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(a) The question has arisen
whether notes issued by mortgage banking companies to finance their
acquisition and temporary holding of real estate mortgages are
eligible for discount by Reserve Banks.
(b) Under section 13 of the Federal Reserve Act the Board has
authority to define what are ``agricultural, industrial, or commercial
purposes'', which is the statutory criterion for determining the
eligibility of notes and drafts for discount. However, such definition
may not include paper ``covering merely investments or issued or drawn
for the purpose of carrying or trading in stocks, bonds, or other
investment securities''.
(c) The legislative history of section 13 suggests that Congress
intended to make eligible for discount ``any paper drawn for a
legitimate business purpose of any kind''4
and that the Board, in determining what paper is eligible, should
place a ``broad and adaptable construction'5
upon the terms in section 13. It may also be noted that Congress
apparently considered paper issued to carry investment securities as
paper issued for a ``commercial purpose'', since it specifically
prohibited the Board from making such paper eligible for discount. If
``commercial'' is broad enough to encompass investment banking, it
would also seem to include mortgage banking.
(d) In providing for the discount of commercial paper by Reserve
Banks, Congress obviously intended to facilitate the current financing
of agriculture, industry, and commerce, as opposed to long-term
investment.3 In the main, trading
in stocks and bonds is investment-oriented; most securities
transactions do not directly affect the production or distribution of
goods and services. Mortgage banking, on the other hand, is essential
to the construction industry and thus more closely related to industry
and commerce. Although investment bankers also perform similar
functions with respect to newly issued securities, Congress saw fit to
deny eligibility to all paper issued to finance the carrying of
securities. Congress did not distinguish between newly issued and
outstanding securities, perhaps covering the larger area in order to
make certain that the area of principal concern (i.e., trading in
outstanding stocks and bonds) was fully included. Speculation was also
a major Congressional concern, but speculation is not a material
element in mortgage banking operations. Mortgage loans would not
therefore seem to be within the purpose underlying the exclusions from
eligibility in section 13.
(e) Section 201.3(a) provides that a negotiable note maturing in 90
days or less is not eligible for discount if the proceeds are used
``for permanent or fixed investments of any kind, such as land,
buildings or machinery, or for any other fixed capital purpose''.
However, the proceeds of a mortgage company's commercial paper are not
used by it for any permanent or fixed capital purpose, but only to
carry temporarily an inventory of mortgage loans pending their
``packaging'' for sale to permanent investors that are usually
recurrent customers.
(f) In view of the foregoing considerations the Board concluded that
notes issued to finance such temporary ``warehousing'' of real estate
mortgage loans are notes issued for an industrial or commercial
purpose, that such mortgage loans do not constitute ``investment
securities'', as that term is used in section 13, and that the
temporary holding of such mortgages in these circumstances is not a
permanent investment by the mortgage banking company. Accordingly, the
Board held that notes having not more than 90 days to run which are
issued to finance the temporary holding of mortgage loans are eligible
for discount by Reserve Banks.
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