Reinventing the Federal Home Loan System
A vital cog in the US financial system is at risk. For 89 years, the Federal Home Loan Bank System has been a trusted source of liquidity for most banks, credit unions, and insurance companies nationwide. Without significant change, this remarkable public-private partnership is coming to an end.
Created in 1932 during the last days of the Hoover administration, this complex structure of 11 – 12 at the time – banks scattered across the United States has been a bulwark of our financial system. Member-owned but federally supported, these 11 banks provided emergency liquidity to their members through secured advances. The system is able to finance itself through the debt securities it issues that carry reduced risk premiums due to the implied guarantee of the federal government.
The mortgage banks that make up the system are jointly owned by the financial institutions in their districts. This is in stark contrast to their distant cousins from government-sponsored companies, Fannie Mae and Freddie Mac, which were owned by profit-seeking shareholders and are now under trusteeship. Each federal mortgage bank devotes a significant portion of its net income to affordable housing and economic development in its district.
Through the Great Depression, numerous recessions, the fear of the year 2000, the savings and loan collapse, and other strains in the financial markets, the system has been a stable source of funding for financial intermediaries. . Long before the Federal Reserve deployed its “urgent and demanding” instruments during the 2008 financial crisis, the system offered a funding oasis when few others were in sight.
Now, this beacon of the financial system itself is in jeopardy – not because of its own missteps, but rather because of the pandemic actions of the same federal government that created it. The Federal Reserve has so flooded the financial system with liquidity that the members who own the banks of the system no longer need to borrow from it, thus questioning its raison d’être.
Advances to member institutions, the cornerstone of the system, currently amount to $ 350 billion. This contrasts with the $ 658 billion two years ago. System assets, over $ 1.2 trillion during the financial crisis, are now about half of that. This is not a jolt, this precipitous drop in advances and assets should persist in the years to come. Moreover, even when interest rates normalize, the system will still face enormous challenges from its members with other competitive sources of funding available to them.
It would be easy, given its diminishing use and relevance, to hand the system over to, say, the Civil Aeronautics Council and other government agencies that have exceeded their targets. The banking home loan system, however, is different. Like a important study observed, the 11 mortgage banks “make a difference in what is done in the world”. Indeed, they do. From affordable housing to job creation, economic development, the preservation of community banks, the system and its banks have made a difference.
The question is: will mortgage banks be relevant in the future?
Most would like government and quasi-government institutions to be as lean and efficient as possible. Focusing this lens of efficiency on the system at this point could easily lead to the conclusion that the system should be dissolved or that all 11 banks should be consolidated. Before it gets relegated to the bureaucratic dust heap, however, a closer look should focus on its unique business model and how, with modest modifications, it could be reused to meet the challenges of the world. modern era.
The system combines the benefits of federal government support with local vision and control on the ground through its semi-autonomous federal mortgage lending banks. Each bank is closely monitored by the Federal Housing Finance Agency. The board of directors of each bank is made up of member directors and independent directors from its region. All banks are jointly responsible for the obligations of their peers, adding a level of self-discipline that is reinforced. By law and culture, the system is mission-driven – perhaps even wrongly.
Congress, having created the system, should take a close look at its potential social and economic usefulness. Such an analysis will likely lead to the conclusion that the system’s business model, although outdated, is particularly suited to today’s financial needs and challenges.
In this important undertaking, recent remarks Acting Currency Comptroller Michael Hsu is informative. He directly addressed the problem that banks face when challenged by fintechs invading their regulatory perimeter. Rather than abandoning the usual position of broadening the regulatory scope of banks to include fintechs, he challenged banks, fintechs and regulators to reinvent the regulatory scope for the modern era, an approach he described as “an upgrade”.
If Congress chooses this more enlightened route of upgrading the federal home loan system, the framework for doing so is relatively clear. The adjustments needed to restore the current relevance of the system fall into three categories. They are: the mission, the membership and the guarantees. To guide you in examining each category, to paraphrase the late Senator Robert Kennedy, the most productive investigation is not “Why?” ” but why not?”
Regarding the mission of the system, why not expand it beyond housing finance to include finance initiatives in the areas of climate change, infrastructure development and economic equity? The current mission has been interpreted narrowly by the FHFA and even more narrowly by each of the banks. Yet the demands of today’s economy have far exceeded those of the 1930s.
When it comes to membership, why not open up membership eligibility to small business lenders nationwide who create two-thirds of all new jobs, fintechs that promote financial inclusion, and non-banks to the origin of most current home loans? The leveled perimeter will include many of them, and furthermore, banks and credit unions are an increasingly small part of the financial system.
Regarding guarantees, why not extend the guarantees eligible for system advances to include the many asset classes, in addition to mortgages, which support the more modern mission of the new system? Housing is vital, but so are roads, bridges, renewable energy, small businesses and sustainable farms. Why not broaden the scope of the guarantees that each bank in the system can accept as collateral for its advances?
Here is the challenge.
The system enjoys a huge financial advantage. However, the change is unlikely to come from within its ranks. Member institutions tend to view their modest ownership interests in their respective federal mortgage loan banks as a claim on the capital of each bank. Members generally fail to recognize that every bank’s capital, including over $ 22 billion in retained earnings, has been accumulated over nine decades largely through the implicit federal guarantee of the system’s debt obligations.
The upgrade process should make every enlightened member-owner of Federal Home Loan Banks recognize that the increased value of their investment in a redesigned and dynamic system far outweighs any short-term dilution of their current investment. in the banks, which are in a state of secular decline. The system will survive through growth, not one-off spending cuts.
Thus, change will have to come from informed external sources. The possibility for the Biden administration to appoint a new forward-looking leader (including the appointment of the current interim director) to lead the FHFA is one such source. The same goes for the many and varied players who could benefit from having access to a new and improved system. Nowhere does it write that upgrading has to be a painful exercise. It can also open many doors of opportunity.
The opinions expressed are solely those of the authors and do not necessarily represent the views of any organization with which the authors have been or are now affiliated.