The GSE Public-Private Hybrid Model Flunks Again: This Time It’s the Federal Home Loan Bank System (Part 2)

March 11, 2024
Donald H. Layton

The core thesis of this two-part article is that the congressional design of GSEs has a fundamental flaw: that subsidies and privileges given to a GSE will inevitably, over time, drift to being used unduly to produce stand-alone profit to benefit their owners and executives, and too little to support its intended mission. In other words, the profit-versus-mission balance originally intended by Congress in the GSE public-private hybrid business model flunks3 in the long term, drifting towards too much of an emphasis on profit and too little on mission. In this view, this is the root cause of the distortions and problems found at GSEs, including the FHLBs.

The Role of Federal Home Loan Banks in the Financial System

March 7, 2024
Congressional Budget Office

CBO describes the role of Federal Home Loan Banks (a government-sponsored enterprise) in financial markets, their financial condition, the value of the federal subsidies they receive, and the risks they pose.

The Federal Home Loan Banks Support System Stability

November 2023
Damien Moore, Martin Wurm, and Mark Zandi, Moody's and The Urban Institute

The Federal Home Loan Bank (FHLB) system has faced a barrage of criticisms recently, one of the most common of which has been that the FHLBs increase instability in the financial system. In this brief, we address this argument by explaining how the FHLBs stabilize the financial system in times of stress and showing how the system reduces the risk of bank failure, particularly for the nation’s smaller banks.

We model the impact of FHLB lending on a bank’s probability of failure, considering year-over-year changes in multiple measures of a bank’s financial strength, including FHLB advances, share of FHLB advances as a percent of total assets, Tier 1 capital, nonperforming assets, liquid assets. The model results show that an increase in a bank’s use of FHLB funds reduces its odds of failure by as much as a third, and for smaller banks with $50 billion or less in assets, the impact is greater. Ultimately, the FHLBs are a critical source of stability to the financial system, not instability. The FHLBs could use some updating, but that means building on this critical, if poorly understood, network of institutions to serve more of the financial system, not handicapping them.

In Defense of the Federal Home Loan Banks
April 2023
Jim Parrott, Mark Zandi
Much of the discussion thus far has been critical of the system, driven largely by concern that the FHLB system’s role is ill-defined

and overly broad, affording its members significant economic benefit for which the taxpayer receives too little in return. We believe this is based on a misconception of the role of the FHLB system, which depends in large part on the breadth of its reach and the benefit it provides its members. In this brief, we clarify how this system works, how it benefits the mortgage market and the broader economy, and how it can be improved with some modest changes.

Improving The Government’s Lender of Last Resort Function: Lessons From SVB and Signature Bank

April 24, 2023

Greg Baer, Bill Nelson, Patrick Parkinson and Brett Waxman, Bank Policy Institute
While failures of SVB and Signature Bank have raised questions about examination, regulation and resolution, a fourth area requires considerable review and likely reform: the lender of last resort function

How the FHFA Can Increase Federal Home Loan Bank Affordable Housing Investments
March 2023
Michael Stegman for the Urban Institute

The Federal Housing Finance Agency (FHFA) has initiated a sweeping review of Federal Home Loan Banks (FHLBanks) as the system enters its 10th decade focusing on, among other issues, how the system can return to its historical mission of providing liquidity to financial institutions across the country to expand mortgage lending in a changing marketplace, and finding sensible ways to strengthen the “FHLBanks’ role in promoting affordable, sustainable, equitable, and resilient housing and community investment,” the subject of this brief.

Federal Home Loan Banks and Financial Stability Harvard Public Law Working Paper No. 22-20
June 2022
Gissler, Stefan and Narajabad, Borghan and Tarullo, Daniel K.,
The Federal Home Loan Banks are the less well-known siblings of Fannie Mae and Freddie Mac. Since these government-sponsored enterprises were created in 1932, changes in housing finance markets have rendered largely irrelevant their original purpose of increasing the availability of mortgages. Yet the level and scope of their activities have increased dramatically in recent decades. These activities have at times both exacerbated risks to financial stability and obstructed the missions of federal financial regulators. Behind these undesirable outcomes lies the public/private hybrid nature of the FHLBs. The private ownership and control of the FHLBs provide the incentive to take advantage of the considerable public privileges from which they benefit – including an explicit line of credit from the United States Government and an implied guarantee of all their debt similar to that enjoyed before the Global Financial Crisis by Fannie Mae and Freddie Mac. This paper examines the past incidence and future potential for the FHLBs to amplify financial stability risks. It offers a framework for regulatory reform by the Federal Housing Finance Agency to contain these risks and avoid harmful interference with the activities of other federal regulators.

FHLBs are in vogue
May 2023
Silicon Valley Bank
Key takeaways: FHLBs, a type of agency bond, have gained popularity thanks to their yield potential, lower perceived risks, and diversification benefits. FHLBs have a strong track record and carry the implicit backing of the U.S. government, making them an intriguing option to Treasuries given the rancorous debt ceiling discussions. Although FHLB demand and issuance as surged to record levels, their embedded risk protocols should not worry investors, in our opinion.

Federal Home Loan Bank May Save Borrowers Money, Level the Playing Field for Small Banks
Feb. 4, 2021
Dayin Zhang
Buying a home is likely the most important personal finance decision a consumer can make. In the U.S., the mortgage market is heavily dominated by the government. Government policies and interventions, such as low-cost wholesale funding implemented by the Federal Home Loan Bank (FHLB), are designed to improve the odds of home ownership—to achieve the American dream. Access to wholesale funding ideally makes it easier for bank lenders in need of liquidity to borrow from FHLB, thereby passing that cost reduction on to prospective homeowners.

The Federal Home Loan Bank (FHLB) System and Selected Policy Issues
August 27, 2020
Congressional Research Service

Should Nonbank Mortgage Companies Be Permitted to Become Federal Home Loan Bank Members?
June 2020
Karan Kaul and Laurie Goodman
In this comment letter, we assess whether FHLB membership should be expanded to include other types of institutions not currently eligible for membership. We focus on independent mortgage bankers, commonly known as nonbank mortgage lenders and servicers. Nonbanks have drastically expanded their mortgage market activities over the past decade, accounting for 90 percent of lending backed by the Federal Housing Administration (FHA) and the US Department of Veterans Affairs (VA) and about half of all lending backed by Fannie Mae and Freddie Mac. Yet they do not enjoy the same access to federally backed lending that depositories do. This strains nonbank liquidity, especially during downturns, such as the present COVID crisis. This comment letter thus addresses the question of whether nonbanks should be eligible for membership.

Unintended Consequences of Post-Crisis Liquidity Regulation
Nov. 2, 2018
Sundaresan, Suresh M. and Xiao, Kairong
Post-crisis liquidity regulations have led to a new realignment among banks, government-sponsored enterprises, and money market funds. Banks increasingly draw liquidity from government-sponsored enterprises known as the Federal Home Loan Banks (FHLBs) to meet the Liquidity Coverage Ratio requirement. The FHLBs, in turn, increasingly obtain liquidity from MMFs because Money Market Reforms discourage MMFs' lending to private institutions. This new realignment may reduce the effectiveness of liquidation regulations and introduce fragility. Our findings highlight the importance of moving the fragmented regulatory landscape towards a more coordinated approach.

The Federal Home Loan Bank System: A Chronological Review and Discussion of Key Issues
June 2017
George J. Gaberlavage, Consumer Federation of America
In this context of potential far reaching changes in the federal government’s support for housing and home finance, CFA commissioned this extensive summary of the Federal Home Loan Banks and their evolving mission and membership. Prepared by George Gaberlavage, Principal at Orleans Street Policy Works, LLC and former Policy Integration Director at AARP, it is meant to provide consumers, elected and appointed officials with a comprehensive review of the system. We hope it will help inform all those involved in considering the future of such support.

Federal Housing Finance Agency Office of Inspector General: An Overview of the FHLBank System’s Structure, Operations, and Challenges
2012
Produced by The Florida State University (FSU) Center for Economic Forecasting and Analyses (CEFA)

The Federal Home Loan Bank System: The Lender of Next-to-Last Resort?
November 2008
Adam B. Ashcraft, Morten L. Bech, and W. Scott Frame, Federal Reserve Bank of NY Staff Reports
The Federal Home Loan Bank (FHLB) System is a large, complex, and understudied government-sponsored liquidity facility that currently has more than $1 trillion in secured loans outstanding, mostly to commercial banks and thrifts. In this paper, we document the significant role played by the FHLB System at the onset of the ongoing financial crises and then provide evidence on the uses of these funds by the System’s bank and thrift members. Next, we identify the trade-offs faced by member-borrowers when choosing between accessing the FHLB System or the Federal Reserve’s Discount Window during the crisis period. We conclude by describing the fragmented U.S. lender-of-last-resort framework and finding that additional clarity about the respective roles of the various liquidity facilities would be helpful.

Should the FDIC Worry about the FHLB? The Impact of Federal Home Loan Bank Advances on the Bank Insurance Fund
July 2005
FDIC Center for Financial Research Working Paper No. 2005-10
Does growing commercial-bank reliance on Federal Home Loan Bank (FHLBank) advances increase expected losses to the Bank Insurance Fund (BIF)? Our approach to this question begins by modeling the link between advances and expected losses. We then quantify the effect of advances on default probability with a CAMELS-downgrade model. Finally, we assess the impact on loss-given-default by estimating resolution costs in two scenarios: the liquidation of all banks with failure probabilities above two percent and the liquidation of all banks with advance-to-asset ratios above 15 percent. The evidence points to non-trivial increases in expected losses. The policy implication is that the FDIC should price FHLBank-related exposures.