CRITICISM OF PLAN

Press, Volume LXXI, Issue 21412, 2 March 1935, Page 12

CRITICISM OF PLAN

# MORTGAGE BONDS MARKET WEAK SELLERS MAY BE A DANGER SOME FURTHER OBJECTIONS The possibility of the whole of the structure of the National Mortgage Corporation collapsing under the weight of weak sellers anxious to convert bonds into cash is seen as one of the major objections to the corporation by Mr J. D. McMillan, of Wellington, the author of a pamphlet criticising' the proposals. After dealing in great detail with the objections to the scheme, the pamphlet offers what Mr McMillan considers are safer and more simple remedies.

In an introductory note, the writer says that while he realises the need for centralised control, he has grave fears that the freedom promised in Mr Coates's pamphlet may become compulsion, and he later amplifies this argument to show that the whole of the control of money in New Zealand might pass to the hands of the Minister for Finance, with disastrous results if the Minister happened to be either a weak man or a man with ambitions for power. Mr McMillan divides his criticism under six heads, and treats it from the viewpoint of the corporation itself, the shareholders, the bondholders, the mortgagors, the mortgagees, and the State. The corporation is unsound, he says, because it permits advances of up to 70 per cent, without guarantee, and up to 80 per cent, with a guarantee of valuation. The Danish Credit Associations are permitted to advance up to 60 per cent, on first mortgage, and advances rarely went beyond 40 to 45 per cent. Flat mortgages did not exceed one-third of the valuation. In the United States, the Federal Land Banks and Joint Stock Land Banks were not permitted to lend more than 50 per cent, of the valuation, and advances must be passed by the Federal Farm Loan Board. What was prudent and wise was so well known and widely practised in New Zealand by the State itself that no argument was necessary. The Reserve Fund The ability to issue up io 20 times capital and reserves was unsafe in view of the established practice in other countries. The reserve fund, apart from the capital subscribed, was a borrowed reserve, and was therefore possibly unique and to some extent illusory. The permanent reserve fund would be of benefit only to the next generation of borrowers and bondholders, if it was ever successfully established.

The effect of the State guaranteeing 10 per cent, of an 80 per cent, advance and claiming release as soon as 10 per cent, of the capital was repaid put the corporation in much the same position as if it lent 70 per cent, on flat mortgage for four or five years, which would probably be the time necessary to repay the 10 per cent. The corporation received no direct benefit from amortisation for that period, and the bondholders' risk was increased proportionately. "Taken singly," says the pamphlet, "any one of the above criticisms may not be of first-grade moment. Taken as a whole they place the corporation on a basis which is less prudent that experience has taught others is wise, and it is safe to say that no mortgage company operating in New Zealand today (Government or otherwise) would make advances up to 70 or 80 per cent. If you doubt it, apply. It is difficult to see how, then, by lumping all our troubles in an immense corporation, the difficulties and dangers so patent to all lenders to-day, will fade and leave scathless the new undertaking. The corporation in every respect is less sound than is desirable." The Shareholders Dealing with the shareholder's position, the pamphlet says that from the arguments already given, it must be an unhappy one. The right of the Minister for Finance to deflect profits after approved dividends and special reserves have been provided for, puts him at the mercy of one man. To-day's Minister might take an equitable view. To-morrow's might say, "The State before the individual."

The pamphlet goes on to detail the liabilities assumed by the share capital in conjunction with the State contribution in its guarantee of the debentures issued against an unknown value of assets when the State Advances mortgages are handed to the corporation. The shareholder, it is stated, immediately assumed responsibility for a one-fourth share of whatever losses may be suffered on the State mortgages taken by the corporation in exchange for debentures. A great deal depended on the "safe proportion" decided on by the directors when they took over. The shareholders, too, stood last in the line. Even if the borrowed reserve was lost it had to be paid back, and the shareholder thus started by supporting a liability of, say, £50,000,000, the responsibility for building up adequate reserves, and then paying the borrowed reserves back, with all the time the Minister for Finance to be considered. The pamphlet issued by Mr Coates pointed out that there was at present no reliable basis for valuation, and the shareholder would thus be liable for the mistakes made by the field force in arriving at valuations where there is no basis for valuation. Bondholders and Shareholders Bondholders were a shade better off than the shareholders. There was no stabilisation fund, and the pouring on to the market of the volume of bonds needed if refinancing was to be done on the scale needed would give every encouragement to depreciation. If the demand for money firmed the interest rate, bondholders would be in for an unenviable time. The debentures were definitely risky. The mortgagor had three choices. He could have a voluntary settlement approved by the court of review, he could accept supervision of the Rehabilitation Commission for five years, with a further five years' probation, or he could walk off. Any farmer who submitted to the 10-year term deserved it, and the point was not worth arguing. The real point was that under a private mortgage corporation he would not be allowed to refinance at more than 60 per cent, of the valuation, but under the proposals he would be allowed to refinance at 80 per cent. Refinancing through the corporation would therefore leave a far greater burden on his back. If the mortgage was for £3OOO, under private control

it would be adjusted at £IBOO, but under the corporation it would be adjusted at £2400. The mortgagee had two options, voluntary adjustment or a "stay order" and 80 per cent, of the value of the farm in five years' time, with 50 per cent, of any equity that might accrue at the end of another five years. It appeared to I. j Hobson's choice. If the mortgagee refused to accept what the court to-day considered just, he could accept 80 per cent, of what an unknown valuer might consider just in five years' time. The mortgagee who accepted that arbitrary fixation and risked the 10-year term would surely be a speculator to gamble on what he might get in five years' time. Risks to State The State might very easiiy substantially increase its losses by the transaction with the Mortgage Corporation. Assuming that the State held good mortgages to the value of £50,000,000, they would be exchanged for corporation debentures. The value of the exchange would depend on the market quotation for debentures. It was reasonable to suppose that a fair proportion of those holding debentures would in the first year want to convert them into cash. Weak holders depressed the market. If the corporation issued £10,000,000 worth of debentures in the first year, perhaps £2,000,000 worth might come on the market. Let there be one hitch, one evidence of want of confidence, or one indication that sellers were weak, and buyers would hold off. Debenture prices might drop to 90 per cent., and the State, if it wished to sell, would have dropped £5,000.000. Assuming that reviving prosperity brought about a demand for money, what would be the price of 3i per cent, mortgage bonds? No private holder of bonds to the value of £5,000,000 would invite 10,000 holders, many of whom might be weak, to pool with him so that together they might all sink or swim on the market. If the private lender would not do it, the State should not do it. Further, no sound financial institution in New Zealand to-day would take over £50,000.000 worth of State Advances securities without the most thorough investigation of every security. Therefore the public should not be asked to do so.

A drop in prices of the debentures during the first year would bring the whole giant machine to a standstill. If within several years the debentures issued to the State were £50,000,000 and to the public the same amount, and if from no other cause than dearer money the value of 3J per cent. National Mortgage debentures dropped to 70, then the securities held by the State would have depreciated by £15,000,000, and those held by the public to a like amount, making a total of £30,000,000 to be retrieved by the State if it wished to take some action to bring bonds back to par. Safeguarding: Investors "It may be said that I take a pessimistic view," Mr McMillan says. "In the formulation of such proposals questions of optimism and pessimism do not enter. It is the plain duty of those who will lead the public to invest to use every safeguard consistent with the nature of the investment. Speculators do not expect safeguards. Investors do."

In submitting details of a plan to effect refinancing through local controlling bodies, allowing growth to be along sound financial lines, the pamphlet states two essentials. The first is to give the mortgagor hope and to make it possible for him to carry on at present prices. The mortgagee was forced to do this in his own interests. The second was that to restore to the mortgagee any present concession by way of adjustment if prices rise say within five years, or if the farm is sold at a profit during an agreed period.

Alternative Proposals Mr McMillan suggests:— (1) A National Mortgage Board, whose chief functions would be to grant charters to and supervise subsidiary mortgage corporations. Many legal firms in the Dominion, he says, could run a company within their offices. (2) The corporations, with directors approved by the board. Any responsible group of men should be permitted to form a corporation (provided there was no wasteful overlapping) and the debentures of all such corporations should rank as trustee securities. If however, only the debentures of the national corporation were trustee securities, private enterprise would be completely eliminated. Adequate protection against the debentures depreciating through the market operations.

(4) Relief commissions to remain and be represented on the national mortgage board which might coordinate the activity of relief commissions. (51 Amendments to relief legislation to permit voluntary adjustment and elimination from the Mortgagor's Relief legislation by consent. (6) A simple basis of present adjustment with restoration according to price levels. (7) Minimum of state interference.