Regulation A Sec. 201.109 Eligibility for discount of mortgage company notes.
(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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