About six months ago I co-wrote a Bank Think article stating that, in light of its declining fortunes and its failure to adapt to a changing marketplace, the mission of the Federal Home Loan Bank System ought to be reevaluated. I followed that up weeks later with an open letter to FHFA director-designate Sandra Thompson, who regulates the system.

These articles led to a particularly useful meeting with Ms. Thompson and her senior staff on the topic. Later at a public event, Ms. Thompson commented favorably on the notion of establishing an advisory committee to explore the possibilities of modernizing the Home Loan Bank System.

Headquarters Of The Federal Housing Finance Agency

These calls for reform were met with silence from the System and from the Federal Home Loan banks. Then last week, a community banker who also serves as vice chair of the American Bankers Association, came to the system’s defense. Her exhortation, “Don’t mess with success,” was a disappointment. Touting the dubious success of a deeply flawed system fails to recognize the enormous potential of that system.

Success? This is the same system that had to be relieved it of its responsibilities as a regulator and of its critical role as a deposit insurer. Its inferior performance in both capacities materially contributed to the savings and loan crisis of the 1980s. This is the same system that also contributed to the 2007-9 financial crisis by lending to the likes of Countrywide Mortgage, IndyMac, etc., and by purchasing enormous amounts of toxic private-label mortgage-backed securities (PLMBS) loaded up with subprime loans.

Resting on its questionable laurels is not a sound strategy. Better to have embraced the future.

Instead, the defense of the system relies on the same tropes and half-truths that have underpinned it for decades. For example, we heard the shopworn boast that “ … no Home Loan bank has ever suffered a loss on an advance in the system’s 90-year history.”

To begin with, what would you think of a bank that in ninety years of operations never suffered a loss on a loan? Would it conjure up George Bailey … or Old Man Potter? It was the economist Allan Meltzer, who famously said, “Capitalism without losses is like religion without sin.”

But the half-truth behind the boast is even more revealing. The Federal Home Loan banks have a more than passing familiarity with losses. Advances are just part of the System’s story. The whole truth reveals the horrible investments they have made particularly in the lead-up to the 2007-9 financial crisis. These misguided PLMBS investments totaled over $76 billion and caused the system to take on enormous losses threatening the very existence of some of Federal Home Loan banks.

As the late Paul Harvey would say, “Now you know the rest of the story.”

You might ask, “Why are the Federal Home Loan banks so conservative with their advances yet so profligate with their investments?” Christopher Leonard, in his book, “The Lords of Easy Money,” answers the question succinctly: the search for yield.

But yield for whose benefit? Consumers? Taxpayers? No, the yield proceeds are destined for the same financial institutions that own the eleven Federal Home Loan banks and, of course, for the executives of those banks who are lavishly compensated for managing these government-sponsored enterprises.

This explains why bankers are so enamored of the system and why, to no one’s surprise, the system’s generous dividends were not mentioned in the article. For the banks that own them the Home Loan banks are a reliable source of dividend income. It is a very simple business model: borrow funds in the capital markets at below-market, taxpayer-subsidized rates and invest those funds in securities at market rates.

Now, I am in favor of banks being liquid and having strong earnings. Just not at the taxpayers’ expense. This brings us to another glaring omission in the bankers’ defense of the system: taxpayer support.

The system would not be able to sell any of its consolidated debt obligations were it not for the implicit taxpayer backing of those instruments. At least some acknowledgment of the taxpayers’ role is called for in any paean to the Home Loan banks. After all, the long-suffering taxpayers are the system’s enablers. Ought they not get some return on their investment rather than the silent treatment?

In support of the highly inefficient 11-bank network, it is recited that the Federal Home Loan banks are close to their communities and their mandatory payments for affordable housing are highlighted. There is, however, a contradiction here. On the one hand, it is claimed that each Home Loan bank is knowledgeable about the communities of its multistate district. But at the same time, it is admitted that these banks are “not well known” and “not well understood” in the very communities they serve. Which is it? If they are so invaluable to their communities, why the anonymity?

As for affordable housing, the Home Loan banks’ funding of these efforts is paltry. Sure, the law makes them devote 10% of their net income to affordable housing. With their waning fortunes, however, even these modest contributions have shrunk. From 2019 to 2021 contributions to affordable housing programs have declined 44%. In 2021, only 0.28% of the system’s assets was devoted to affordable housing. The prospects for 2022 based on first-quarter data are not encouraging. Is this a badge of honor or a fig leaf?

Now, consider that the Home Loan banks are exempt from paying federal, state and local income taxes. Their affordable housing efforts don’t come close to compensating for the value of their tax-exempt status. The difference goes to their bank owners. Imagine what could be accomplished if the system’s enormous $723 billion balance sheet were more focused on the nation’s affordable housing problems.

At last, there is the trope that the Home Loan banks have become the “lenders of first resort” for their bank owners. Let us concede this point. What law or regulation is it that confers this role on the Home Loan banks? Are not private pools of capital supposed to be the first lenders to privately owned banks? Isn’t deposit insurance from the FDIC and the discount window at the Fed enough of a taxpayer subsidy? As a study by the Federal Reserve Bank of New York found, the many government liquidity facilities, including the system’s, are already fragmented and need to be rationalized.  

Congress intended the system to serve a public purpose, namely housing, not lender of first resort. However, the system has been co-opted by the banks to serve their own interests. It is the abandonment of the system’s public purpose that prompted the General Accountability Office to conclude: “Additionally, there is limited empirical information available regarding the extent to which the System is fulfilling its housing and community mission.”

Without any public purpose what is its purpose?

There is much the system can do to be a part of the modern financial system. The system could help address the pressing financial needs of the housing supply chain, low- and moderate-income borrowers, climate change remediators, emerging financial technology companies, small and minority-owned businesses, to name just a few. To its credit, the system has demonstrated it can make advances in a conservative sustainable way consistent with safety and soundness standards.

But change requires a temper of the will and a spirit of the imagination that has not been a hallmark of the system. A new generation of system leaders, a new regulator, the voices of enlightened stakeholders, and meaningful congressional oversight can turn that around.

Finally, the ABA’s belated defense of the system leaves the reader with some homey New England advice: Don’t remove your furnace in the summer thinking winter will never come. As a New Englander myself, I concur with this advice. I would add, however, that if your furnace has been burning coal for 90 years, any season is the right season for its replacement.





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