It’s not every day that a regulator for a trillion-dollar bureaucracy nearly 100 years old signals that a total overhaul may be in order. But that’s what happened when new Federal Housing Finance Agency Director Sandra Thompson told Congress she was beginning a comprehensive review of the Federal Home Loan Banks’ mission and operations ( FHLB).
It seems that the FHLB’s long history of resistance to change is coming to an end. This story has served them, if not the nation, well over the years. One can only hope that the darkness in which they have operated for 90 years is about to end.
But first a primer on FHLBs.
The FHLBs are 11 quasi-governmental institutions scattered across the country, from Boston to San Francisco. They were created during the Great Depression of the 1930s by an act of Congress. The initial mission of the FHLBs was to provide much-needed assistance to the housing finance market. Their owners are 6,800 banks and insurance companies of all sizes.
FHLBs survive on a subsidy from the taxpayers of all debt securities they issue, plus a statutory exemption they enjoy from paying federal, state, or local taxes. Their low public profile contrasts with the enormous influence they quietly wield in the halls of Congress.
FHLBs make their money by borrowing cheaply in the money market at preferential rates subsidized by taxpayers. They again lend these funds exclusively to their owners, banks and insurance companies. The FHLBs add a slight markup, but even after that the banks still get a better rate than they could on their own, for example by paying higher deposit rates to their customers.
Less than a year ago, borrowing from FHLBs was at an all-time low, with banks and others teeming with cash thanks to the Fed’s monetary policies. Today, these borrowings have jumped 46% (146% in just one of the FHLBs). This access to borrowing at the 11 FHLB counters is one of the main reasons why banks are slow to raise interest rates for customers at the counters of their counters.
Regardless of the mercurial use of their facilities, one thing has become abundantly clear about the FHLBs; they no longer fulfill a public mission as before. Distinguished commentators have pointed to the Emperor’s lack of clothing. They questioned the rationale for the ongoing government subsidy of FHLBs.
It’s no wonder the FHLBs are doing what they’ve always faced with a challenge… retreating into foxholes. But this time it’s different.
This time, in addition to a skeptical regulator, they are faced with the problems of irrelevance, inefficiency and the growing awareness that their operations are contrary to the best interests of depositors and the public.
At the time of their creation, the members of the FHLBs were exclusively savings and credit associations and insurance companies active at the time in the origination of mortgage loans. The FHLBs could be sure that the proceeds of their loans to these two groups would end up in the housing markets. Not anymore.
Today, FHLB members are mostly commercial banks that have long sold mortgages to non-banks such as Quicken. And few, if any, of the insurance companies that operate FHLBs provide mortgages. Add to this the emergence of securitizations as the dominant tool adding liquidity to the mortgage market and it is easy to see why so many have described FHLBs as off topic.
Thompson’s review will seek a new mission for the FHLBs. The modern mission should take into account the needs of the economy for affordable housing, infrastructure and small businesses. Perhaps “home” should be dropped from the FHLB title as being too restrictive.
The second weakness of FHLBs is inefficiency. The 11 FHLBs sell identical products in each of their districts. There’s no need for 11 duplicate IT systems and 11 C-suites (many of which receive multimillion-dollar compensation) providing redundant quasi-government services.
The only cost justification for this duplication is if, in a redesigned FHLB system, new products, new members, and new warranty requirements require the expertise of personnel and systems not currently on board. Failing that, massive FHLB consolidation should be one of the results of Thompson’s review.
Third, banks use their FHLBs to raise funds that they would otherwise pay at higher interest rates to their own depositors. This can only be justified if the FHLBs add public value in exchange for their taxpayer subsidy. They are not.
These and other questions will be addressed during the review, FHLBank System at 100: Focusing on the Future, which was officially launched in the past few days.
Focusing on the future promises to be a transparent and dynamic process. This is good news for the public interest. Operating in daylight, however, could prove to be a challenge for the 11 FHLBs.
William Isaac, former chairman of the FDIC (1978 to 1985) and former chairman of Fifth Third Bancorp, is chairman of the Secura/Isaac group. Cornelius Hurley was an independent director of the Federal Home Loan Bank of Boston (2007-2021) and teaches financial services law at Boston University.
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