A MORE EFFECTIVE MORTGAGE INSURANCE SYSTEM

MILES L. COLEAN, Economic Consultant, Washington, D. C. This paper is directed to the following specific questions assigned

to me:

In what ways could the programs administered by the Federal Housing Administration, the Veterans' Administration, and the Federal National Mortgage Association be supplemented or modified to increase and to improve the distribution of the pool of credit available for new residential construction? What can be expected from Federal Housing Administration's certified agency program as a factor to change the size and distribution of this pool of credit?

The phrasing of these questions suggests that the volume of credit for new residential construction is considered to be inadequate and that improvements are felt to be needed in the distribution of whatever volume of credit may be available. These suppositions are difficult to prove or to disprove with any finality.

My view is that, aside from artificial impediments to the flow of funds, which will be discussed later on, and possibly from certain institutional deficiencies, the residential mortgage market during the time since World War II has not on the whole been badly served. At the same time, I believe it may be safely asserted that there is something to be desired in the manner in which mortgage funds are distributed both by locality and in point of time.

I. THE QUESTION OF ADEQUACY

The flow of funds for residential mortgages, compared with that for other forms of private debt investment, gives at least some measure of the adequacy of the supply of funds for this type of financing. Except for a dip during the depression years 1929 to 1933, the proportion of total private, long-term debt represented by nonfarm residential mortgages has steadily risen from 28.3 percent in 1929 to 48.9 percent in 1957, the debt on 1- to 4-family structures accounting for the bulk of the increase (see table 109). During that period the increase in the dollar volume of outstanding residential mortgage debt was $96.4 billion (387 percent), while the outstanding volume of other private long-term debt increased only $63.7 billion (101 percent). As of the end of 1957, the outstanding volume of all residential mortgage debt was $121.3 billion; of home mortgage debt, $107.6 billion; and all other private debt, $126.9 billion.

Whether or not this dramatic increase in investment in residential mortgages to the huge present total provided an "adequate" supply in some abstract sense is a matter of subjective judgment on which I shall not venture an opinion. It is clearly evident, however, that from the point of view of effectively obtaining an increasingly dominant share of the funds available for all types of private long-term invest

ment, the mortgage market has fared very well indeed. There may in fact be some basis for arguing that, because of the special competitive advantages that Government has given the mortgage market, other claimants for long-term funds have been unduly stinted in the availability of funds for their purposes.

The importance of Government action in giving residential mortgages their paramount place in the market is unquestionable. The Home Owners Loan Corporation played a crucial part in stopping a 4-year decline in residential mortgage debt and in bringing about an upturn in 1933. In the years from 1934 to 1941 the insured mortgage system of the Federal Housing Administration was influential in bringing about a gradual improvement of the position of residential debt and of maintaining its level and further improving its relative status during the war years. The most spectacular shifts in the dollar volume and the relative position of residential debt, however, came in the postwar period, following the creation of the home loan guaranty system of the Veterans' Administration.

In 1945, before the VA operation had got well underway, the outstanding amount of insured and guaranteed mortgages was $4.3 billion and comprised only 23.1 percent of all residential mortgage debt. By 1957 the outstanding volume was $47.2 billion and the proportion had increased to 43.8 percent. (See table 110.) The dollar volume of noninsured, nonguaranteed residential mortgages also had a substantial growth during the postwar period, from $14.3 billion in 1945 to $60.4 billion in 1957, but its growth was far less spectacular than that in the Government-sponsored area.

In view of these developments, a case can be made that residential mortgage financing, whether or not made under Government auspices, has obtained during the postwar period, if not an "adequate,” certainly a preeminent share of the total available supply of long-term funds. If the volume of mortgage funds is not adequate, the lack, on the face of it, is not due to any inability on the part of mortgage financing to capture an increasing share in the total, but rather a shortage in the total supply itself.

The possible means, if any, that might be developed for increasing the total supply of long-term funds is a subject beyond the scope of this paper. It is enough to note here that, in the long run, the size of the supply of such funds is limited by the savings of the people. An invocation of money magic in an effort to augment the funds that can be obtained through true savings produces the illusion rather than the reality of greater availability, for all such efforts get down merely to an increase in bank credit, a device that may be used only to a limited degree without risking an inflationary increase in the money supply. At several times during the postwar years, magical formulas, such as the pegging of Government bond prices and the pouring of Treasury funds into the Federal National Mortgage Association, have been used in the effort to find a substitute for savings; and the results have contributed to the considerable loss in the value of the dollar during the periods affected.

Actually, the great increase in the dollar amount of home financing (and perhaps to some degree also in its proportion to the total of private investment) is much affected by the postwar inflation, which produced a 41.4 percent rise in residential building costs between 1945

and 1957 (see table 111). The Federal Home Loan Bank Board estimates that at least 20 percent of the outstanding amount of home mortgage debt in 1957 resulted from inflation above average dollar values in the years 1947-49 (see table 112). Since the Board's constant dollar figures are adjusted on the basis of the Consumer Price Index rather than on that of building and land costs, they unquestionably understate the true extent of the inflation.

It also appears to have been sometimes supposed that the supply of funds for residential mortgages can be increased in times of a general shortage of investment funds by liberalizing the terms of borrowing. Such revisions in terms on section 203 mortgages were made, for example, in December 1956, March 1957, and August 1957. Contrary to this view, such actions only increase the pressure of demand without in any way affecting the supply, and contribute in this way to the increase in the cost of money and the inflation of land prices and construction costs.

In summary it may be concluded that, during the postwar period, residential mortgage finance has achieved a predominant position in relation to total private long-term debt, and that this result has been in considerable degree due to the activities of Government-sponsored agencies. It also seems fair to conclude that efforts to reach this goal have at times resulted in overstimulus of demand and resort to an expansion of credit in excess of savings that have added their weight to the inflationary pressures present during most of the period. It is hard to see how the share of the total volume of available funds going to residential mortgages could have been increased much, if any, without seriously infringing upon the claims of other areas of long-term investment.

II. THE QUESTION OF DISTRIBUTION

While it is difficult, if not impossible, to show that, taking the postwar period as a whole, residential mortgage financing has been a badly favored sector of the long-term investment market, there is evidence that the flow of home-mortgage funds has been seriously interrupted from time to time and that some parts of the country and some types of communities have had more difficulty than others in obtaining ready access to mortgage funds.

In an economy as dynamic as ours, an economy offering as wide a variety of investment outlets as ours, and one in which the competing demands for funds may sometimes shift with considerable rapidity and for reasons often difficult to explain, it is to be expected that the year-to-year flow of funds to any particular area of investment will exhibit some variability.

Considering, moreover, the differences in the rates of growth of the several regions of the country, the frequent lack of correspondence between the areas of capital accumulation and those of capital demand, and the varying costs of doing business even within short distances from the seat of operations, it is not surprising to find that some communities have more ready and ample access to funds than do others. Although, in an imperfect world, the existence of the kinds of variations described above is not surprising, and although to some extent they may be unavoidable, it is not to be contended that they are intrinsically desirable. Consequently, there should be wide agreement

that the elimination of avoidable variations in the flow of investment funds is a valid objective of public policy. Over the past quarter century, the Federal Government has directed much effort to this end. It is quite clear, however, that, while Government has obviously had a considerable degree of success in its effort to direct to residential financing an increasingly large share of the total fund of savings, it has, with some notable exceptions, been less successful in equalizing the distribution of funds from year to year, from region to region, and from community to community.

The exceptions may be noted first. Outstanding among them is the effect of mortgage insurance. The achievement of a broader geographic and social distribution of the funds potentially available for residential mortgage financing was outstanding among the purposes of the originators of the FHA mortgage-insurance system. They sought to accomplish this by providing a recognizable standard measure of mortgage security, by increasing permissive loan-to-value ratios and maturities, and by creating a self-supporting means of pooling the major part of the risks of the transaction, whether the risks were inherent in the very nature of the business or were related to the hazards produced by State foreclosure legislation and the liberality of the mortgage terms.

To a remarkable extent, the effort was successful. In the course of time, the FHA insured mortgage was generally accepted as a standard piece of paper that could be confidently and freely traded in with minor regard to State lines and State statutes. Institutions that had not previously been active in home finances became so, and a nationwide mortgage market came into being. For the first time funds from the areas of capital concentration became widely available for home mortgages in areas with insufficient local funds. In the process, regional differentials in interest rates were substantially diminished.

These trends were greatly accelerted following the introduction in 1944 of the home-loan guaranty plan of the Veterans' Administration, which further liberalized mortgage terms for the large class of home borrowers with which it dealt and decreased the risk to which the lender was exposed. As already noted, a spectacular increase in the volume of home-mortgage investment ensued, and this volume was generously spread throughout the Nation. The ratio to the total of FHA and VA mortgages made in each State when compared with the growth of population per State as a percent of total population growth since 1945, as a crude measure of geographic distribution (see table 113), shows that the rapidly growing and usually under-capitaled areas have been the special beneficiaries of these programs. further indication of the broad geographical distribution that has been obtained is the popularity of these mortgages with life insurance companies, which are the principal investors in the national market and which have given overwhelming preference to insured and guarantied home mortgages over conventional written home mortgages. (See table 114.) To a degree, the same is true of mutual savings banks, some of which have become important participants in the national market for FHA and VA mortgages.

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A greater problem than broad geographic coverage has been the distribution of funds to nonmetropolitan communities. Quite generally the smaller towns of the country have limited local sources of mort

gage funds and their ability to obtain mortgage money from the outside is adversely affected by the cost and trouble, both to the governmental agencies and to the private institutions, of handling business in these communities. On the part of the Government directly, a solution has been attempted by authorizing the Veterans' Administration itself to make loans in remote areas. A notable effort to channel private mortgage funds into remote localities has been that conducted during recent years by private lending institutions, with Government auspices, under the name of the voluntary home mortgage credit program. For reasons that will be discussed later, neither program has provided a satisfactory answer to the problem.'

The most serious problem in the distribution of funds for FHA and VA mortgages, however, are not those just discussed. A much graver and more far-reaching difficulty exists in the distribution of mortgage funds from time to time than it does from place to place. Yearto-year variations in the availability of FHA and VA money, and hence in the resulting volume of activity, are characterized by violence and wide amplitude. Taking the two operations together (and not taking into account the buildup period prior to 1948), the number of private houses started under the FHA and VA programs has varied in a single year as much as 46 percent on the upside and more than 40 percent on the downside. In the VA program alone, where the variations were the greater, an annual increase of as much as 96 percent and a decrease of 53 percent have been experienced. (See table 115.) If the number of completed loan transactions is considered, the violence of the fluctuations is almost as great. Annual changes in the number of mortgages guaranteed by VA have ranged from an increase of about 80 percent to a decrease of nearly 40 percent and, of mortgages insured by FHA, from an increase of 43 percent to a decrease of nearly 26 percent. (See table 116.) Still another measure of the fluctuation is that of the annual dollar volume of FHA and VA mortgages acquired by life insurance companies. Again taking the two activities together, the range in volume has been from a year's increase of nearly 64 percent to a year's decline of 45 percent. If the VA volume is taken separately, the fluctuation is spectacularly greater-from 616 percent up to nearly 67 percent down. (See table 117.)

The range of these fluctuations makes that part of housebuilding that depends on FHA and VA financing one of the most volatile elements in the entire economy. In fact practically the whole of the variability in housebuilding activity is associated with the ebb and flow and ebb of funds for FHA and VA mortgages. It will be noted that this volatility is not characteristic of conventional financing, which throughout the period since 1950 (which includes the troubled time of the Korean war) has provided the solid base for housebuilding year in and year out with a stability in striking contrast to the undependability of the Government-sponsored home-credit programs. The most extreme variations in conventionally financed starts since 1948 have been 28.4 percent up in 1950 (the year of the pre-Korean rush) and 8.3 percent down in 1951 (the year of regulation X). (See table 115.) Otherwise the range of year-to-year change has been less than 10 percent on the upside and 7 percent on the downside.

1 Comment on the certified agency program, instituted by FHA in October 1957 for the purpose of facilitating FHA activity in noninetropolitan areas, will be found in the latter part of this paper.

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