what the Federal Housing Administration takes into account when it determines its financial position by comparing estimated reserve requirements with actual reserves. Specifically, the 15th Annual Report of the Housing and Home Finance Agency states, "Since the incidence of an economic reversal cannot readily be predicted, the most conservative basis for reserve valuations for such future losses and expenses is to assume that adverse economic conditions of approximately depression magnitude might develop immediately. The reserve valuations are designed to measure the liability as the result of the development of such a contingency." On this basis, the Mutual Mortgage Insurance Fund, the oldest account in the Federal Housing Administration's books and one that is largely unencumbered by special programs, did not overcome a deficiency in its reserves (actual insurance reserves minus estimated reserve requirements) until 1954, 20 years after it was established. Subsequently, the rate of new insurance written exceeded the rate of accumulation of reserves and a deficiency again appeared in this account in 1959. As of June 30, 1961, FHA reported a $27 million deficiency, or less than 4 percent of the estimated reserve requirements of this account. More to the point, however, actual reserves, including participating reserves available for this fund, equaled 3.26 percent of the outstanding balance of insurance in force.

These figures do not imply an inadequate reserve or poor financial condition on the part of the Federal Housing Administration. They simply provide an estimate of requirements under the worst possible set of conditions and one basis for evaluating the financial feasibility of the proposed insurance corporations. Assuming that the private insurance corporations would also provide protection against a major collapse, is a minimum level of reserves equal to 5 percent of the unpaid principal outstanding adequate? On face value, this requirements would appear to exceed the standard being used by FHA. However, inclusion of intrests and closing costs in the insurance corporations' contingent liabilities would reduce their actual reserve ratios to levels more nearly equal to those attained by FHA. Despite this similarity, there are market differences that should provoke concern over the feasibility of a 5-percent reserve ratio.

The Federal Housing Administration has several strong points that are not available to a private corporation nor evident in the proposed legislation. First, FHA is a Federal agency with 30 years' experience. Presumably, it would be supported by the Treasury if events became so catastrophic that its reserves proved to be inadequate. Second, FHA meets its immediate liabilitiess by payment in long-term debentures which provide a period of 20 years in which to market the properties and recover any losses sustained. In the interim, it would have to meet only administrative expenses and interest on its debentures. Experience of the Home Owners' Loan Corp. strongly suggests that under this arrangement the Federal Housing Administration could work its way ou of a serious depression situation.

The proposed insurance corporations would, on the other hand, be required to meet their obligations immediately in cash. Properties recovered and liquid assets held would have to be disposed of in distressed markets. The strain would obviously be severe, enough so to doubt the efficacy of a 5-percent reserve base. Third, FHA began its operations at a highly propitious time, at the depth of a real estate depression. For nearly 30 years FHA has enjoyed the built-in protection of a growing demand for housing and an inflating price level. The proposed mortgage insurance corporations, on the other hand, would begin their operations at the time when the market for residential mortgages has shown some signs of faltering and is certainly somewhere along the upside of the real estate cycle.

Of course, reserves could be built up more rapidly by charging premiums substantially higher than FHA and retaining profits-assuming no serious decline occurs in the first 20 years. The statute is flexible on this point, requiring only that "adequate" premiums be established. But, this flexibility can create several complicating problems. First, the insurance corporations may be unwilling or unable to charge a premium large enough to provide the necessary protection. Second, success in accumulating a significant volume of reserves would be under persistent fire of stockholders and users of the insured mortgages to reduce premiums. FHA has already withstood one such endeavor to reduce its premiums. Third, insurance corporations may set different premium levels, thereby adding another set of compartments to the market and another variable to the calculus of selecting investment alternatives. Finally, FHA experience

clearly indicates that the private corporations would have to charge premiums substantially higher than those now charged by FHA. Of course, any premium in excess of the FHA premium would reduce the anticipated benefits of a resale market for mortgages. Borrowing costs would inevitably be higher and institutional investors may remain partial to FHA or existing conventional mortgages. Indeed, high premiums would threaten the success of the entire formula. The foregoing analysis may be construed as speculation, because there are no private insurance firms providing 100 percent insurance for residential mortgages. To do so, however, one must ignore the fateful history of private mortgage guarantee and insurance corporations of the twenties and the failure of mortgage insurance, like any insurance against economic decline, to meet the conditions necessary for determining risk on an actuarially predictable basis.

It may be argued that the private mortgage insurance corporations are not designed to insure against the business cycle, that they are instead designed to insure against moderate fluctuations within the cycle, or variable economic fluctuations within geographic areas of the United States. However, this position raises questions concerning the need for private insurance corporations. Large institutional lenders can, in effect, protect themselves against these less drastic reversals by diversification within their mortgage portfolio and diversification between investments in mortgages and other alternatives. Smaller lenders could be protected through FHA or through some form of portfolio insurance, rather than by creating new submarkets to further hamper the development of the resale market. In any event, to hold that the insurance corporations do not pretend to insure against major declines would undermine their ability to attract institutional investors to the 90 percent conventional mortgage.

After tracing through the necessary analysis, it appears that there is a real need for changes in the organization of the mortgage market which would provide the efficiencies sought by the American Bankers Association. Yet, the plan does not seem to be capable of fulfilling this need. How, then, can a workable formula be devised?

Looking again at the existing market structure, one must wonder why a lowequity conventional loan and a private insurance arrangement is necessary. It appears that the ABA proposal would, in effect create a private insurance program analogous to FHA which would be supported by private marketing corporations analogous to Fannie Mae. The only reason one can find for duplicating these systems within an already complex market structure is a desire to make a low-equity conventional mortgage an attractive investment vehicle and a conclusion that there is no hope of overcoming the problems created by rigidity in the interest rates on FHA mortgages, congressional manipulation of Fannie Mae's activities, and the red tape that has long threatened the FHA program. Wouldn't it be infinitely more feasible to attack these and other faults in the structure of the existing market than to embark on uncharted waters with storm signals flying for all to see?

After all, recent years have not been totally without progress. The Federal Housing Administration is actively engaged in devising methods that would reduce the time and red tape involved in processing. Under recent legislation, the Housing Administrator has been adjusting the rates of federally insured mortgages to maintain a reasonably close approximation to actual competitive rates. All types of institutions are already permitted to hold the low-equity FHA mortgage that the housing market of the sixties will undoubtedly need. It would seem, therefore, that without any great changes FHA mortgagesbacked by the financial strength of the Federal Government-could gain wider investor favor.

Still, the problem of developing an adequate resale market for FHA mortgages remains. Here, again, the more difficult problem of affecting widespread reforms in the primary mortgage market rears its head. What seems to be most urgently needed is market determined rates or at least administrative flexibility in establishing the FHA interest rates, and greater uniformity in laws that exclude certain States from the national market and in laws that regulate institutional lending. It would appear that this is the only road to the development of a workable and adequately performing resale market for mortgages. If such a formula is too grandiose and, therefore, hopeless, so is the creation of an adequate resale market for mortgages.

Senator SPARKMAN. Mr. Norman P. Mason, housing consultant. Come around, Mr. Mason. We have had the privilege of having you before us on previous occasions. We welcome you back this morning. We have your paper. You proceed in your own way.

STATEMENT OF NORMAN P. MASON, HOUSING CONSULTANT Mr. MASON. Mr. Chairman, my name is Norman P. Mason. I have been before this committee before.

Currently I do not represent any organization or group. The opinions I have are my own, gained in 5 years as Commissioner of the Federal Housing Administration, 2 years as Administrator of the Housing and Home Finance Agency, and for the same period as Chairman of the Board of the Federal National Mortgage Association. My ideas, too, are the result of a lifetime in the housing industry, as a trustee and board member of a mutual savings bank, as an operator of a construction material business for 30 years. My whole business lifetime-over 50 years-has all been spent in the building industry. Today, perhaps I am a sort of self-appointed representative of the public, Mr. Chairman, not representing any particular group.

I believe that the Mortgage Market Facilities Act of 1963 (S. 810) represents a constructive step in the development of an efficient secondary market for conventional mortgages. While today the need for this may not seem pressing, I believe that it is a step which must be taken soon-should be now-to insure that home buyers may not be pinched when the need for housing expands as it surely will. I remember well testimony before this committee last spring by demographic experts pointing to the expected expansion in the number of our families here in the United States. Now is the time to get our house in order for this.

Let me say here and now that I, too, like others who have appeared before this committee, believe in a strong, helpful FHA and FNMA system, and I do not believe that the legislation proposed in S. 810 will impair either of these agencies. Actually, the creation of a market facility which serves some of the market that they now serve tends to keep an agency on its toes-responsive to the needs of homeowners. During my service as FHA Commissioner we were always aware of the Veterans' Administration loaning program and this kept all of us in FHA on our toes to try to give the home buyers equally good service. There is a place for both FHA and the proposed mortgage marketing and guaranteeing organization proposed in S. 810.

I believe that FHA and FNMA are meeting their obligations to the best of their ability. The officials of the executive departments of the Federal Government are charged with the responsibility within the framework of existing Government programs of maintaining a stable level of employment. These agencies are useful in fulfilling this obligation since housing is one of our major industries employing many workmen directly and in related industries.

I do not believe this Congress, responsive as it is to the will of the people of America, is ready to deprive the executive department of this tool.

In the case of the new organizations as proposed in S. 810, the industry will have, as it has always wanted, organizations which will operate as private industry does. They will have freedom to set interest rates in direct response to market forces-a proposal frequently sought by industry when I was FHA Commissioner. By making mortgages readily marketable they will expand the source of capital that can go into housing loans. Such legislation would permit some

lenders, particularly in the smaller cities, to serve their markets more effectively without the danger of freezing their assets or depriving other phases of the economy of needed capital.

I believe the proposals in S. 810 will be beneficial to the general homebuying public, to the building industry, to our financial system, to the whole of our economy.

This is a short statement for me to make before this committee, Senator Sparkman, in view of some others I have made from time to time. I would be very happy to answer any questions within the limited ability I may be able to.

Senator SPARKMAN. Well, it is brief, but it is quite full of substance and certainly to the point. We appreciate it very much.

You heard the questions I put to Mr. Neel regarding the FHA and FNMA and the housing policy of 1949, the proposal that private industry should do all it could; in other words, it should be encouraged to and urged to fill the housing needs insofar as practicable, but that the Government should not hesitate to step in into areas where private enterprise cannot fulfill the job.

You subscribe to that policy, do you not?

Mr. MASON. I subscribe to this very much. In fact, the reason I am here, really, is because this S. 810 is a proposal which gives private industry the chance to do this and to do ít responsively.

We have had various attempts made, back and before we had the enlightened housing legislation we have, which resulted in disasters for the housing industry, because we did not have responsible ethics in private industry to do this.

This legislation, with its Federal chartering, I believe gives private industry the ability to operate within an ethical pattern and to do a good job.

Senator SPARKMAN. I feel that that is true.

And, by the way, you bring out a point here that I think is quite pertinent, and that is with reference to the interest rate. I started to suggest to Mr. Neel a while ago when he was on the stand at one point that his organization and this committee used to argue for a good bit, was a flexible interest rate.

I remember back when Mr. Bill Clarke came up with the idea of a formula that might be written into the law that would allow the interest rate to change from time to time. I was always rather sympathetic with the idea for a flexible interest rate. And I can remember that the various organizations interested in homebuilding and home financing have, throughout the years, recommended a flexible interest rate. You make the point here that this would permit flexible interest

rates.

Mr. MASON. Yes, Senator Sparkman. You know and I know the pressures that have been existing for a long time, and probably with reason, for an interest rate which would properly reflect the marketability of the particular mortgage from the particular area.

We obtained a little of this flexibility by the means of discounts. These are very unex

Senator SPARKMAN. I still shudder at the sound of the word.

Mr. MASON. These were very unacceptable to Government, they are very unacceptable to lenders, or were at the start, certainly, and completely un-understandable to the average person in the public who has to pay them in the long run.

It seems to me that this private industry corporation would get away from all that so that the mortgages could be written to reflect the needed inerest rate to draw money to the particular part of the country.

Senator SPARKMAN. By the way, you were head of FHA, I believe, in 1954, when we changed FNMA, were you not?

Mr. MASON. I was Commissioner of FHA, acting from April to the end of August, and then was Commissioner from August on in 1954. Senator SPARKMAN. Yes. Do you remember when we changed the makeup of FNMA?

Mr. MASON. Yes; I do.

Senator SPARKMAN. And we provided that participants in its program would be required to purchase a certain amount of stock, depending upon the amount of participation. And the hope was that FNMA would have then become privately owned, insofar as this part of FNMA operations would be concerned.

Mr. MASON. Yes.

Senator SPARKMAN. Under this plan the secondary mortgage operation would eventually become privately owned.

Mr. MASON. Privately owned.

Senator SPARKMAN. Now let me ask you, we have had about 8 years of experience, nearly 9; we have got $90 million, I believe it is, of common stock that has been issued to private individuals. I believe the figure was given of $168 million, is that it, total of $168 million Treasury participations?

Mr. MASON. Preferred stock; yes.

Senator SPARKMAN. Preferred stock that would be required to be retired.

Well, with the progress that has been made, do you have any high hopes fo FNMA ever becoming wholly privately owned?

Mr. MASON. Well, Senator, when this change was made in the legislation, I felt it was a very wise one. I would say that people bought stock in FNMA reluctantly. I mean it was a sort of a forced operation.

Senator SPARKMAN. Yes; it was a forced operation.

Mr. MASON. Rather than one of great industry seeking to secure private ownership of the organization. I think it would be very desirable to have it privately owned. But it certainly is a way in the future yet.

Senator SPARKMAN. By the way, what is that stock selling for today?

Mr. MASON. Well, it keeps going up, Senator, all the time.

Senator SPARKMAN. It sold for a long time at 50 cents on the dollar, did it not?

Mr. MASON. When I was Chairman of the Board, it was around 50 or 55 to 60.

Senator SPARKMAN. Yes. And it seemed to be rather an unattractive investment.

Mr. MASON. Well, it was very interesting, Senator, because the people who had to buy it as a result of the legislation generally did not care to hold it, but a great many people felt that there was a potential, as there is in this organization for this stock sometime to become very valuable, and there was much debate back and forth on this question in investment circles.