No, Federal Home Loan Banks didn’t cause the SVB collapse

The Federal Home Loan Banks have been taking some heat for their eleventh-hour lending to Silvergate, Silicon Valley and Signature banks. We regulated and then represented these FHLBanks through 40 years of economic ups and downs, hearing time and time again uninformed criticisms that the banks were too small, too large, too dominated by big commercial banks or too unresponsive to one political agenda or the other. But it truly is odd to blame them for doing what they were established and authorized to do, particularly when it is hard to find any more successful federal endeavor over the last 90 years. We are all ears if anyone can name one.

As various legislators including Sen. Sherrod Brown take aim at the FHLBanks because they lent to troubled banks — a role that they were designed and have regularly been asked to perform — it suggests that there may be more than meets the eye here.

It is entirely fair to evaluate the role of the FHLBanks in these collapses, but the same is true of other, perhaps more inconvenient, questions and culprits. What role did Congress’s insatiable spending and the Federal Reserve printing trillions of dollars over the last 15 years play, for instance? Did the Fed’s 15-year suppression of interest rates at historically low levels only to jerk them up as inflation inevitably threatened the economy set financial intermediaries up to fail? And just how did those failed banks operate themselves into such dire condition under the watchful eyes of their federal and state regulators?

But we digress.

Congress devised the FHLBank System in 1932 to help savings and loan associations finance home mortgages and rejuvenate an economy battered by the Great Depression. Today, after many adjustments by Congress over the years, it is a cooperative of 11 regional wholesale banks, each comprised of member financial institutions. In 1989, Congress expanded membership to include commercial banks, recognizing that the shrinking role of S&Ls in American housing finance would require a new set of mortgage lenders.

Congress’s foresight has been borne out by the fact that Wells Fargo, JPMorgan Chase, PNC Bank and Citizens Bank are now among the top 10 mortgage lenders in the country and are part of the economic backbone of the FHLBank System that community banks and consumers rely on. Those commercial banks would have been unlikely to make any mortgage loans 40 years ago.

The 11 privately capitalized FHLBanks borrow jointly from the capital markets at favorable government-like rates and then relend those lower cost funds to their member institutions to stimulate home mortgage lending. Money is of course fungible, but however those borrowings are immediately used, loans from the FHLBanks must be collateralized with mortgages and other prescribed financial instruments. Members cannot do an end run around the housing finance mandate of the system. In addition, it is the FHLBank System that repaid the tab resulting from the S&L crisis of the 1980s and 1990s and today directs no less than 10 percent of its annual profits to affordable housing projects.

The Federal Home Loan Banks have also been chastised for having a priority over unsecured creditors that puts it first in line to be repaid when member institutions fail. Curiously, that is precisely what both Congress and state legislators provided in enacting laws that protected the interests of the FHLBanks as secured creditors. Congress understood that liquidity is critical in stressful economic periods, particularly given the fact that commercial banks have always been reluctant to borrow from the Federal Reserve Banks given the stigma attached. Prudential bank regulators have historically supported continued lending by FHLBanks when member institutions get into trouble so that they have time to explore rescue solutions and plan for orderly resolutions.

Some question whether the FHLBanks should be incentivized in this way to act as financial emergency room physicians to avert or delay bank failures if the result is the subordination of the interests of the FDIC in its role as financial undertaker. But that is a debate that resolved years ago, favoring the option that allows financial institutions to have ready access to FHLBank loans as long as they can meet the stringent underwriting requirements that apply. The rapid deterioration of Silicon Valley Bank after social media ignited a virtual run of $42 billion in deposits the day before it was closed, and the $100 billion in withdrawals reported at Republic Bank, demonstrate just how quickly things can unravel these days and threaten financial stability.

Those who would have the FHLBanks participate even more than they do in affordable housing or other programs or activities in political favor at any particular time are free to plead their case to Congress. Those decisions should not be made by individual legislators or unelected regulators. History has shown that the best thing the FHLBanks can do for all consumers is to perform as Congress intended, and create housing credit that fosters economic growth and maximizes market stability.

A recent University of Wisconsin study highlights the FHLBanks’ record of success. Their lending generates an estimated $130 billion of additional mortgage lending each year, while saving consumers $17 billion in interest payments. That success is even more remarkable taking into consideration the fact that no FHLBank has ever lost a dime on any loan made to a member institution in the last 90-plus years. That is an accomplishment that is unlikely any other lender in America can boast of.

It is fair to ask Congress to reconsider what the FHLBanks should do to make 21st century housing markets and depository institutions work even better, and whether the inherent subsidy of mortgage finance in the system should continue. And to digress one last time, while its record is being evaluated, perhaps other related issues such as Fannie Mae and Freddie Mac languishing in conservatorship for 15 years should also be attended to. Whatever is decided, we are confident that no one will like a U.S. financial system without FHLBanks.

Thomas P. Vartanian is executive director of the Financial Technology & Cybersecurity Center and a former general counsel (1981-83) of the agencies that handled the S&L crisis. He is also the author of “200 Years of American Financial Panics” (2021) and “The Unhackable Internet” (2023).

Robert H. Ledig is managing director of the Financial Technology & Cybersecurity Center and an author of “21st Century Money, Banking & Commerce.”