BANKING ACT OF 1935

TUESDAY, APRIL 2, 1935

IN THE HOUSE OF REPRESENTATIVES,
COMMITTEE ON BANKING AND CURRENCY,

Washington, D. C.

The committee met at 10:30 a. m., Hon. Henry B. Steagall (chairman) presiding.

The CHAIRMAN. Gentlemen, we have Mr. Franklin W. Fort, former Congressman from New Jersey. I am sure that the members of the committee know him. He has come to discuss this bill. We are glad to have you do so, Mr. Fort, and you may proceed in your own way, without interruption, until such time as you desire to be interrogated.

STATEMENT OF FRANKLIN W. FORT, FORMER REPRESENTATIVE IN CONGRESS FROM NEW JERSEY, AND FORMER CHAIRMAN OF THE FEDERAL HOME LOAN BANK BOARD

Mr. FORT. Gentlemen, I have tried to analyze this bill from the standpoint of a practical banker, which is one of my occupations. As a banker, I have had some practical experience which may be of some value to you. The bank of which I am president, for instance, advertised, in 1932, our willingness to lend money; and if necessary, to borrow it for the purpose of relending, and did borrow to relend, right through the depression, and showed the borrowings in our statement without detriment to our standing with our depositors.

Then in December 1934, we reduced the rate of interest on all types of loans, mortgages, collateral loans, and discounts so that no loan pays over 5 percent, where the borrower has recognized his honorable obligation during the depression even though unable to make substantial payments. I mention these things because I shall refer to the results of both of these policies later.

Mr. REILLY. What is the name of your bank? Mr. FORT. The Lincoln National Bank at Newark, N. J. There are 2 or 3 phases of this bill, gentlemen, on which I do want to comment-2 or 3 major phases, and some minor ones.

In the first place, my service on the Federal Home Loan Bank Board, of which I had the privilege of being chairman at its inception, substantially modified my views as to what constituted sound mortgage lending.

I have always believed, and still do believe that mortgages are probably the safest form of long-term investment of money. I have grave doubts, however, as to the wisdom of a straight mortgage under any circumstances by any type of lender. Indeed, since the depression, I am convinced that nothing but amortization mortgages should be made by any lender, unless it is distinctly upon the understanding that the mortgage is to be paid off in full at an early maturity, if it is a straight mortgage.

Then I do not believe that liberal mortgage loans are in the interest of either the borrower or the lender. There are few communities in the United States today where the tax rate is as low as $3 on the hundred.

Let us take the provision of this bill, and for the moment overlook the 75 percent provision that you may loan 60 percent of the value of the property. A tax rate as low as $3 on the hundred constitutes a fixed charge for the owner to meet of 5 percent on the mortgage. Nowhere can he get a mortgage at less than 5 percent interest; and in many of the communities where the interest is rate is 12 percent.

Consequently, the minimum fixed charge between taxes and interest on 60 percent of the value of the mortgage is 10 percent on the mortgage-5 percent on the mortgage for taxes and 5 percent for interest; and in many of the communities where the interest is higher and taxes are higher, it can run up practically to 20 percent of the mortgage without difficulty.

There is no property in the United States which can stand that fixed charge, unless it is a speculative proposition which is chiefly unimproved real estate, and you are not dealing with that type of loan here.

Now, in the second place, the depression has shown, as I have said before, absolutely, that there must be amortization of mortgages.

Your bill contemplates, in its 75-percent provisions, a maximum of 20 years for the amortization, which is 5 percent of the mortgage as an annual amortization charge.

If you add that 5-percent amortization to the 5-percent tax minimum and 5-percent interest minimum-if you are going to lend 60 percent of the value of the property, you are putting 15 percent of that mortgage, or 9 percent of the property value, as an annual charge against the borrower before maintenance and upkeep charges, and there are mighty few properties in the United States which can stand that charge these days. I do not believe it is in the interest of borrowers to encourage that type of lending.

We have recently had a survey in New Jersey by the building and loan associations of the whole problem of mortgage lending, in which they have recommended, in spite of their old policies, a limitation on the amount of loans for building and loan associations to a maximum of 60 percent, even on their method of amortization, which allows a share in the profits back to the borrower.

Mr. Ford. What is that method like; how long does it run? Mr. FORT. About 12 years, with a share of the profits back, in our State, rather than the direct-reduction mortgage method, although they have recommended changing to the direct-reduction method rather than profit-sharing.

They have further recommended another requirement: That the owner must have a substantial equity. In other words, they have looked ahead to the point of opposing first-mortgage loans where the owner has a substantial second mortgage, because the depression has taught them convincingly that it is not in the interest of either the borrower or lender to make too liberal mortgage loans and to cut into the equity of the borrower too greatly.

Now, let us take the situation, if you start even with the 60-percentloan provision, a man can budget the 60-percent loan for its first year or two; that is to say, he can figure that, at the end of a year, if he holds his job and holds his health, he is going to be able to meet the requirements of that mortgage for a year, or possibly he can see 2 years ahead, but that is the limit that he can possibly foresee.

Now, let us suppose that he loses his job, or is ill, or for any other reason gets behind the first year. As I pointed out, the minimum fixed charge for taxes and interest is 10 percent of the mortgage. You have increased the mortgage in a little over 1 year of bad luck from a 60-percent mortgage to a 70-percent mortgage; and at 70 percent a conservative lender must foreclose, because the auction-sale value of real estate is very rarely over 70 percent of its normal value. Consequently, if you start at 60 percent, you are definitely letting your borrower put his neck in the noose.

I think you should start at 50 percent, as the present law is. We all know that banks have had trouble enough in this depression with frozen loans on real estate. I think you should start at the 50-percent rate, but I would favor a provision that permitted the banks to recast their loans upward as far as 60 percent, to save foreclosure.

That is to say, a man that starts at 50 percent may lose his job, he may get in bad health, and the lender must foreclose, if he is behind 1 year. I would like to see a provision that a bank might, at the end of a year, turn in and lend him more money, or increase that mortgage up to 60 percent, and then carry him, give him a chance to come back, not foreclose on him, and not force additional costs on him. But you cannot do this on top of a loan which starts on the 60-percent basis, because that makes your loan too high.

In other words, your lending limit ought never to be at a point beyond which you cannot go in order to save foreclosure; but, if you start at 60 percent, you are rendering foreclosure compulsory in many cases.

I want to emphasize again that what I am urging is in the distinct interest of the borrower, because the lender will still be paid if he forecloses when the loan.reaches the 70-percent stage; and the lender must foreclose when it reaches the 70-percent stage, if he has any conception of trusteeship to the depositors in his institution.

Now, so far as the lender's end of this thing is concerned, as I said a moment ago, we have seen plenty of banks close in this depression through 50-percent mortgage loans; that is, supposed 50percent loans.

May I say in that connection that, of course, the valuation of real estate is the least accurate of the sciences, if it can be termed "a science." You can take any committee in any bank and send them out to appraise a parcel of property, and there is never a chance that three men will agree on that value. They may compromise to reach an agreement, but no one of the three, acting alone, will put the identical value on it the other two did.

Consequently, you should have in here, from the lender's angle, protection against appraisal error, which is involved in a certain percentage of the loans. That is the chief consideration, I think, from the standpoint of the lender. And this means you should retain the 50-percent basis of the present law.

Now, about the length of mortgages-3 years is either too long or too short. A man can see ahead a year, sometimes 2 years, with reasonable accuracy; but a loan made in 1929, maturing in 1932, was a 3-year loan. It could have been refinanced in 1930 or possibly in 1931. You could, if you had made it in 1929, have gotten new money in 1930 or 1931, some way or other, possibly at a high premium, but you could have refinanced it. Three years is a term that you can not reasonable foresee. My own feeling is that a mortgage should be made of only two types. A straight mortgage should not run over 2 years without renewal requirement, because that far ahead a man can reasonably foresee and have a reasonable chance to refinance it if it is called for payment. If it is for a time longer than that, it ought to be on an amortization basis, and a high amortization basis.

I said to the Pennsylvania State Bankers Association 2 years ago that, in my judgment, no commercial bank ought to make a straight Ioan, unless to a business enterprise, with the understanding that that mortgage was to be paid at maturity, without renewal, and only when the money was needed for new capital. But generally mortgages, if they are to be held at all by commercial banks, should be on an amortization basis for two reasons: First, for the borrower, because, if he is on an amortization basis, his fixed charges are brought down annually, and his ability to recast the loan, in case of necessity, is simplified.

Second, from the standpoint of the lender, because neighborhoods change in cities with almost lightning rapidity. A loan that is good as a 60-percent loan today may be bad as a 50-percent loan in 2 years. In the country, for instance, out in Kansas lately, with dust storms or something of that sort, what was an excellent loan a year or two ago may not be worth anything today. The lender must have the security of justifying his original appraisal that is brought about by a definite and substantial reduction of the loan.

I have a theory, personally, that mortgage loans should be amortized contrary to the usual practice. The usual practice is to amortize mortgage loans at a fixed annual rate, the same rate every year from the inception of the loan. I think that mortgage loans should be more heavily amortized in the earlier years and then allowed to tail off in amortization to a moderate annual charge.

Certainly, if they are to be as heavy as 60-percent loans, in the first instance, they should be brought down to a maximum of 50 percent within the first 2 years, which the borrower can reasonably foresee. Thereafter the amortization might be slower, after the loan has been rendered secure for the lender and rendered recastable for the borrower, by early substantial reductions. Once reduced to the point of absolute safety there is no objection to slow amortization from the borrower. I would see no objection on a conservative 50percent loan to reducing the annual amortization thereafter, so that it ran 25 years-2 percent of the property value a year on the balance. But I do see serious objection to starting at 60 percent and then applying 2 percent or 3 percent a year as amortization, because the mortgage is still above the danger mark for 4 or 5 years, if it starts on that basis.

Now, one other thing on the mortgage provisions of this act which I feel very strongly on is this: I believe it is a serious mistake to make it possible to borrow a mortgage at the Federal Reserve bank. In setting up the Federal home-loan-bank system, the first board deliberately-and so stated publicly-fixed the situs of the 12 Federal home-loan banks in different cities from the Federal Reserve cities, for this reason: We believed that the administration of longterm credit, which real-estate credit is, was a distinct and separate thing from the administration of short-term credit. There are lots of times when short-term credits should be tightened and long-term credits eased; and the reverse is also true.

If you are putting the rediscounting of mortgages into the Federal Reserve System, you are merging in the one institution control both of long- and short-term credit, and the policies, under the language of this act, will have to be identical, because the same rediscount rate will cover both types of rediscount.

I believe that, having the Federal home-loan-bank system, you should make mortgages rediscountable only with it, if the commercial banks are to carry them at all.

The present provisions extend membership in the Federal homeloan-bank system to building and loan associations, savings banks, and insurance companies, which are the chief mortgage holders. The rediscount privileges of the home-loan-bank system should be extended to cover mortgage loans of commercial banks, both in order that the handling of long-term credit might be kept separate and apart from the handling and control of short-term credit, and in order that the policies of credit administration on mortgage loans should not differ between the two institutions. If you have two institutions loaning on or rediscounting mortgages, you will have no uniformity of mortgage policy.

Now, a large part of the real-estate difficulties of this depression came from too great extension of mortgage credit, due to easy money.

In the long-range working of the home-loan-bank system its most useful public service, in my judgment, will come from a sound administration of the problem of real-estate credit, the prevention of booms in real estate, the prevention of too great an extension of building operations, and of speculative operations; the prevention of those extensions of credit which lead chiefly to the eventual collapse of real estate and which did lead to the collapse of real estate in this depression. But it can happen often as it has often happened that at the very time that there should be a tightening of credit on real estate, there should be an extension and loosening and relaxation of credit to the ordinary commercial banks against commercial transations. But if you put the two functions into one institution, you render impossible the separation of credit control, which, I think the depression has taught us, is essential.

The psychology of the short-term lender is not the psychology of the long-term lender, and should not be. The view is not the same; the controlling background is not the same.

Now, you have a home-loan-bank system-and may I say, parenthetically, that while I believe it is being run splendidly by a very fine board of men-you should not give them control of any other problem or divide their authority over their problem.