Housing Can Be Financed

I

PRIVATE industry, we are told, has failed to produce adequate, decent, safe, and sanitary homes. A little while ago we were hearing that the needed housing must be built by the Federal Government. Now we are hearing that housing must be financed by governmental action and aid, and built either by local public authority or by private enterprise.

The Congress has been responsive to public demand. At the closing session of 1937, the United States Housing Authority was created with the power to extend loans and grants to local housing authorities for the financing and subsidizing of publicly owned housing projects. At the present session, the Federal Housing Act has been amended to liberalize the loans that may be insured by the Federal Housing Administration. In addition, steps have been taken to make it easier to promote National Mortgage Associations, which it is hoped will create new opportunities for the investment of private funds in longterm insured mortgages and maintain an effective market for such investments.

Thus within the space of a few months the Congress has enacted two measures of the greatest importance to housing, dealing respectively with public and private finance. Does this mean that the way has at last been cleared for concrete achievements in housing,¹ and that the difficulties of finance which have seemed so baffling are at last overcome? The large majority of those who are interested in better housing are far more anxious to see the dirt fly and the bricks laid than they are to discuss abstract principles of finance. The idea persists that finance is a sort of Aladdin’s lamp which, if rubbed the right way, will work a miracle and cause the desired housing to spring into being. An obliging Congress has rubbed the lamp both ways, once in the direction of public finance for public housing and once in the direction of private finance for so-called commercial housing. Both the Congress and the public naïvely await the miracle.

But finance is not a miracle. Finance is a man-made device. It is a method created by men for measuring the value of the various types of services performed by many different types of men and interchanged among them. The ability of men to specialize on particular tasks made it necessary for them to depart from primitive methods of barter, to devise and experiment with money, and then gradually to evolve the intricate system of credit machinery which to-day challenges popular understanding.

Our credit machinery is as yet by no means perfect. It is in a state of continual evolution, adapting itself little by little, though we are scarcely aware of it, to our changing needs and our changing capacity to minister to one another’s needs. If we are to succeed in financing housing, we must have an idea of what we are doing and what types of services we are interchanging. We must develop a philosophy of finance which is both understandable and workable; for unless we understand finance we shall not be able to make it work.

II

There was a time when the American who needed a home went into the forest and hewed the logs himself. He needed very little coöperation except for the heavy work of frame raising, when he called the neighbors in and made a party of it.

To-day the American who wants a home concentrates diligently upon his own specialized task, whatever it may be. He seeks to earn and save money with which to pay other workers who specialize in home building. But a man who must save all his life before he can get enough money together to pay for a home is likely to derive small comfort from it. Therefore, since there are other men who are dependent for their livelihood upon the task of home building, we have devised means whereby the home seeker may finance or anticipate his potential savings and enjoy his home during his lifetime, pledging his future earnings to liquidate the financing.

The first step in the evolution of home finance was the development of groups of people who had surplus savings and yet did not need additional homes for themselves. These people lent their savings to others, who paid them an interest charge, gave a mortgage as security, and eventually paid off the mortgage out of their savings. Institutions known as savings banks were developed to assist men of small means to put savings aside for the rainy day. Large numbers of small deposits placed in the savings banks created large concentrated savings. Thus, by acting in groups, men found that they had the same power to initiate work that was possessed by men of wealth. Hence the savings banks developed a usefulness to society as lending institutions equal in importance to their original purpose of facilitating savings. Our great lending institutions, including savings banks, life insurance societies, and building and loan associations, have been the source to which society has turned for funds to finance housing and other forms of construction whose usefulness lasts over a long period of years.

The mortgage system which has evolved as a result of savings is the outgrowth of the ways which men have developed for working at specialized tasks and for exchanging their services. There are three essentially different types of services performed by three representative types of workers. The first is the plodder, the man who day by day does work whose value to society just about equals the value of the things he requires from society. He earns what may be called a balanced livelihood. The plodder needs savings to tide him over rainy days.

The second is a different type of man. He is an inventor, a scientist, a man who produces services or things which are not consumed by immediate use. He may spend his days working upon something which may not be productive until the end of his life. He earns a deferred livelihood. He needs savings to live on, although he may have none.

The third does certain things in the early part of his life which are of such immediate value to society that he receives in payment more than he can readily use. He therefore earns a precipitated livelihood. Sometimes a man may enjoy a precipitated livelihood because he falls heir to the deferred livelihood of his father.

Men who enjoy precipitated livelihoods resort to savings banks and other types of investments because they prefer to defer the enjoyment to which they are entitled. But the funds do not lie idle. Men who earn deferred livelihoods are eager to use these savings in order to pay living expenses during the interval when their own work is unproductive. All workers in the construction industry play a part in creating things of longrange value and must therefore pledge the ultimate fruits of their labor to secure the immediate wherewithal to live.

Here we have a system of pledges interchanged. Each pledge is a contract to allow another to derive, in advance, enjoyment which is yielded on condition that repayment be made so that the rightful owner of the pledge may take his enjoyment at a later date, when repayment is made. It has been the dislocation of our system for interchanging pledges between those who earn different types of livelihoods that has necessitated most of the recent legislation dealing with finance.

If deferred and precipitated livelihoods exactly balanced one another, our difficulties would be considerably lessened. Such, however, is not the case. The needs of all of the three typical groups of workers are constantly changing, and, in addition, technological improvements which increase the productivity of the individual worker are continually forcing more workers into the group which must depend upon deferred livelihoods. When it appears that these workers cannot be financed out of savings with a reasonable prospect for the return of the savings, unemployment is inevitable.

Furthermore, in order to protect owners of savings against loss, restrictions have been quite properly imposed by law upon the types of investments that may be made by life insurance societies, savings banks, and other types of trustees. This means that in times of stress the interchange between those who earn precipitated and deferred livelihoods may be thrown still further out of balance simply because adequate return cannot be assured to permit exchange. Many of our lending institutions have not been able, or have not seen fit, to avail themselves of the insurance provided by the Federal Housing Administration for this reason.

The single insured mortgage of the FHA, formerly covering 80 per cent and now allowed to cover 90 per cent of appraised value for appraisals of less than $6000 per house, has undoubtedly helped to eliminate the vicious secondmortgage practices of the pre-depression days. Although it was not then apparent, it is now realized that the high discounts exacted for refinancing second mortgages, plus bonuses and other charges, plus high interest rates and inflated appraisals, drained away the legitimate earnings of properties which should have been used to reduce the original mortgage loans. It seems certain that the institutional lenders will unite in opposition to any attempt to return to former second-mortgage practices, and that they will insist on maintaining a sound policy with respect to amortization.

Those who expect quick results must exercise patience and realize that real estate still carries an enormous debt built up in the past when there urns no conception of mortgages as a revolving fund and when it was still imagined that real estate continually increased enough in value to carry a permanent fixed debt. It is significant that complete records of mortgage debt are not extant. In 1930, farm mortgage debt was known to exceed $9,000,000,000. The total mortgage debt of the nation has been variously estimated at between $23,000,000,000 and $42,000,000,000. Such disparity is in itself significant. Even though the Reconstruction Finance Corporation, the Home Owners Loan Corporation, the Federal Housing Administration, and other credit agencies of the Federal Government have aided in financing and refinancing obligations in excess of $4,000,000,000 with provisions for varying rates of amortization, we are still confronted with the task of finding a way for liquidating the balance of our mortgage obligations.

III

In order to realize the importance of a progressive means for liquidating mortgage debt, it is necessary to digress briefly to examine the relationship which exists between those who build houses and those who live in them. This relationship is too frequently misunderstood, because it is commonly supposed that the purchaser of a home takes it off the market and that that act completes the transaction. Neither the purchaser nor society at large can consume housing. People do, however, consume the shelter which is produced by housing. Shelter is measured by the time element during which it is enjoyed, as well as by the quality and quantity of shelter supplied. Theoretically society makes its payments in the form of a rental for shelter rather than as a payment for a house. It is helpful, therefore, to designate this payment as the rental equivalent, which means annual charges whether borne by home owners or by tenants.

Advance payment by the home owner in the form of a purchase price anticipates the payment of the annual rental equivalents. It causes the owner to perform for himself the banker’s role of adjusting the time disparity between two types of services — namely, the furnishing of labor and materials for the production of housing, and the consumption of the shelter which is produced by the house. Much of the propaganda regarding home ownership has been misleading.

We need to clarify what takes place upon the payment of the rental equivalent. Small periodic payments are made which approximate the use value of the shelter. These set up a return flow of installment payments which gradually reduce² the amount of credit that has been advanced to defray the cost of creating the housing. This takes place irrespective of whether the owner or an investor advances the money to pay construction costs. The home owner pays the rental equivalent, in part by forgoing interest on his own capital.

Thus we see that, in theory at least, the financing of housing consists of a flow and a return flow of recording payments. Society took a real forward step when it developed the device of utilizing the precipitated savings of one of its groups to finance the deferred livelihood of another. Based upon this simple device, a great impetus was given to the financing of the exchange of services which involve a time differential — as, for example, the production of the capital facilities of housing and the consumption of the resultant commodity, shelter.

But the devices which society develops do not always function smoothly, because they are not always completely understood. Money is sometimes drawn away from needed uses. At such times artificial means are tried to direct the flow of money toward such purposes as housing.

IV

The attempt to stimulate the financing of housing dates from 1920, when the New York State Legislature empowered municipalities to limit taxes on family units constructed during a period of housing shortage. This was followed by a provision permitting insurance societies to invest directly in low-rental housing and to enjoy limitation of tax to land value only for a period of twenty years. Results were produced in both cases because the limitation of realestate taxes increased the margin of profit and stimulated the flow of funds into housing.

In 1926 the first definite attempt was made to set up a state housing bank to issue tax-exempt bonds carrying low interest rates, these bonds to be secured by mortgages on low-rental housing projects built under the auspices of the State Board of Housing — real-estate taxes to be limited to land value only, and the corporations operating the housing to be exempt from other state or local taxes. The legislation was passed without the establishment of the bank. Nevertheless, housing aggregating in total cost $23,000,000 was constructed. For the last three projects, however, it was not found practicable to secure mortgage funds on a commercial basis, and as a result loans from the Federal Government were obtained.

In 1934 the New York State Legislature amended its housing law to permit the establishment of municipal housing authorities. Cities were empowered to grant initial revolving funds, and the authorities were permitted to issue taxexempt bonds. Again it was found that neither institutional nor private lenders could be depended upon for finance. The authority found itself unable to sell its bonds in quantity to produce results. It did, however, induce the Housing Division of the Federal Emergency Administration of Public Works to carry out two large projects, and then entered into an agreement to operate these at rentals made possible by Federal subsidy. To-day Federal policy has been shifted to permit loans and restricted capital grants to be made to local authorities, plus annual subsidies of an amount not to exceed interest and amortization charges.

As a result we have two Federal policies with respect to housing: one as concerns housing which is publicly owned and operated, and the other with respect to general long-term finance for housing purposes. In those states which have followed the lead of the Federal Government there are, similarly, two state policies. One is to get as much in loans out of the Federal Government as possible and then to get the Federal Government to defray costs of both interest and amortization, charging these to future nation-wide tax collections. The other policy leaves the states grappling in forty-eight different ways with the mortgage problem and passing legislation to permit institutional lenders controlled by the state to take advantage of the new type of amortizable mortgage insured by the FHA.

Let it be granted that the need is established for a reasonable supply of municipally owned housing to provide for economically stranded groups and tenants displaced by demolition or other changes due to public improvements. There still remains the problem of rebuilding our whole system of housing finance, on sound principles. Governmental action arrested the mortgage situation before it reached the proportions of a major catastrophe, despite the advice of a few who contended that liquidation should have been allowed to run its course. It is now recognized by all that some sort of control must be devised for mortgage finance which will prevent a recurrence of mortgage manipulation and yet allow sufficient independence of action to avoid the stultification of initiative and enterprise.

V

The idea has persisted that, unless savings are set aside, the specialized services necessary to produce housing cannot possibly be paid for. We have been accustomed to think that both mortgage finance and investments in equities have been drawn exclusively from the savings pool.

We have already seen, however, that as society grows more complicated fewer and fewer things which men produce can be exchanged directly,³ while a larger proportion of men are constantly employed to produce things such as capital goods that cannot be consumed directly but which, when serviced, do in turn produce commodities or services which can be consumed. We know that the savings set aside by those who earn precipitated livelihoods do not bear a fixed relation to the amounts needed to finance the advance labors of those who earn deferred livelihoods. In other words, savings alone are insufficient to pay for the housing, machinery, and other types of capital goods that society needs.

The use of credit has been the factor that has made it possible to increase greatly the range of human activities. Credit originates and takes the place of money to liberate work on the basis of an estimate of the value of that work. Credit must be liquidated and canceled out by the actual exchange value of the services derived from that work expressed in money. When there is failure to cancel out a credit, the result is obviously inflationary, because the quantity of money is increased without verification by actual exchange. Experience has taught the necessity for differentiating between credit, which is an instrument of exchange into which the time factor enters, and money proper, which is an instrument for measuring direct exchange.

For this reason there has been a determined effort to confine the use of credit to short-term purposes and to depend upon the savings and investment pool for long-term needs. The method employed was strict regulationof theproportion of long-term investments allowed to commercial banks as members of the Federal Reserve, to restrict discount privileges on collateral loans, and to require special reserves. Notwithstanding the precautions taken, there has been a tendency for bank credit directly as well as indirectly to augment⁴ the savings and investment pool. So great has been the pressure that the original Federal Reserve Act of 1913 has been modified three times, in 1917, 1927, and 1935, to increase the latitude allowed member banks with respect to real-estate loans and other forms of long-term investment.

Unfortunately there is as yet too little understanding of how to deal with the tendency of credit to augment the investment pool. We have failed to recognize how large a proportion of what we thought to be investment funds were in reality long-term credits which required liquidation just as inevitably as the short-term credits which we have learned so much better how to handle. Our failure to provide a means for the liquidation of these baffling long-term credits has been a cause of periodic concealed inflationary movements accompanied by advances in commodity prices.

There is much direct evidence that one of the most dangerous aspects of the great depression was a result of our lack of understanding of the fundamentals of long-term finance. In attempting to work our way out, both the Hoover and the Roosevelt administrations found it necessary to set up special agencies to aid banks, corporations, and individuals in the baffling task of liquefying and liquidating frozen capital assets. Most important of these agencies has been the Reconstruction Finance Corporation. The purposes of many of the others are evidenced by their names: the Farm Credit Administration, the Home Owners Loan Corporation, the Public Works Administration, the Federal Housing Administration, and the United States Housing Authority. All of these agencies have served a useful purpose even though the general effect has so far been principally reflationary. In this connection it should be pointed out that for some years there has been a well-defined movement to establish a Central Mortgage Bank. Such an institution is greatly needed. The Central Mortgage Bank must be something more than a mere discounting agency. It should exercise the function of a reserve bank for longterm credits with power to control the expansion and contraction of credits.

At the present time there is a pressing need for a thoroughgoing scientific study of the whole matter of long-term credit and its relation to our existing credit and monetary system as set up by the Federal Reserve Act. It may be found preferable to create a system of reserve mortgage banks within the existing Federal Reserve System, or even to develop one of the existing emergency agencies into the nucleus of a mortgage reserve system.

Overtures ⁵ have already been made to Congress to authorize a commission to study the problem of long-term finance. This commission, with the advice of experts, should place before a later Congress (a) proposals for the better coördination of the many existing agencies of long-term finance formed during the depression, and (b) specific proposals designed to provide for the intelligent direction and control of long-term finance — on the one hand to lessen the danger to our monetary and short-term credit system caused by periodic price inflations and the freezing of needed money and credit in long-term obligations, and on the other hand to provide for orderly long-term credit expansion balanced with the capacity of the nation to expand industrially.

The time has come when we must put behind us the notion that our capacity to expand depends solely on our ability to save and our willingness to invest.⁶

VI

We have arrived at a point in our argument where we may state boldly that if America needs and wants better housing it has the capacity to achieve it. The factors that make financing possible are based upon our knowledge, first, that the people who will live in improved types of housing will be able little by little to liquidate the credits that are advanced to produce this housing; second, that we have the man power and materials necessary to construct housing. We can set to work as soon as agreement is reached as to the method for liquidating the needed credit.

If America is to have housing, then we must learn how to finance housing. There are, however, serious obstacles to be overcome. So immersed are we in what Professor Arnold has called ‘the folklore of capitalism ’ that we may prevent the financing of the very thing which we desire by insisting that housing shall not be financed unless certain conditions are set which are emotional survivals of an outworn antagonism to capitalism. The first of these is the idea that the governmental aid must be invoked only for those people who cannot pay what is considered an economic return for the services rendered them. This of course leads to the equally erroneous concept that when the government undertakes a housing project for demonstration purposes the terms on which the project is financed need not be balanced on an economic basis, but may be made to simulate a balance through subsidy. We have found it difficult to distinguish between governmental aid for housing and government ownership. We have illogically assumed that economic dislocation was due to industrial failure, and have clamored for the government to take over many of the functions of industry at the same time that we have failed to perceive that the breakdown in finance and credit was due to governmental failure to apply its constitutional mandate ‘to coin money and regulate the value thereof.’ This mandate presupposes the exercise of governmental authority to maintain an economically sound credit system employed with a diligence and intelligence equal to the intelligence which government has shown in preventing the issue of spurious currency.

Although we stand on the threshold of a better understanding of the workings of both shortand long-term credit, we are still confusing credit with the older merchandising concept of ’investment,’as the purchase of a capital asset which, after its purchase, can somehow become a piece of merchandise to be held for sale at a profit in a capital market.

It is not to be wondered at that men who have but recently lost their faith in the buying and selling of investments for profit should be slow to find an advantage in investment without exploitation at a time when the capital market is, to say the least, quiescent.

In a society which has developed three distinct types of workers, of whom, as we have shown, an increasing proportion are dependent upon deferred livelihoods, it is essential that, a continuous flow of credit be made available so that the economic system may be kept in balance. It is therefore fortunate that the Roosevelt Administration has had the courage to extend credit liberally in the attempt to reduce unemployment below the danger point. It is significant, however, that, in spite of the declared purpose to finance housing, the major portion of the credit extended has been put into ’made work’ for relief purposes, public works, parks, highways, and national defense, none of which provide for any appreciable means for liquidating the credit except by resort to taxation. Short of repudiation, there appears to be no way out except taxation and more taxation. It is a reflection on the popular understanding of credit that, in the case of those housing projects which have been financed, the terms arranged have been such as to preclude the liquidation through rent of the credits which the government has vouched for. Thus housing which could and should be made self-liquidating has been made a further charge upon taxation.

It is unfortunate that our cities have been equally guilty with private industry in neglecting to provide for the amortization of credits invested in capital resources. Consequently our cities to-day are not in a position to liquidate through taxation the credits of which they are greatly in need to improve their capital plant. Consequently we must look for an outlet for credit that offers an assured return for the long-term credits which are needed to give work to those who are dependent upon deferred livelihoods. Housing still offers the best opportunity for the absorption of new credits on terms which can provide for assured periodic amortization payments out of rents or the rental equivalent. There is reason to believe that economic pressure alone will ultimately compel the financing of housing. The only real obstacles are our failure to understand the true significance and use of credit and our failure to distinguish between ‘folklore’ and what we have been pleased to call ‘economic laws.’

VII

A new generation has grown up since the remarkable essay entitled The Moral Equivalent of War was published by Professor William James of Harvard. Professor James was wise enough to see in war the power to weld great masses of people into a self-conscious entity dedicated to a common purpose so greatly desired that all minor conflicting purposes are willingly reconciled and reoriented. Professor James was perhaps the greatest student of psychology that America has produced. Had he been alive during the great depression he would have understood the psychological significance of the ominous undertone of criticism which was heard throughout the frenzied effort by the government to combat the depression. Over and over again it was said, perhaps by cynics, that ‘a first-class war would lift us out of the doldrums.’ Two years after the United States entered the war against Germany, 4,250,000 men were enrolled in the army and nearly 9,500,000 men and women were employed at home in production for war purposes. The same nation has failed to marshal similar man power to combat the depression because it has lacked a moral equivalent for war.

Let us for a moment think what would be the result if similar man power could be put to work for improved housing. Here the word ‘housing’ is used in its largest sense. It is intended to connote rearrangement and rebuilding of large sections of our cities as well as the building of better homes and better farm buildings for the agricultural population, plus those service appurtenances which are essential to the convenient use of housing in both city and country.

The same people who condone the inevitable debt which is left by war are the first to decry a public debt incurred for a purpose other than war. Men have not yet learned to think of a moral equivalent of war which is worth the price. Were it suggested that a debt should be incurred for housing of even a fractional part of the debt for war, it would be condemned as one which could have been avoided and was therefore needless. Improved housing, however, involves only the wreckage of outworn physical things which have outlived their usefulness and presupposes the creation of new and more usable housing, and it does not leave a mountain of debt with no hope of paying that debt except through taxation. Furthermore, housing is something which is greatly desired and which we can afford. The credits advanced can be liquidated through rents.

It is possible to measure the amount of new housing which is needed by the people of the United States and which can reasonably be created in any given year. It is possible to measure the housing needed in various communities and to classify this housing by size and quality of facilities as well as by income groups.⁷ It is possible to calculate the expansion of credit required annually to liberate the work necessary to produce the amount and types of housing needed in the various classifications. Instead of a hit-or-miss method of expanding credit such as has been employed in the past, here is an outlet of definite determinable proportions. Furthermore, here is a method for expanding credit on the basis of a contract calling for the liquidation of a given percentage of the credit every month.

So great are the variations in the terms of finance that only at considerable risk of being misunderstood can even the most general suggestions be given within the compass of this article. For the past seven years the situation has been such that Federal authorities have been compelled to take the initiative in the dispensing of credit Government has been called upon to provide a balance of needed credit to supplement other available credits. Therefore it is appropriate that government should base the amount and nature of its credit advances upon a programme calculated to stabilize the disparity between America’s capacity to produce and its capacity to consume. In the case of government the purpose of credit expansion is to produce results. If there is an assured method for liquidation, the interest rate can be written down to very nearly nil. Therefore, it would be possible for the government to issue twenty-five-year special housing bonds amortizable at 4 per cent per annum, with an interest rate sufficient only to cover servicing and insurance. These bonds might be prorated among the Federal Reserve member banks to establish credits against which funds for desired types of housing improvement could be drawn. The bonds could be made eligible as reserves under terms set by the Federal Reserve Board.

If a credit expansion of exactly one billion dollars per annum should be continued by the government for twentyfive years, at no time would the total expansion amount to more than thirteen billions, and by the end of the twentyfifth year the amortization payments at 4 per cent would have reached the amount of the annual outlay, so that thereafter no additional expansion would result. In these days of accurate record keeping there is little necessity for tying a policy of credit expansion for housing to arbitrary fixed annual amounts such as might be set by Congressional appropriation. The Federal Reserve Board receives accurate periodic reports on credits extended by its member banks. These reports, considered in relation to employment statistics and to a survey of need, should be an index of the supplementary credit needed to balance production and consumption. Hence the Federal Reserve Board might set each year the amount of credit expansion to be assigned to housing.

Every factor points to the advantage and necessity for financing housing. No thoroughgoing study has yet been made of the possibilities. So far Congressional committees and groups who have drafted Congressional and state legislation have been advised principally by the type of men who have made themselves recognized merchants of investments. As has already been shown, we have allowed credit inflation to swell the investment pool and then have waited for the lure of the profitable sale of investments to provoke more inflation. It is not surprising that so little progress has been made.

Housing cannot be financed until the relation between credit and investment is better understood. We must realize that we cannot protect our short-term credit machinery against inflation merely by vain limitations on the types of ‘investments’ permitted to member banks of the Federal Reserve System. It is very important that bankers as well as the officials of investment institutions should join in the study of the only partially understood phenomena of longterm credit. The proposed Congressional Commission to study long-term finance should aid in bringing both imaginative and experienced minds together and in arousing popular interest. The need for such study is being thrust upon us by the development of our civilization, with its subdivision of tasks and in particular its well-defined classifications of livelihood.

Banking is the profession to which the nation must look with hope for the future. The banker is the man who makes it possible to keep abreast of our technical competence. By adding the time element to money and creating credit, the banker has performed one of the greatest services ever rendered to civilization. Our recent sufferings are largely due to lack of understanding of credit, that new tool to facilitate exchange which we, whether we know it or not, are still working upon to beat it to a true and workable temper. Housing can be financed. A better understanding of our credit problem will make this possible. The financing of housing and the recognition of its relation to our capacity to expand will in turn help to stabilize our general system of finance and guard us against the recurrence of dangerous booms and depressions.