Introduction, 198. — I. Concepts of equilibrium and the “machine,” 198. — II. Difficulties with the concept of the “machine,” 200. — III. The “event” approach, 202. — IV. Major limitation of the “event” approach, 205. — V. Implications of the “event” approach, 208. — VI. Summary, 210.

Recently, in this REVIEW (J. K. Galbraith, "Market Structure and Stabilization Policy,this REVIEW, XXXIX (May 1957) I24-33) Professor Galbraith has asserted that in the case of monetary policy the "inflation can be controlled by denying credit to what are, in a general way, the least powerful firms" (page 132). Elsewhere, these least powerful firms are identified as the smaller firms (pages 131, 132, 133), and evidence concerning the distribution of bank loans by size is presented, to indicate that "while the case cannot be proven, there is a strong probability that in the last couple of years the effect of monetary policy has been to ration credit from all sources away from smaller firms in the competitive sector and to larger firms in the oligopolistic sector" (page 133).

Lending institutions usually operate in a set pattern with respect to FHA and VA lending. That is, life insurance companies and commercial banks are stronger supporters of federal housing finance programs than savings and loan associations. Therefore, the impact of FHA and VA programs on specific markets is predictable. That is, in those markets where savings and loan associations are the predominant lenders the proportion of insured lending will be lower than in areas where life insurance companies and/or commercial banks predominate. The object of this note is to test the applicability of these conclusions to the city of Ann Arbor, Michigan, a non-metropolitan mortgage market. For the purpose of this note, “market structure” is defined in terms of the percentage distribution of home mortgage recordings among the various types of lenders.2 Thus two markets would be “structurally” identical if each type of lender records the same proportions of mortgages in both markets. Under this definition, it is clear from Table 1 that in 1956 the structure of the Ann Arbor mortgage market differed in a number of ways from that of the national market as a whole. With the exception of mutual savings banks, all types of institutional lenders operating in the national mortgage market were repre-sented in the 1956 Ann Arbor market. About 38 per cent of the value of Ann Arbor's home mortgages was furnished by three savings and loan associations—the most important single source of funds. On a national basis, savings associations accounted for 35 per cent of home mortgage recordings. Next in importance to these mutual organizations were four commercial banks, which as a group recorded close to 24 per cent of Ann Arbor's home mortgages. The corresponding figure for commercial banks in the national market was 20 per cent. Life insurance companies, which recorded about 7 per cent of home mortgages on a national basis, were twice as important in the Ann Arbor market. As a group, they underwrote approximately $2.6 million of home mortgages, or 14 per cent of the Ann Arbor 1956 total. Because of the relative abundance of long-term funds from local and national institutions, individuals have been insignificant as a source of mortgage money in Ann Arbor. In 1956, only 3 per cent of the value of home loans on properties within the city were supplied by individuals. The individuals' corresponding share in the national market was 13 per cent. “Other” lenders, who accounted for the remaining 21 per cent of 1956 home mortgage recordings in Ann Arbor, included one trust company, one educational institution, and several mortgage and realty companies. So far, we have described the structural disparities between the Ann Arbor and the national mortgage markets. The question is, with what degree of accuracy can these disparities be utilized to forecast differences in the use of government mortgage insurance programs in the two markets? We know that life insurance companies and commercial banks are strong national supporters of FHA and VA programs; we have seen the greater combined importance of these groups in the Ann Arbor market. Can one predict, on the basis of these points, that the proportion of insured lending would be higher in Ann Arbor, and that of conventional lending accordingly lower, than the national average? Table 2 shows that in 1956 the ratio of conventional lending to total lending in Ann Arbor was actually 73 per cent, 4 percentage points higher than the corresponding national average of 69 per cent. What we have here is apparently a local exception to the general tendency described by the Gillies and Curtis' hypothesis. How can we account for this exception? A closer examination of Table 2 reveals two important circumstances. First, commercial bank activities with respect to conventional lending in Ann Arbor were quite a bit above the national average. While 66 per cent of the total volume of home mortgages recorded by all commercial banks in the United States were of the conventional type, the corresponding figure for Ann Arbor was 77 per cent. Second, “other lenders”-not an unimportant market force-were significantly heavier conventional lenders in Ann Arbor as compared with the national pattern. Thus, while only 25 per cent of the total volume recorded by “other lenders” in the United States was of the conventional type, the comparable figure for Ann Arbor was 76 per cent.3 These two factors combined were apparently more than enough to offset the unusually low conventional lending by life insurance companies in Ann Arbor and to raise the city's ratio of conventional lending to total lending above the national average. The fact that conventional lending in Ann Arbor was proportionately higher than the national average should not lead one to conclude that Ann Arborites were not getting their share of FHA financing. As can be seen from Table 2, 18 per cent of Ann Arbor's 1956 home mortgage recordings were FHA-insured, whereas the corresponding figure for the nation as a whole was only 10 per cent. However, VA financing was considerably more scarce in Ann Arbor. Only 9 per cent of the city's home mortgage recordings in 1956 were VA-guaranteed, whereas the corresponding national figure was as high as 22 per cent. What has caused this peculiar difference in the relative impacts of FHA and VA programs? Perhaps the most important single explanation of the relatively small volume of VA financing in Ann Arbor can be traced to the VA's own appraisal policy. Under the law on VA financing, a home loan is insurable only if the purchase price paid by the veteran for the property does not exceed the “reasonable value” of the property as determined by VA appraisers. However, VA appraisers operating in the Ann Arbor area have been overconservative in their determination of “reasonable value”-overconservative, that is, in relation to Ann Arbor's high construction costs and in relation to what the home buyers are willing and capable of paying. On the other hand, the FHA and conventional lenders have been more realistic about local conditions and are not concerned with setting legal upper limits on purchase prices. As a result of all this, sellers frequently find it more profitable to deal with home buyers who do not need VA financing. This disinclination toward VA financing on the part of sellers is responsible to a considerable degree for the different impacts of FHA and VA programs on the local market.4 Finally, it should be added that the willingness of Ann Arbor home buyers to pay prices higher than are considered “reasonable” by VA appraisers and their ability to meet the higher down payments under FHA and conventional financing partly reflect their above-average income and wealth positions.5 In a recent article, Gillies and Curtis advanced the hypothesis that the extent of government-insured mortgage lending in various areas could be predicted on the basis of the structure of local mortgage markets. Their argument was based on the primary assumption that lenders operating in local markets exhibit a clearly delineated set of actions or attitudes with respect to FHA or VA lending. This paper has shown that in 1956, at least, the market structure did not provide us with an accurate basis for predicting the impact of FHA and VA programs on the Ann Arbor market. This is due to the fact that major types of lenders there deviated significantly from their respective national patterns regarding the extent of conventional versus insured lending. The foregoing analysis also suggests that factors other than market structure could be significant in determining the impact of federal housing finance programs on specific markets. Other factors which may have been operative in the 1956 Ann Arbor market include the lending policies of local institutions; the income and wealth positions of home buyers; the level of local construction costs; and the appraisal policy of the VA. It seems clear, therefore, that what the predictability hypothesis of Gillies and Curtis describes is a general tendency—a tendency which is subject to local exceptions such as those which occurred in the Ann Arbor market

Lending institutions usually operate in a set pattern with respect to FHA and VA lending. That is, life insurance companies and commercial banks are stronger supporters of federal housing finance programs than savings and loan associations. Therefore, the impact of FHA and VA programs on specific markets is predictable. That is, in those markets where savings and loan associations are the predominant lenders the proportion of insured lending will be lower than in areas where life insurance companies and/or commercial banks predominate. The object of this note is to test the applicability of these conclusions to the city of Ann Arbor, Michigan, a non-metropolitan mortgage market. For the purpose of this note, “market structure” is defined in terms of the percentage distribution of home mortgage recordings among the various types of lenders.22 Gillies and Curtis defined market structure in terms of the proportion of outstanding mortgages held by each type of lender (ibid., p. 364). Since in the Ann Arbor mortgage market the volume of assignments has been small relative to total recordings, the two definitions of market structure are roughly interchangeable for operational purposes. Thus two markets would be “structurally” identical if each type of lender records the same proportions of mortgages in both markets. Under this definition, it is clear from Table 1 that in 1956 the structure of the Ann Arbor mortgage market differed in a number of ways from that of the national market as a whole. With the exception of mutual savings banks, all types of institutional lenders operating in the national mortgage market were repre-sented in the 1956 Ann Arbor market. About 38 per cent of the value of Ann Arbor's home mortgages was furnished by three savings and loan associations—the most important single source of funds. On a national basis, savings associations accounted for 35 per cent of home mortgage recordings. Next in importance to these mutual organizations were four commercial banks, which as a group recorded close to 24 per cent of Ann Arbor's home mortgages. The corresponding figure for commercial banks in the national market was 20 per cent. Life insurance companies, which recorded about 7 per cent of home mortgages on a national basis, were twice as important in the Ann Arbor market. As a group, they underwrote approximately $2.6 million of home mortgages, or 14 per cent of the Ann Arbor 1956 total. Because of the relative abundance of long-term funds from local and national institutions, individuals have been insignificant as a source of mortgage money in Ann Arbor. In 1956, only 3 per cent of the value of home loans on properties within the city were supplied by individuals. The individuals' corresponding share in the national market was 13 per cent. “Other” lenders, who accounted for the remaining 21 per cent of 1956 home mortgage recordings in Ann Arbor, included one trust company, one educational institution, and several mortgage and realty companies. So far, we have described the structural disparities between the Ann Arbor and the national mortgage markets. The question is, with what degree of accuracy can these disparities be utilized to forecast differences in the use of government mortgage insurance programs in the two markets? We know that life insurance companies and commercial banks are strong national supporters of FHA and VA programs; we have seen the greater combined importance of these groups in the Ann Arbor market. Can one predict, on the basis of these points, that the proportion of insured lending would be higher in Ann Arbor, and that of conventional lending accordingly lower, than the national average? Table 2 shows that in 1956 the ratio of conventional lending to total lending in Ann Arbor was actually 73 per cent, 4 percentage points higher than the corresponding national average of 69 per cent. What we have here is apparently a local exception to the general tendency described by the Gillies and Curtis' hypothesis. How can we account for this exception? A closer examination of Table 2 reveals two important circumstances. First, commercial bank activities with respect to conventional lending in Ann Arbor were quite a bit above the national average. While 66 per cent of the total volume of home mortgages recorded by all commercial banks in the United States were of the conventional type, the corresponding figure for Ann Arbor was 77 per cent. Second, “other lenders”-not an unimportant market force-were significantly heavier conventional lenders in Ann Arbor as compared with the national pattern. Thus, while only 25 per cent of the total volume recorded by “other lenders” in the United States was of the conventional type, the comparable figure for Ann Arbor was 76 per cent.33 According to detailed statistics, the predominance of a local educational institution (which restricts itself to conventional lending only) over trust, mortgage, and realty companies was largely responsible for the unusually heavy conventional lending on the part of Ann Arbor's “other lenders.” These two factors combined were apparently more than enough to offset the unusually low conventional lending by life insurance companies in Ann Arbor and to raise the city's ratio of conventional lending to total lending above the national average. The fact that conventional lending in Ann Arbor was proportionately higher than the national average should not lead one to conclude that Ann Arborites were not getting their share of FHA financing. As can be seen from Table 2, 18 per cent of Ann Arbor's 1956 home mortgage recordings were FHA-insured, whereas the corresponding figure for the nation as a whole was only 10 per cent. However, VA financing was considerably more scarce in Ann Arbor. Only 9 per cent of the city's home mortgage recordings in 1956 were VA-guaranteed, whereas the corresponding national figure was as high as 22 per cent. What has caused this peculiar difference in the relative impacts of FHA and VA programs? Perhaps the most important single explanation of the relatively small volume of VA financing in Ann Arbor can be traced to the VA's own appraisal policy. Under the law on VA financing, a home loan is insurable only if the purchase price paid by the veteran for the property does not exceed the “reasonable value” of the property as determined by VA appraisers. However, VA appraisers operating in the Ann Arbor area have been overconservative in their determination of “reasonable value”-overconservative, that is, in relation to Ann Arbor's high construction costs and in relation to what the home buyers are willing and capable of paying. On the other hand, the FHA and conventional lenders have been more realistic about local conditions and are not concerned with setting legal upper limits on purchase prices. As a result of all this, sellers frequently find it more profitable to deal with home buyers who do not need VA financing. This disinclination toward VA financing on the part of sellers is responsible to a considerable degree for the different impacts of FHA and VA programs on the local market.44 This paragraph is based on personal interviews with builders, real estate brokers, and mortgage lending officers operating in the Ann Arbor area. Finally, it should be added that the willingness of Ann Arbor home buyers to pay prices higher than are considered “reasonable” by VA appraisers and their ability to meet the higher down payments under FHA and conventional financing partly reflect their above-average income and wealth positions.55 In 1956, Ann Arbor “households” (defined here as an occupied dwelling unit) had an average disposable income of $10,856, almost twice as high as the corresponding national average of $5,720 (see Standard Rate and Data Service, Inc., Spot Television Rates and Data, XXXIX [May, 1957], 27, 260). In a recent article, Gillies and Curtis advanced the hypothesis that the extent of government-insured mortgage lending in various areas could be predicted on the basis of the structure of local mortgage markets. Their argument was based on the primary assumption that lenders operating in local markets exhibit a clearly delineated set of actions or attitudes with respect to FHA or VA lending. This paper has shown that in 1956, at least, the market structure did not provide us with an accurate basis for predicting the impact of FHA and VA programs on the Ann Arbor market. This is due to the fact that major types of lenders there deviated significantly from their respective national patterns regarding the extent of conventional versus insured lending. The foregoing analysis also suggests that factors other than market structure could be significant in determining the impact of federal housing finance programs on specific markets. Other factors which may have been operative in the 1956 Ann Arbor market include the lending policies of local institutions; the income and wealth positions of home buyers; the level of local construction costs; and the appraisal policy of the VA. It seems clear, therefore, that what the predictability hypothesis of Gillies and Curtis describes is a general tendency—a tendency which is subject to local exceptions such as those which occurred in the Ann Arbor market

In “the Federal Home Loan Bank System and the Control of Credit” (Journal of Finance, XII [1957], 319–32), Gordon W. McKinley set forth an erroneous analysis in support of the view that there is little or no need for the monetary authorities to exercise greater control over savings intermediaries. The principal errors in his analysis can be demonstrated by reconsidering the three questions he sought to answer (p. 320). Defining money as “anything which is normally, consistently, and generally used as a store of value and/or a medium of exchange” (p. 321), McKinley answered this question in the negative. What McKinley defined, however, is not money but assets. The unique property of money is that it serves as a store of value and as a medium of exchange. It is true that all stores of value which do not serve as means of payment are, in varying degrees, substitutes for holding money, but it is unnecessary and actually extirpatory of correct analysis to include these substitutes in the concept of money. If the concept of money is not restricted to those things serving as a medium of exchange, the concept of the velocity of the circulation of money, which McKinley misapprehended but did not abandon in his analysis, loses its significance. One can speak of time deposits, savings and loan shares, etc., as having a certain “rate of turnover,” but this is not the same concept as the velocity of the circulation of money. Time deposits and other savings claims turn over against money. In the same sense one can speak of the rate of turnover of inventories, real estate, used cars, or any other non-money asset. The turnover of money and the turnover of time deposits, savings and loan shares, and other non-money assets are obverse phenomena. Savings intermediaries, including the savings departments of commercial banks, do exert a quantitative effect upon monetary magnitudes. However, this effect is not on the quantity of money, as McKinley contended, but on the velocity of the circulation of money. By issuing very liquid substitutes for holding money, savings intermediaries make it quite easy for spending units to vary their ratios of total outlays to money balances. McKinley's analysis not only failed to delineate this velocity effect but actually obscured it, because of his incorrect definition of money. It is one thing to show that savings intermediaries are not free of Federal Reserve influence and quite another thing to show that the Federal Reserve can control these intermediaries so that their operations are not destabilizing. McKinley drew the latter conclusion, although his arguments (pp. 325–28) demonstrated only the former. In the face of a tight-money policy, savings intermediaries may find, as McKinley argued, that it is more difficult to induce spending units to give up demand deposits in exchange for savings claims, but a tight-money policy also raises yields on earning assets, thereby providing savings intermediaries with the means and incentive for more aggressive expansion of liabilities. Far from exercising effective control over the total of liabilities of savings intermediaries, Federal Reserve policy may contribute to destabilizing changes in the rate of expansion of the liabilities and, hence, the lending capacity of savings intermediaries. There is more reason to believe that Federal Reserve policy may influence the composition of assets of savings intermediaries than the total of their assets and liabilities, but even here the evidence is not nearly so conclusive as McKinley asserted. The decline in security prices associated with a tight-money policy may make savings intermediaries less willing to shift from securities to loans, but does this effect do any more than temper a strong, destabilizing shift? Effective control must surely go beyond the partial mitigation of destabilizing forces. It would have been helpful if McKinley had documented his allusion to the “clear statistical evidence in studies made by the Federal Reserve Board.” McKinley gave an affirmative answer to the first part of this question and a qualified negative answer to the second part, but unfortunately he failed to pose here the really pertinent question. That the Federal Home Loan Banks create certain deposit balances which members use as a means of payment is not crucial to the issue of whether their policies should be “consciously co-ordinated” with Federal Reserve policies. The relevant point is that, by making advances to members, the Federal Home Loan Banks provide a source of marginal liquidity in much the same way and with much the same effects as any central bank performing the function of lender of last resort. By varying the cost and availability of advances, the Federal Home Loan Banks not only alter the distribution of lendable funds but also affect the capacity of the entire financial system to hold debt, i.e., its capacity to generate lendable funds. McKinley conceded that in recent years the Federal Home Loan Banks “may have been motivated by a desire to exercise selective control over credit flows” and that “such use of their powers appears to be beyond the compass of legislation establishing the Banks and suffers also from the difficulty of co-ordination with Federal Reserve policy” (p. 332). What McKinley failed to recognize even in this regard, however, is that, whether or not the Federal Home Loan Banks are “motivated by a desire to exercise selective control,” they must at all times have some conscious policy with respect to the cost and availability of advances to members, and such policy, whatever it may be, has an effect upon the distribution of lendable funds. Over and above this qualitative effect, the operations of the Federal Home Loan Banks have a quantitative effect, because the banks are part of the mechanism determining the capacity of the financial system to generate lendable funds and to alter the velocity of the circulation of money. To attempt to measure the importance of the Federal Home Loan Banks in this regard would extend these remarks beyond the space limitations of this comment. Whether the quantitative aspects of the operations of the Federal Home Loan Banks should be consciously co-ordinated with Federal Reserve policy is part of the broader problem of controlling changes in the velocity of the circulation of money. It would be presumptuous to attempt within the space limitations of a comment to make a case that the Federal Reserve should have greater control of savings intermediaries. One thing is clear, however, McKinley's approach is not the way to demonstrate that such control is not necessary.

Peer Reviewed

The object of the National Bureau of Economic Research is to ascertain and to present to the public important economic facts and their interpretation in a scientific and impartial manner.The Board of Directors is charged with the responsibility of ensuring that the work of the National Bureau is carried on in strict conformity with this object.2