Debate over financial regulatory reform has been far-reaching (see Brunnermeier et al. 2009 and Wyplosz 2009). Yet one set of institutions has gone largely unnoticed: the Federal Home Loan Bank (FHLBank) system, a government sponsored enterprise composed of 12 regional bankers’ banks that has been at the centre of sustainable home ownership finance in the US since 1932 .
The lack of attention by lawmakers is not entirely a surprise. The Federal Reserve has long overshadowed the FHLBank system. Moreover, FHLBank leaders and supporters may well prefer flying under the Congressional radar to wait out the present financial storm. Regardless of the reason, we show in our recent book Mission Expansion in the Federal Home Loan Bank System (Cassell and Hoffmann 2010) that by neglecting the FHLBank system, lawmakers miss a chance to tap the most important source of housing finance expertise in the federal government. In addition, we lose an opportunity to reform the FHLBank system, which, while not at the centre of the current foreclosure and financial crisis, was certainly a player.
Tap the FHLBank system’s housing finance expertise
Responding to the home mortgage foreclosure crisis of the Great Depression era, President Herbert Hoover spearheaded construction of a national system of Home Loan Banks. Modelled on the Federal Reserve, the FHLBank system’s size and implied government guarantee enables Home Loan Banks to raise money collectively and cheaply in the capital markets and make wholesale loans – termed ‘advances’– to member institutions, primarily for homeownership lending. Thus, for 78 years the FHLBank system has been the primary source of housing finance expertise in the US. Lawmakers should take advantage of such expertise in two ways.
First, Congress and the administration should recognise that the FHLBank system has demonstrated administrative capacity to understand and oversee the range of functions necessary for responsible, sustainable home ownership finance including regulating mortgage structure, supervising mortgage origination, and licensing mortgage bankers. Consumer protection in housing finance should be placed with the FHLBank system’s regulator, the Federal Housing Finance Agency, and not with the Federal Reserve or the proposed Consumer Financial Protection Agency.
Second, federal policies to minimise the societal harm from foreclosures, including the Home Affordable Foreclosure Alternatives Program, should be placed in the FHLBank system, the agency whose primary mission for the past seven decades has been housing finance. At present foreclosure policies are housed mainly in the Department of Treasury, an agency with relatively little housing finance expertise.
The FHLBank system requires reforms
While it is an important resource that should be tapped, the FHLBank system also requires reform. IndyMac Bank and Countrywide Bank, two of our most notorious dealers of toxic loans, were both enabled by the cheap liquidity they received from the FHLBanks of San Francisco and Atlanta, respectively. A recent report by the Federal Housing Finance Agency found that in 2008, a fifth of the collateral used to secure advances from the FHLBanks were either non-traditional, subprime or Alt-A loans. The FHLBank system has taken important internal steps to tighten its lending and underwriting standards. Despite this, we suggest three major institutional reforms are also needed.
First, a cap should be placed on the size of depository institutions eligible for FHLBank system membership. There are approximately 8,000 members of the FHLBank system, most are small- and medium-sized commercial banks and savings and loan associations serving all regions of the country. Yet four institutions - Bank of America, JPMorgan Chase, Citigroup, and Wells Fargo – control 31% of the stock in the Federal Home Loan Bank system. Enabling such large institutions to grow even larger through access to cheap liquidity is unnecessary and destabilising. These private institutions are large enough to raise capital on their own without the support of the federal government and taxpayers.
Second, lawmakers should refocus the FHLBank system’s attention on its public purpose by making the system more like the Federal Reserve Banks and less like Fannie Mae and Freddie Mac. While FHLBanks’ boards of directors would have discretion regarding the dividend they pay to member institutions, Federal Reserve Banks would pay members a dividend that is fixed in statute. Federal Reserve system earnings, after covering the system’s costs of operation, would be turned over to the Treasury. Such a reform would not guarantee that Federal Home Loan Banks stays on mission, but it would relieve pressure on FHLBank managers to make policy decisions intended to maximise dividends potentially at the expense of taxpayers.
Edward DeMarco, acting director of the Federal Housing Finance Agency, recently criticised FHLBanks’ risky investments and called on them to return to their core mission of providing advances for home mortgage lending. Capping dividends is one step to achieving that goal.
Finally, again in keeping with the Federal Reserve model, Congress should eliminate fixed assessments on FHLBanks. Currently, FHLBanks are obligated to make an annual payment to cover the Savings and Loan bailout of the 1980s and a 10% assessment to fund affordable housing programmes. As a practical matter, the S&L obligation is almost paid off and should be wound down as planned, but we recommend eliminating the obligation for affordable housing. Let FHLBanks make decisions based on the need for housing finance in the economy, the viability of member institutions, best practices in home mortgage structure, and the institutional stability of the FHLBanks – not on an imperative to make money. Let earnings after the cost of operations revert to the Treasury or be restricted for housing and community development needs. The latter option is likely to result in more, not fewer, funds for affordable housing and community development.
Comparisons between the present financial crisis and the Great Depression are often overstated. Yet, the public institutions that helped solve the financial crises of the 1930s offer a resource to lawmakers today, albeit with some needed adjustments. As reforms to America’s financial regulatory structure are finalised, elected officials should finally take note of the FHLBank system, America’s greatest resource in housing finance.
Figure 1. FHLBank System Assets, 1989-2007 (Dollar amounts in billions)
Cassell, Mark K and Susan M Hoffmann (2010), Mission Expansion in the Federal Home Loan Bank System, SUNY press.
Brunnermeier, Markus K, Andrew Crockett, Charles A Goodhart, Avinash Persaud, Hyun Song Shin (2009), The Fundamental Principles of Financial Regulation, CEPR Geneva Reports.
Snowden, Kenneth A (2010), “Is this your grandfather’s mortgage crisis?”, VoxEU.org, 10 September.
Wyplosz, Charles (2009), “The ICMB-CEPR Geneva Report: “The Future of Financial Regulation”, VoxEU.org, 27 January.