in excess of 75 percent.


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Thi3 could be accomplished by amendment of charters by the Federal

Home Loan Bank Board, but this Board has never takaa any action

in that direction..

While the type of function performed by both the Federal

and non-Federal Savings end Loan Associations is recognized by

the Federal Housing Administration &s important, at th<5 same time

it must be remembered that both theoe of institutions, ac-

cording to estimates by the Federal Home Loan Bank Board, hold

only approximately 23 percent of the home mortgages of the country.

We do not see the wisdo® of the government*s expending $3,000,000

in tha rehabilitation of this type of institution and in the es-

tablisliiaent of additional Federal associations*

Inioff-r as the purpose* of this amendment are nto aid

in the development of a sound home building and home ownership

program" it obviously duplicates almost verbatim the functions

of the Federal Housing Administration provided in the National

Housing Act- It would seem undesirable for the government to

duplicate the expenditures and organization to accomplish these

identical purposes*

3° Sectior 42 provides for the establishment of aNational Housing Corsaission.

On this we are for the most part neutral. Attention

is called to the fact, however, that there exists at the present

time a Senate Committee and a President's Commission established


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for the purpose of studying the methods of coordinating activities

In the Executive Departments of the government. Vie assume that

these committees will study the problem of coordinating housing

agenciesu It seems a duplication of the functions of these cc

mittess to establishment of a National Housing Coa-

aiscv; in thi3 drafto

re, furthermore, that the establishment of such

oi} can ba accomplished by Executive Order or by a

Senate or Hours resolution without the formality of legislation.

The Federal Housing Administrationi, however, would support legis-

lation designed to establish a Housing Coordination Board con-

sisting of the heads of housing agencies, with power to take such

action aj they deem advisable to consolidate all the housing ac-

tivities of the government under such agency or agencies as

ded advisable«


to chairman eccles from j. if. daiger

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