The Evolving Role of the Federal Home Loan Banks in Mortgage Markets

Article excerpt

The 1929-33 contraction had far reaching effects in many directions, no least on monetary institutions and academic and popular thinking about the role of monetary factors in the economy. A number of special monetary institutions were established in the course of the contraction, notably the Reconstruction Finance Corporation and the Federal Home Loan Banks, ...

-Friedman and Schwartz ( 1963 )

Created by 1932 legislation, the Federal Home Loan Bank System is part of the federal infrastructure for promoting home ownership in the United States. For much of its history, the System's 12 Federal Home Loan Banks (FHLBs) have fulfilled their mission by providing liquidity to the housing finance industry, primarily the nation's savings and loans and savings banks. More recently, they have assisted commercial banks as well. The FHLBs increase the liquidity of mortgage markets by making advances (loans) to member institutions, which use the advances to make new mortgage loans. Advances are secured against the members' mortgage-related assets.

The 198Os thrift debacle resulted in legislation that completely overhauled the federal regulatory system for savings and loans and the Federal Home Loan Bank System. The System underwent major restructuring, but the fundamental mission of the FHLBs remained housing finance.

While the mission of the FHLBs has not changed, their activities have expanded in a number of important ways. Over the past decade, the FHLBs substantially increased the size of their investment portfolios, including their holdings of mortgage-backed securities. In 1999, the FHLBs' lending authority was extended by the Gramm-Leach-Bliley Act to include the loans secured by small business and agricultural credits of community depository institutions (currently defined as depository institutions with $538 million or less in total assets). To date, lending activity under this new authority has been trivial-only $8.4 billion of advances (1.72 percent of total advances) secured by small business and agricultural loans were outstanding on December 31, 2002.

From the perspective of its traditional housing finance mandate, the FHLB System undertook a major new initiative in 1997: the direct holding of mortgage loans. Through purchases of mortgage loans from FHLB System member institutions, the FHLBs join the ranks of the two other government-sponsored enterprises that have a mission to promote home ownership-the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation-in promoting the secondary market for mortgages. The evolution of FHLB mortgage activities took another important turn recently as the FHLB of Chicago recently received permission to operate a new program in which mortgage assets purchased from FHLB members are securitized.

The public commitment to support home ownership remains strong, and expanding the FHLBs' housing-related asset powers is consistent with that objective. But as with other government-sponsored enterprises, the FHLBs' public charters convey upon them special treatment not afforded privately chartered firms, providing them with competitive advantages in the marketplace-not the least of which is the perceived implicit government backing of their liabilities. Therefore, the continuing evolution of FHLB activities merits periodic review.

* Providing Liquidity to Mortgage Lenders

The FHLBs were established as a liquidity facility for the housing finance industry. Initially, they operated as deposit-replacement facilities, making advances to thrifts and other FHLB member institutions. Thrifts would use FHLB advances to insulate their mortgage lending activities from shifts in loan demand and deposit flows. Through time, these housing lenders began to use FHLB advances as a routine source of funding for their mortgage assets.

For the better part of six decades, membership in the FHLBs was limited to institutions specializing in housing finance-largely savings associations. …