Magazine article American Banker

Viewpoint: FHLBs' Critical Role in Restoring Liquidity

Magazine article American Banker

Viewpoint: FHLBs' Critical Role in Restoring Liquidity

Article excerpt

The third quarter was one of the most tumultuous in years, and it should not have been surprising that the contagion of delinquency and defaults on subprime loans spread rapidly with brutal results.

The shifting structure of the market for mortgages echoes the transformation of financing for emerging markets. Though once largely confined to bank portfolio lending, emerging markets have shifted heavily toward capital markets, with extensive internationalization and a proliferation of debtholders.

Massive expansion of the mortgage securities markets meant the nexus of borrower and lender has been attenuated. Many originators were more lax in approving credits than they would have been if loans had stayed on their balance sheets - a situation compounded by financial engineering that made the credit reality of loan pools supporting complex instruments more opaque.

The seizing up of investors' willingness to take on more mortgage-backed securities had several consequences. First, confidence in the interbank market dwindled, driving up fund rates and often reducing tolerance to only overnight lending. Second, large poolers, which warehouse mortgages until they are securitized, faced a buildup in holdings and an evaporation of funding.

It was a liquidity crisis thrust suddenly upon us.

In stepped the Federal Reserve Board and the European Central Bank. In two major dollops, the Fed rapidly injected $70 billion of additional liquidity, hoping to break the fever. This injection and the reduction of the discount rate were widely heralded.

Less noticed was the role of the Federal Home Loan Banks. These triple-A government-sponsored enterprises - organized as a cooperative for banks, thrifts, insurance companies, and credit unions - played their intended role as a provider of liquidity.

As the Fed acted, the 12 Home Loan banks injected an additional $163 billion of liquidity to calm the markets, in the form of loans to members ranging from small community banks to large commodity players. All told, 8,100 financial institutions own and can borrow from the Home Loan banks.

The Federal Home Loan Bank System's office of finance issued overnight and term debt on demand. The banks in the system - one of the world's largest debt issuers, with more than $1.14 trillion of outstanding consolidated obligations - enjoy the broadest receptivity in the capital markets, passing on the proceeds of attractively priced, triple-A agency debt to members.

The Home Loan banks were a major pacifying influence. They provided on-request funding of varying durations as other sources of liquidity dried up or became prohibitively expensive.

They opened their doors 75 years ago this week, and it is appropriate to remember the circumstances surrounding their creation. …

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