My final comment on the housing bill relates to title 6 and, more particularly, to section 603 wherein the Home Owners Loan Act of 1933 was amended. The amendments proposed by section 603 are the result of a long, tedious process of discussion and compromise between the interests of the administration, of certain Members of Congress, and of the savings and loan business. In these discussions, Congressman Gordon McDonough has played an important and valuable role, and the savings and loan industry and the Government owes Congressman McDonough much commendation for his patient work.

Section 603 is an excellent example of how reconciliation of the various interests of the business and of the Nation can be effected. Here the broad powers granted to the Home Loan Bank Board are spelled out in statutory form and at the same time the supervisory effectiveness of the Board is tremendously increased. The provisions of 603 give the Board for the first time a law of misdemeanor and a method of enforcing it. For too long the Home Loan Bank Board has been confronted with the awesome choice of either using a conservator to enforce its actions or of doing nothing. By the provisions of this section, the Board is, in effect, given the power to issue cease-and-desist orders after compliance with the necessary requirements of proper administrative proceedings and, in addition, is given resort to the judicial processes for the enforcement of such orders. This fills a tremendous void in the previous processes of the Board. On the other hand, however, by writing into the statute inhibitions on the use of this power and by spelling out the grounds on which conservators may be appointed, guaranties are given to the industry against arbitrary use of this enhanced power.

Mr. WELLMAN. Mr. Chairman, my remarks are directed principally concerning title I of the bill and more specifically to those provisions of title I which make substantial changes in what we term the title II, section 203, FHA loan, with the provisions of title III respecting the reorganization of the Federal National Mortgage Association and the provisions of title VI respecting the allocation of power into the Home Loan Bank Board respecting conservatorship.

There seems no question and no disagreement among all of the parties interested in this bill that title I makes substantial liberalization of the previous existing FHA title II, section 203, loan. I think Mr. T. B. King, of the Veterans' Administration, testified before this committee to the effect that these amendments would place the nonveteran in virtually the equal position respecting housing credit terms. Of course, beyond that solid point of agreement, we branch off into various disagreements that run all the way from how the FHA should be organized down through whether the President should have the various powers granted to change term and raise or lower amounts, to questions of political and economical philosophies, as to whether this bill is a step toward or a step away from private enterprise.

It seems to me, however, that the basic element of the bill and the key to reconciling these various differences of opinion is found in the validity of the FHA insurance fund itself.

Under the mutual mortgage insurance fund, to the extent that it is able to absorb the losses that are taken or would be taken, the FHA is a self-supporting operation; to the extent that the insurance fund is inadequate to cover any such losses, the FHA is not a self-supporting operation.

One of the first studies that I have seen done on the adequacy of the FHA insurance fund is found in the appendix 7, I believe it is, of the President's Advisory Committee, where the FHA made such an analysis of the adequacy of its insurance fund on section 203 in the light of certain basic assumptions, and this study revealed that the insurance

fund in terms of the portfolio that existed as of June 30, 1953, was from $70 to $100 million short of being an adequate amount.

The fund at the present time amounts, as I believe, to approximately 12 percent insurance coverage against total outstanding portfolio and the recommended increase would bring it to approximately 22 percent. However, evaluating a risk and a portfolio is not merely a matter of what the risks are at any given time. It depends on two additional elements: 1 is the volume of new mortgages that you write and 2, the risk characteristics of those new mortgages.

If you have a portfolio that is just being amortized out, your risk position is obviously decreasing. On the other hand, if you were to double your portfolio in 1 year you would be increasing your risk and more particularly would you increase it if the type of loan, new loan that you were making, represented a substantial increase in the risk. Now, I think that the provisions of title I, the liberalizing provisions respecting loan amount and extension of amortization period represent substantial increases in risk. For instance, if you were to take the assumptions that the FHA study makes on the adequacy of its present insurance, and take the loan currently permitted under regulations, which would be on a $12,000 property, $9,600 loan, and write it for a 20-year term, you would have a gross risk of loss of approximately $379. If you, on the other hand, were to increase that loan amount on that same $12,000 property, to the maximum permitted under this bill, to $10,600, you would have raised your loan amount about 10.86 percent, but you would have increased the amount of your possible risk by over 47 percent; if you assume a foreclosure within 3 years from the inception of the loan of the magnitude that has been assumed by the FHA in making its analysis for the President's Advisory Committee. If you were to simultaneously extend that increased loan-that $10,600 loan-an additional 5 years, to, say, 25-year term, you would increase that risk still further-that amount of risk of loss to approximately 60 percent.

So the provisions of the bill do have a substantial effect on the adequacy of an insurance fund which already is admittedly inadequate. Now, the problem, of course, is what do you do about that, and it seems to me that we are not confronted because of these facts with throwing the FHA insurance out the window or admitting it is a subsidized system. I think we can take certain corrective steps.

First of all, I would respectfully suggest that the committee, in the drafting of this bill, accept the recommendation of the President's Advisory Committee and instruct the Housing and Home Finance Agency to prepare and report back to the Congress an independent objective study of the possible foreclosure and loss experience of the FHA portfolio. Even the committee itself, although the FHA study was admirable, admitted it was just a beginning, and certainly if we are going to evaluate these programs we should have some concept as to the losses that might well be involved.

The second possible solution to some of these problems would be to get away from the idea that we have to always charge a half of 1 percent premium. If you are a corporation of a certain credit risk, you can borrow money at a certain rate, if you are rated a single "A" corporation you borrow money at a certain rate. If you are a little better, you can get a double "A" rating and get the money cheaper.

On the other hand, if you are triple "A," you are in the big league and get your money lower than anyone else can get it. I can see no reason why if a half of 1 percent insurance premium rate is an adequate insurance rate for the existing FHA loan plan, and if these extensions are granted, which admittedly increase the possibility of risk of loss we should hold the same insurance premium rate. If we were to increase the risk 50 percent, we should correspondingly increase the insurance rate 50 percent, which would have the effect of raising the premium rate on that type of loan from a half of 1 percent to three-quarters of 1 percent.

In other words. I think there is certainly no magic in a half of 1 percent insurance premium, and that our objective should be to develop flexibility in the operation of the FHA, not with the objective of eliminating the FHA, because I don't think anyone in the United States would disagree that the FHA has made a substantial contribution to the condition of housing and to the construction of mortgage credit, but we certainly should not keep ourselves in the rut of thinking a half of 1 percent is totally inadequate.

The second major problem that the FHA itself raises is that it insures the lender practically against any kind of loss. The result of that insurance is that the FHA of necessity has to take over the underwriting job because it is taking all the risk. It has to evaluate the desirability of each individual loan. It certainly cannot permit the individual lenders, against loss of which it is going to provide insurance. It can't allow that individual lender to perform that function. It has to perform that function itself.

Now, the result of that, of course, is that you get a highly centralized type of mortgage credit structure, and the more liberal you make that FHA loan plan the greater will be the use of that facility and the more centralized will be the direction of your mortgage lending.

One of the great virtues of a private mortgage system is that individual lenders have their prejudices and their opinions, because this is a business of prejudice and opinion. We might as well not kid ourselves on that. There are differences of opinion as to what is a good loan, what is a good borrower, what is the right kind of property; if the FHA is going to do all the underwriting, then the FHA's opinions and prejudices-and I say that without any criticism of the FHA-their opinions and prejudices as to what is a good borrower, what is a good property, what is a good loan amount are going to dominate the mortgage structure credit of the United States. It is almost inevitable. I am sure that many Congressmen as well as many individual lenders have heard lots of complaints about low FHA valuations, unrealistic minimum property requirements, and cumbersome processing procedures. Some of them are justified, some of them are not justified, but basically a good part of those complaints come out of trying to have a national mortgage system that applies throughout all the 48 States and the Territories, covering all these various types of mortgage and risk situations, out of 1 central office. Here, again, we are confronted with the same kind of a problem, what do we do about it? Again, I feel that we are too prone to think in terms of what we did in 1934. We put 100 percent insurance plan in 1934 because the economy was flat on its back and it was the only way you could get mortgage credit into the home-building and home

financing business, but this is 1954. Do we actually need in all classes and in all types of residential mortgages 100 percent insurance? Is there no way we can develop a system where individual lenders assume a part of the risk? If the individual lenders would assume part of the risk, the trend and tendency toward centralization of the mortgage structure would be dissipated.

I think the FHA itself has part of the answer in title I plan on property improvement loans. Here the FHA insures a percentage of a portfolio. It does not insure each individual loan. Hence, it does not have to determine the desirability of each individual loan. By insuring a percentage of the portfolio, it throws the burden upon the individual lender to perform his classic function of determining among competing potential borrowers who is a good borrower, what is a good property, and what is a proper loan. Here again I think the FHA should examine and explore the possibilities of having different types of insurance plans, certainly under section 220 and 221 of the bill you are going to have 100 percent insurance, but in the run-of-the-mill garden variety single-family residences well located with a person purchaser, I certainly don't think we need 100 percent insurance and if we could get away from that concept we could interject flexibility, mobility into our lending structure.

So far as title III of the proposed bill is concerned, dealing with the Federal National Mortgage Association, there are three basic functions as you gentlemen are probably more aware of than am I, the special assistance function, the liquidating and management function of the existing "Fannie May" portfolio, and, of course, the third function, the so-called secondary market operation.

Basically, in my opinion, there is no reason for the elaborate procedure for converting "Fannie May" into this private corporation, if the only objectives were special assistance and the management in the liquidation of the existing "Fannie May" portfolio.

The validity of this change, this conversion of stock, surplus undivided earnings, etc., into capital stock, is justifiable only insofar as section 304 of the bill is going to work. If section 304 does not work, then there certainly is no reason for going through this elaborate conversion process. As a matter of fact, it might be better not to, for the surplus and undistributed earnings of "Fannie May" instead of then being in stock could be kept as reserves and undistributed earnings to absorb any losses that might be suffered by "Fannie May" in the subsequent liquidation of its existing portfolio, so the changes of title III in my opinion stand or fall on this secondary market operation.

The secondary market operation is something there has been a lot of conversation about, every time the mortgage market gets tight the conversation gets more aggressive and when the market gets easier the conversation on the mortgage gets to die down.

The two critical problems of the secondary market are: One, problem for membership in the vicinity, and second, it will operate on the purchase principle. Raising these two points I am, of course, assuming although I understand the home builders are not in complete agreement with me on this, that this is to be a genuine secondary market operation, not to be an investment holding company for the purpose of buying mortgages and holding them for any period of time. It is a genuine secondary market operation.

The problem of incentive of membership is a very complex one. We can't have compulsory membership like we have with the Federal Reserve System or as we have with the Federal Home Loan Bank System. We can't gear the stock requirement purchases to size, or assets. So because of those problems we have had to resort to this 3-percent discount, or stock purchase certificate plan.

In other words, the problem is, who is going to be a member of this corporation; who is going to want to be a member? What is the incentive for membership? Personally, I don't feel there will be an incentive for membership, because subsection (b) of section 304 provides that these mortgages are going to have to be purchased at or below current market price, which, of course, is going to be a little difficult to decide sometimes, but if the mortgages are purchased in accordance with the statutory standard, and then you tack on to that a 3-percent, or even a 2-percent additional discount in the form of a stock purchase plan, I think you practically eliminate the possibility of any incentive for anyone to be a member of it, but beyond that, you have, I think, an even more basic problem and that is the problem that unlike any other secondary operation, where a corporation is compelled to borrow the funds that it is going to use, you have a facility that is going to purchase assets. Now, when the Federal home-loan bank borrows money to lend to its members, it lends those funds. It thus distributes the risk between itself as the facility, and the individual borrowing member, but when you have a "Fannie May" it is not going to do that. "Fannie May" is going to go buy the mortgages, the individual seller of those mortgages is through with the transaction. He has no further connection with it, and the risk of price rises or falls have no concern of his.

The result, in my opinion, is that we have a very unique kind of an animal here no secondary mortgage corporation in Europe to my knowledge has ever engaged in the purchase of principal. All of these corporations have operated on the lending principle and I personally would rather see the "Fannie May" used as a lending operation. It could operate on a warehousing basis, where it was warehousing mortgages, not for the 5-, 6-month period that is normally permitted to your commercial banks, but it could warehouse mortgages for an 18month or 2-year period, lending funds on the collateral of those mortgages, which would obviate this problem of having the facility take all of the risk of market changes.

If it worked on that principle and if it charged a legitimate fee for its operations, as any warehousing lender does, it could then in effect build its own capital. It could then operate as does the Home Loan Bank System, in the short end of the market, for borrowing its funds, and in fact, it could legitimately require that the servicing fee normally permitted a lender on a long-term permanent sale of onehalf of 1 percent be reduced to, say, a quarter of a percent because the facility is being operated for the benefit of the seller, who in this case would be merely a borrower.

I make these suggestions only to open up other possibilities, to this matter of how to handle the secondary market, because I think it is of great importance that any secondary market operation be conducted in a sound manner, and that failure to conduct it on that kind of a basis would do no good to the private lenders or to the Government.