They specialize in financing the homes of the middle and lowest income groups. For example, approximately 45 percent of the loans made by these associations in 1949 to finance home construction and home purchase were made to families with incomes of less than $3,500; 251⁄2 percent were made to families with incomes of from $3,500 to $4,500. By reason of their governing laws and methods of operation they are the only group of institutions which are equipped to make loans of this type on a practical basis throughout the entire country.

If the functioning of these institutions and their normal growth is curtailed, there will, of necessity, be a lessening of the supply of money for home financing, especially in the critical middle and low income field. Such curtailment or an operation of doubtful safety must result from a tax. Federal and State supervisory officials are constantly prodding these associations to increase their reserves more rapidly; that is, at a higher rate.

It has been the long-standing policy of Congress to foster these institutions for the promotion of thrift and home ownership. To that end the Federal Home Loan Bank System was established, as was the country-wide system of Federal savings and loan associations and the Federal Savings and Loan Insurance Corporation. For the same purpose the Eighty-first Congress enacted H. R. 6743 which further strengthened the building and loan movement while providing for the early return to the Treasury of funds which had been advanced by it in the thirties to the Federal home loan banks and the Federal Savings and Loan Insurance Corporation.

Nearly all of the States have statutes recognizing the sound public policy served by these institutions.

The unfavorable consequences on building and loan associations of a direct income tax would be serious.

1. A direct income tax would necessarily result in either a sharp reduction in dividends distributed to members, or a reduction in loss reserve ratios, or an end to growth, with a drying up of this source of thrift capital. Prudent management and supervisory authorities have long recognized the necessity of considering statutory reserve requirements as the barest minimum only.

2. Believing that prudent management would try as in the past to accumulate adequate reserves for the protection of the small saver, it would appear that the burden of a direct income tax would fall upon the small saver in the form of a sharply reduced dividend rate. If, however, the burden of a direct Federal tax were to fall upon reserves, the result would be a direct weakening of the entire building and loan structure and an unwarranted increased financial risk to the Federal Savings and Loan Insurance Corporation.

3. The tax would inevitably restrict the sound growth of building and loan associations and they would be unable to maintain their position in the expanding economy and the expanding field of mortgage debt. The impairment to the operations of such associations would necessarily diminish in comparable degree their service in the promotion of thrift and home ownership.

There has been no change in the basic purpose of building and loan associations since their origin in this country in 1831, nor has there been any change in the functions which served as the basis for their exemption from Federal income taxes.

Under the original terminating plan, one group of members pooled their savings to provide funds to finance homes of other members. If losses resulted from such loans, they were equitably distributed among all the members on a pro rata basis by the simple device of recapturing the necessary portion of the earnings which had been divided among all members but retained by the association until the maturity of the shares.

The serial plan which later became popular was in effect merely a combination of several terminating groups of shareholdings within the same association. Here again losses as well as earnings were equitably distributed pro rata among the members of the association. These plans of operation were cumbersome, so they were generally abandoned in favor of the simpler type of operation as exemplified by the Federal savings and loan association which represents a combination of the best practices of local thrift and home financing institutions as required by the Congress when it authorized their chartering.

However, the basic concept of the building and loan association has not changed. The association is still the facility through which people of small means pool their savings in order to provide for the financing of the homes of their fellow citizens. The benefit to the individual saver from this arrangement is that he obtains the safety and earnings available through a loan secured by a first mortgage on an American home. It is doubtful whether many of the members of building and loan associations would be able to obtain these advantages without pooling their savings with those of other people.

As in the case of the first association each member of the modern association is a cooperator with the other members in this undertaking for the mutual benefit of all members. As a part owner of the assets of the association he receives a pro rata share of the earnings in the association after the payment of operating expenses and provision for present or potential losses. In the event of dissolution-voluntary or involuntary-he receives his pro rata share in the distribution of assets. This relationship constitutes mutuality.

There is an important difference between the method of meeting losses in the early associations and the modern association. The change in this respect is the result of experience and the requirement of State and Federal laws.

In the original association all of the net earnings each year were divided among all of the members pro rata according to their shareholdings. When losses occurred, they were charged against all of the members' holdings on a pro rata basis.

In the modern association a portion of the earnings are retained each year in a special fund for the purpose of absorbing losses. The portion of such earnings which is retained for the protection of all members is determined by statutory requirements and prudent management based upon the long experience of building and loan associations in general.

The purpose of this more modern arrangement for absorbing losses is to deal fairly and equitably with all the members of the association. Under the old arrangement some members withdrew from an associa tion before losses developed in loans on which they had received their pro rata share of earnings. In such cases the remaining members were forced to absorb an inequitable share of the losses.

There is no basic difference between assessing the members of a building and loan association for their pro rata share of losses after

they occur and the retention of a portion of the members' earnings on their share accounts to meet losses before they occur.

I would like to submit at this point for the information of the committee a letter of January 16, 1951, from the Federal Savings and Loan Insurance Corporation on the subject of the loss experience among building and loan associations. This letter clearly shows that building and loan associations are following a sound policy in building necessary loss reserves for their continued safe operation.

Mr. REED. Mr. Chairman, I ask unanimous consent that this letter to which Mr. Kreutz has referred be included in the record. The CHAIRMAN. Without objection, that may be done. (The letter referred to follows:)

FEDERAL SAVINGS AND LOAN INSURANCE CORPORATION,

Mr. OSCAR R. KREUTZ,

HOUSING AND HOME FINANCE AGENCY,
Washington, D. C., January 16, 1951.

Executive Manager, National Savings and Loan League,

Washington, D. C.

DEAR MR. KREUTZ: We are glad to give you information bearing upon the subject of loss reserves which you raised in your letter of January 3, 1951. First, we may stress their importance and, second, we may give you the results of our studies on the question.

The history of all types of financial institutions has shown in no uncertain terms that adequate provision for possible future losses is vital to safe operation. Moreover, protection against losses must be anticipated in advance. To await their realization is too late. In institutions such as savings and loan associations, losses are mainly cyclical in character and may not make their appearance for a decade or more. This makes the problem more difficult to perceive and possibly more complex because of the deceptive successes of prosperity. Today loss reserves also take on more significance than at any previous time.

In turn, savings and loan associations occupy a large niche in the financial economy so that their operations play a vital part in the functioning of the national economy. The Federal Government itself is directly involved because of the insurance of savings through one of its instrumentalities. In giving recognition to this larger perspective, prudent management and business statesmanship must make adequate provision for loss reserves. It is not a little question; rather, the subject is of national importance.

Prior to the creation of the Home Loan Bank Board and the Federal Savings and Loan Insurance Corporation, cumulative and over-all records relating to losses of savings and loan associations were not maintained. As a result, it is necessary to appraise the problem on a sample or spot-check basis. The information that we can give you in response to your request may be summarized as follows:

Test No. 1: Analysis of the experience of 18 associations which became insured without write-down of their shares or segregation of their assets.

Test No. 2: Analysis of six cases with capital write-down so as to provide a cushion to absorb losses.

Test No. 3: Analysis of 35 associations where segregation of assets was necessary to qualify for insurance.

Test No. 4: Results of nine institutions liquidated by the Massachusetts Share Insurance Fund.

TEST NO. 1

Analysis of the experience of 18 associations which became insured without writedown of their shares or segregation of their assets. In selecting the 18 associations in this category, it should be pointed out that we deliberately took institutions which had more than the usual amount of real estate. We did this for the very sound reason that in providing reserves to cover future contingencies safety is found in maximum rather than minimum coverage. Also, it gave us a more representative basis for the study of losses incurred on real estate owned. At the same time, it should be stressed that the conditions were not serious enough to warrant either a write-down of shares or a segregation of the assets.

As you will note in the enclosed table, the ratio of the gross losses on real estate to the average assets during the 9-year period of 1937-45 amounted to 8.7 percent for the entire period and averaged 1 percent per year. Obviously, if the period is extended through 1949, the respective ratios drop slightly.

TEST NO. 2

Analysis of six cases with capital write-down so as to provide a cushion to absorb losses. In putting the insurance program into effect in the thirties, it was not uncommon to find that many institutions could not qualify for insurance without a write-down of the value of their shares in order to absorb recognized losses or to provide a reserve to meet contingent losses. Obviously, institutions in this category would be in a weaker financial position than those mentioned in the previous category.

To test this type of condition, we made a study of six associations of scattered geographical location. Since the losses were recognized at the time insurance was granted, there is no way of measuring the actual losses which were realized from the liquidation of the real estate itself. Hence, we may simply advise you that the ratio of the write-down to the total assets of these institutions amounted to 19 percent.

TEST NO. 3

Analysis of 35 associations where segregation of assets was necessary to qualify for insurance. Still another method used by the Insurance Corporation as a means of rehabilitating institutions in the thirties was that of segregating unsound assets into separate liquidating trusts or corporations. The shares issued by such institutions to cover the remaining good assets were then insured by us, while the shares against segregated assets realized only liquidating dividends to the extent made possible by the proceeds received from the liquidation of the segregated assets.

We know that there were at least 177 associations subjected to this treatment, but once again complete records were not always kept of the results. However, we do have fairly complete records showing the final losses in 35 cases. In order to apply our findings to the problem before us it seemed best to relate the losses to the total assets as of the date of segregation and not simply to the amount of segregated assets. The purpose of this is to bring the management problem into perspective, since the universally recognized measure of loss reserves for going institutions is the ratio of such reserves to the total assets. We found that in cases of this type the final losses of the 35 institutions, with total assets at the time of segregation of $25,917,550, amounted to $5,621,488, or 21.7 percent of total assets.

TEST NO. 4

Results of nine institutions liquidated by the Massachusetts share insurance fund.— Finally, there are the familiar cases where institutions were liquidated in entirety, and not in part as was true in test No. 3. However, as stated before, the results of such liquidation are generally not available. Often savings and loan associations were liquidated voluntarily by the directors, and, in any event, the State authorities seldom kept comprehensive or uniform records. Fortunately, we have been able to obtain the results of the liquidation of nine cooperative banks by the Massachusetts share insurance fund.

In this instance, because of the existence of the insurance fund, a record of the losses which it suffered from the liquidation of its insured members was maintained. The assets of the nine cooperative banks amounted to $8,700,000 at the time they were taken over and the net losses to the insurance fund amounted to $1,541,000, or 17.6 percent of the assets. For your information, these data were obtained from a book entitled "Three Score and Ten Years" by Oreb M. Tucker, which is a history of the cooperative banks in the State of Massachusetts. We hope that this limited information will be helpful to you, and we will be glad to answer any inquiries that you may wish to make about the study. Best wishes.

Sincerely yours,

WILLIAM H. HUSBAND, General Manager.

Mr. KREUTZ. We are in a period of high prices and prosperity and have been for a number of years. Obviously these associations must build adequate loss reserves. The total amount in the reserve accounts of insured building and loan associations at the end of 1950 was 6.9 percent of their assets. It is apparent from this ratio that building and loan associations are not retaining an excessive portion of their earnings for loss reserves.

At the end of 1949 the total reserves of all insured associations were 6.9 percent of their assets. The insured institutions held nearly 80

percent of assets of all associations and were used for this estimate because the figures were readily available. Assuming that a tax such as has been proposed had been in effect during the previous 5-year period and assuming that the same dividends would have been paid to the members of these associations, there would have resulted a sharp diminution of reserves. For example, on the assumption of a 38 percent tax rate in the period 1945 to 1949, these insured associations would have had total reserves of only 5.4 percent on December 31, 1949, instead of 6.9 percent. Assuming that such a tax had been in effect for the previous 10 years, the reserves at the end of 1949 would have been only 4.8 percent. Moreover as an example of what could happen under higher tax rates, these insured associations would have had total reserves of only 4.3 percent of assets at the end of 1949 instead of 6.9 percent had they been subject to a 47 percent tax rate for the preceding 10 years.

We believe, however, that prudent management would, under a direct income tax, continue to make needed allocations to reserves for losses. It is necessary, therefore, to take a look at the effect of a tax upon the earnings distributed to the members of these associations. For example, we will assume that such a tax was in effect in 1949 and that consistent with statutory requirements and prudent management policies these associations made the same transfer to reserves for losses as were actually made. If under those conditions a 38-percent tax rate had been in effect on these associations, their weighted average dividend rate would have dropped from 2.52 percent to 1.75 percent. If the tax rate had been 47 percent, the weighted average dividend rate would have dropped from 2.52 percent to 1.41 percent. Obviously a direct Federal income tax on these associations would have come directly out of the pockets of the 10,500,000 small savers of the country who are members of building and loan associations and would have resulted in taxing twice the already taxable earnings in the hands of the recipient.

Any such drastic reduction in the rate of dividends distributed to the members of building and loan associations would necessarily result in a drying up of the flow of thrift capital into these institutions. Such a result would be in direct conflict with all of the anti-inflationary efforts which are being developed by the Congress and by the executive departments. In addition, the drying up of this important source of thrift capital would place a greater strain on the resources of the Government by increasing the demand for direct Government financing and building of housing.

A direct income tax will fall upon such associations more severely than do corporate income taxes against banks and corporations generally. No other type of organization compares with savings and loan associations in the long-term character of their investments and the length of the period which elapses before losses are realized. Banks and other corporations, because of the nature of their investments and the earlier development of losses, are generally able to make allowances for such losses before taxes. Savings and loan associations cannot do this because of long-term character of their loans.

As shown by the figures presented and the official reports, savings and loan associations already produce 49.2 percent more tax revenue per million dollars of savings (deposits) than do insured commercial banks.