Don't blame home loan banks for the Fed's lending problems

Tinkering with Federal Home Loan Banks will inevitably end up with half-baked solutions that result in us shooting ourselves in the financial feet. 

Ever since the collapse of Silicon Valley Bank, the utility and availability of the Federal Reserve’s discount window, by which lending is made to banks, has been once again front and center. The window is at times described as “outdated and ill-equipped," and even Fed Chairman Jerome Powell has recently admitted there is "a lot of work to do."

In contrast, the Federal Home Loan Banks — 11 regional, federally chartered banks created in 1932 to provide liquidity to member banks for home lending and community investment — have proven to be effective and efficient lenders to eligible financial institutions, rain or shine.

But that might just be their problem. 

The Fed discount window has been ineffective since it first opened in 1913, particularly in handling financial crises. Borrowing from it has been viewed as the equivalent of raising a red flag and sending up a distress signal. So great is the associated stigma that a 2015 Federal Reserve Bank of New York study concluded member banks were willing to pay a premium to avoid borrowing from the discount window during the financial crisis between December 2007 and September 2008.  

As a result, the responsibility for funding banks in good and bad times has traditionally fallen on other sources of liquidity, including the 11 federally chartered, cooperatively owned Federal Home Loan Banks. Established to provide liquidity through various economic cycles and support housing finance by making collateralized loans to member institutions, these banks lend all of the time, not just when member institutions are in distress.  

Members must meet the Federal Home Loan Banks’ underwriting criteria and put up mortgage loans or other high-quality instruments as collateral to support their Federal Home Loan Bank lending. Federal Home Loan Banks have never lost a dime lending to their member banks; according to a recent study, they have increased mortgage lending in America by 16 percent while reducing mortgage rates by nearly one-fifth.

The Federal Home Loan Banks have provided a constant and reliable source of non-judgmental credit for commercial banks and other eligible institutions, providing stability particularly in times of financial crisis for smaller community banks. That is when large numbers of financial institutions can collapse, overwhelming the capacity of regulators.

Slowing the pace of failure so that the government can find acquirers for failing banks and avoid confidence-busting liquidating payouts to depositors has been a critical strategy in handling every major modern financial crisis.  

The Federal Home Loan Banks have, by default, been looked to for that stabilizing effect, and everyone knows it. In my personal experience, policymakers from Chairman Paul Volcker to President George W. Bush have encouraged the Federal Home Loan Banks to keep lending in crises, even to some of the more notorious failing banks, to buy the government time to put solutions in place.  

Unfortunately, no good deed goes unpunished in Washington, D.C. Once the crisis passes, the blame game begins, and Federal Home Loan Banks have always been an easy target. Indeed, their reward for acting as a stabilizing force during the Savings and Loan Crisis of the 1980s was to be required by Congress to pay off the billions of 30-year bonds issued by the government to finance the rescue.

Some are trying to transform the errors of bank management and regulators in the cases of Silicon Valley, Signature, First Republic and other banks into missteps by Federal Home Loan Banks. They argue that when Federal Home Loan Banks lend to failing banks, they are exacerbating the situation.

This is like blaming firefighters for fires just because they seem to turn up at them so often.

The Federal Home Loan Banks had nothing to do with how those institutions got into trouble. And every single one of them was tightly regulated, right up to the moment of its demise, by state and federal regulators who either allowed or affirmatively invited Federal Home Loan Banks to lend to them.  

In 2023, the Federal Housing Finance Agency issued a 142-page review of a century of the Federal Home Loan Bank System. Last month, it published a Request for Input to solicit public comment to assist it in updating the Federal Home Loan Bank System’s mission statement.

Although these efforts may have merit, they distract from the fact that the other entities regulated by the FHFA — that is, the secondary mortgage market behemoths Fannie Mae and Freddie Mac — have languished in conservatorship for the last 16 years. That has left most of the U.S. mortgage industry effectively in the hands of the government, with shareholders deprived of any financial benefit, even after a company has been returned to profitability.

The Federal Home Loan Banks have done no more and no less than what Congress has empowered them to do. Some would like to make them more direct contributors, beyond the 15 percent of profits many of them already set aside for affordable housing. This is a worthwhile discussion point, but not what they were established to do under current law. Those issues are for Congress to decide. Hopefully, lawmakers understand that making the Federal Home Loan Banks into the direct housing subsidy business would be a mistake. That is a job that their member institutions are far better positioned to handle.  

While not perfect, the FHLBank System is arguably the most successful federal program implemented in the last century. The best way for these banks to assist all levels of housing needs is by continuing to help their member banks maintain the most effective mortgage funding system in the world.  

If we want to get at the real issues in financing, let’s start by figuring out how to make the Fed discount window function without having to concoct lending workarounds, like the ones from the last financial crisis. We must also honestly assess the supervision and resolution tools that financial regulators need to manage stressors in today’s markets. Shockingly, that wasn’t done after the 2008 disaster. Until then, tinkering with the FHLBanks will inevitably end up with half-baked solutions that result in us shooting ourselves in the financial foot. 

Thomas P. Vartanian is executive director of the Financial Technology and Cybersecurity Center. He served as a bank regulator in the Carter and Reagan administrations. Between 1981 and 2018, he either regulated or legally represented the Federal Home Loan Banks. Until 2022, he also represented several preferred shareholders of Fannie Mae and Freddie Mac. He is the author of “200 Years of American Financial Panics.”