Federal home loan banks should serve the public, not themselves

It’s not every day that a regulator for a $1 trillion, nearly 100-year-old bureaucracy signals that a total revamp might be in order. But this is what occurred when the newly confirmed head of the Federal Housing Finance Agency, Sandra Thompson, told Congress that she is commencing a comprehensive review of the mission and operations of the Federal Home Loan Banks (FHLBs).

It appears that the FHLBs long history of resisting change is about to end. That history has served them, if not the nation, well over the years. One can only hope that the obscurity in which they have operated for 90 years is about to end.

But first a primer on the 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 FHLBs’ original mission was to provide much-needed assistance to the housing finance market. Their owners are 6,800 banks and insurance companies of all sizes.

The FHLBs survive by virtue of a taxpayer subsidy of all the debt obligations they issue plus a statutory exemption they enjoy from having to pay federal, state or local taxes. Their low public profile contrasts with the enormous clout they quietly wield in the halls of Congress.

The FHLBs make their money by borrowing cheaply in the money market at preferential taxpayer-subsidized rates. They re-lend those funds exclusively to their owner-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, say, by paying higher deposit rates to their customers.

Less than a year ago, borrowings from the FHLBs were at a nadir as banks and others were flush with cash thanks to the Fed’s monetary policies. Today, those borrowings have surged by 46 percent (146 percent at just one of the FHLBs). This access to borrowing at the FHLBs’ 11 windows is one of the main reasons why banks have been slow to raise interest rates for customers at their tellers’ windows.

Regardless of the mercurial usage of their facilities, one thing has become abundantly clear about the FHLBs; they no longer serve a public mission as they once did. Distinguished commentators have pointed out the emperor’s lack of clothing. They have questioned the rationale for the FHLBs’ ongoing governmental subsidy.

It is little wonder that the FHLBs are doing what they have always done in the face of a challenge … retreating to the foxholes. But this time is different.

This time, in addition to a skeptical regulator, they face the issues of irrelevancy, inefficiency and a growing realization that their operations are antithetical to the best interests of depositors and the public.

At the time of their creation, FHLBs’ members were exclusively savings and loan associations and insurance companies active at the time in originating home mortgages. FHLBs could be confident that the proceeds of their loans to those two groups found their way into the housing markets. No longer.

Today, FHLBs’ members are mostly commercial banks that have long since ceded mortgage originations to nonbanks such as Quicken. And few if any of the insurance companies that tap into the FHLBs originate any mortgages. Layer on the emergence of securitizations as the dominant tool adding liquidity to the mortgage market and it’s easy to understand why so many have described the FHLBs as irrelevant.

Thompson’s review will seek out a new mission for the FHLBs. The modern mission should take into account the affordable housing, infrastructure and small business needs of the economy. Perhaps “home” should be stricken from the FHLBs title as being too restrictive.

The second weakness of the FHLBs is inefficiency. The 11 FHLBs sell identical products in each of their districts. There is no need for 11 duplicate IT systems and 11 C-suites (with many receiving multimillion-dollar compensation) performing redundant quasi-governmental services.

The only cost justification for this duplication is if, in a reimagined FHLB system, new products, new members and new collateral requirements demand the expertise of staff and systems that are not currently on board. Failing that, massive consolidation of the FHLBs should be one of the outcomes of Thompson’s review.

Third, banks are using 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 are adding a public value in exchange for their taxpayer subsidy. They are not.

These and other issues will be raised during the course of the review, FHLBank System at 100: Focusing on the Future, which was formally launched in recent days.

Focusing on the Future promises to be a transparent and dynamic process. This is good news for the public interest. Operating in the light of day, however, could prove to be a challenge for the 11 FHLBs.

William Isaac, former chairman of the FDIC (1978 through 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 to 2021) and teaches financial services law at Boston University.