How to limit the risks to financial stability posed by the Federal Home Loan Bank System

July 22, 2022 will mark the 90e anniversary of President Hoover’s signing of the law that created the Federal mortgage bank (FHLB). Motivated by the difficulties faced by mortgage lenders during the Depression in funding loans even to creditworthy borrowers, FHLBs were designed as a government-sponsored intermediary between these lenders and the debt markets. Yet almost as soon as the FHLB Act was passed, the mortgage market began to change in ways that ultimately rendered this role largely unnecessary. Today, most of the loans granted by the FHLBs are only very loosely linked to their mission of promoting housing finance. But their current business model of borrowing heavily from short-term funding markets and providing longer-term funding to their custodian institutions and member insurance companies poses risks to the financial system. In a recent articleStefan Gissler, Borghan Narajabad and I explain the origins of these risks and propose a set of reforms to address them.

Financial stability risks posed by FHLBs

We believe that the problem is structural and created by the interplay of two characteristics of FHLBs: first, the hybrid public-private nature of FHLBs and, second, the lack of a well-articulated contemporary purpose for them.

Ownership and control of profit-generating FHLBs are in private hands. Members of each of the 11 FHLBs — mostly deposit-taking institutions and insured insurance companies — own the Bank and, under the Federal law on mortgage banks, have the majority of its directors. There are certain governance requirements that are inapplicable to purely private banks and certain discrete public housing obligations. In general, however, governance decisions will reflect the interests of members, who are both shareholders and customers (borrowers) of FHLBs.

Although privately owned and controlled, FHLBs enjoy significant public privileges. Like their pre-2008 siblings Fannie Mae and Freddie Mac, FHLBs enjoy an explicit line of credit with the US Treasury and the market’s assumption of implicit US government support for FHLBs beyond that. statutory amount of $4 billion. As with bonds of other government-sponsored enterprises (GSEs), FHLB debt can be purchased on the open market by the Federal Reserve. FHLB debt has preferred regulatory status in the portfolios of commercial banks and credit unions, and is treated as public debt for the purposes of securities laws. FHLB loans to banks enjoy a resolution super-priority similar to Federal Reserve discount window loans.

The potential for moral hazard created by granting public privileges to privately managed GSEs is exacerbated by the absence of a well-defined contemporary mission for FHLBs in their enabling legislation. While the law leaves a considerable margin for the FHLBs box do, it provides little guidance on what they should do. The original motivation for their creation during the Great Depression is largely irrelevant in today’s housing finance market, in which originators can easily sell mortgages to Fannie Mae, Freddie Mac, or private companies that bundle them together. in securities sold to the public. Unfortunately, Congress has never updated the purpose and role of FHLBs, although it has periodically expanded the range of financial firms that can be members. In fairness to those who run and regulate the FHLBs, he also did not provide much guidance from which the role of the FHLBs could be inferred.

In the absence of a well-defined role from Congress, the FHLBs used their public privileges to create profitable opportunities for themselves in the financial markets. The fact that these activities depend on taxpayer subsidies may be reason enough to examine them closely. Our particular concerns arise because some of these activities have amplified funding and financial constraints and, in some cases, have also undermined the missions of federal financial regulators. In our article, Gissler, Narajabad, and I detail how FHLB’s heightened maturity transformation is central to past and, potentially, future issues.

The basic dynamics by which FHLBs can contribute to stress were observed during both the 2007-2008 financial crisis and the 2020 COVID crisis. As financial stress increased, some FHLB members experienced serious difficulties to get wholesale funding, which they had come to rely on for their business models. They turned to the FHLBs, which quickly extended loans to these members, most with maturities of a year or more. In the short term, these loans appeared to fill financing gaps, leading some to label FHLBs as “lenders of second to last resort”. However, the FHLBs had funded these loans largely by issuing debt to money market mutual funds, which, for both regulatory and risk management reasons, insisted on taking on only short-term debt. term.

The experience of the global financial crisis illustrates the limits of this role of the FHLB. From the end of the summer of 2008, investors began to doubt the viability of the other housing GSEs. Since money market funds did not distinguish in their regulatory disclosure statements between different GSEs, FHLBs became “guilty by association”. In other words, because fund managers didn’t want investors wondering whether they held debt with the increasingly troubled Fannie Mae and Freddie Mac, they essentially stopped investing in FHLBs as well. FHLB’s funding costs have skyrocketed, limiting their access to debt markets.

Unlike the Federal Reserve, FHLBs cannot create their own liquidity. As a result, the FHLBs could no longer fund their members, who had to rely on liquidity provided by the Federal Reserve, the true lender of last resort. The subsidized loans that FHLBs provide before financial stresses develop, as well as the loans they provide at the start of a stressful period that allow members to defer adjustments to their balance sheets, can both at the end of account not to be viable as the voltage level increases.

The role of money market mutual funds in the increased maturity transformation of FHLBs also illustrates how the policies of financial regulators can be undermined by the activities of FHLBs. After the Securities and Exchange Commission passed a rule in 2014 limiting the attractive feature of a fixed net asset value – $1 per share – to shares of money market funds that hold only government securities, demand for securities of state exploded. The FHLBs essentially facilitated the conversion of investment grade funds (money market funds that hold both public and private debt) into government-only funds by issuing nearly a quarter of a trillion dollars in short-term debt. Funds raised with this debt were recycled to FHLB members at favorable rates. Thus, despite the objectives of the SEC’s regulatory reform, the link between money market funds and bank financing has been preserved, but now with an implicit guarantee from the State.

An approach to reform

The absence of a well-defined appropriate role for FHLBs in contemporary housing markets argues for Congress to consider whether there is is such a role, ideally as part of a more general overhaul of federal housing policy. However, as with so many other national issues, the prospects for legislative action are not promising. Accordingly, Gissler, Narajabad and myself recommend that the Federal Housing Finance Agency (FHFA), the regulator with jurisdiction over FHLBs, is undertaking a three-pronged reform program.

First, the FHFA should improve both its own transparency and that of the FHLBs to approximate the practices and requirements of federal banking agencies for comparable activities. Currently, it is difficult for outside analysts to determine precisely what these practices and requirements are. Second, in fulfilling its congressional oversight mandate, FHFA should review its regulations and oversight guidelines to ensure that FHLBs cannot engage in forms of maturity transformation that could escalate systemic tensions on liquidity during periods of crisis. Third, under the auspices of the Financial Stability Supervisory BoardFHFA should engage in regular consultation with other federal financial regulators to minimize the negative impact of FHLB activities on the statutory missions of those agencies.


Organizations whose motivating purpose has been superseded by events often attempt to perpetuate themselves by taking on new roles. Sometimes they manage to adapt to fulfill another valuable social function, sometimes not. When an organization is granted government privileges, there should be careful consideration of any new role the organization takes on to ensure that the public continues to benefit. This is especially the case when the organization’s new roles may actually harm other social goals. The FHLBs appear to us as the exemplary case of organizations that have operated for decades without a clear public mission. While not currently an acute threat to financial stability, reforms undertaken now would be a salutary example of tackling latent risks, rather than just waging the proverbial last war.

The Brookings Institution is funded through support from a wide range of foundations, corporations, governments, individuals, as well as an endowment. The list of donors can be found in our annual reports published online here. The findings, interpretations and conclusions of this report are solely those of its author(s) and are not influenced by any donation.

Comments are closed.