The structure of the Federal Home Loan Banking System, created in 1932, is similar to that of the Federal Reserve System. The 12 regional home loan banks (FHL Banks) provide long-term loans (known as "advances") to member savings institutions, which are required to collateralize the advances with residential mortgages. The purpose of the Federal Home Loan Bank System has been to provide a ready source of long-term mortgages to home buyers. While privately owned and operated, the FHL Banks are considered government-sponsored enterprises because of their federal origin and public responsibilities, and because their obligations are considered implicitly guaranteed by the federal government.
While this system made sense many years ago, the creation and subsequent growth of a secondary mortgage market, along with the emergence of the Federal National Mortgage Association (Fannie Mae) and Federal Home Loan Mortgage Corporation (Freddie Mac), has made the mission of the FHL Banks obsolete. As a result, the FHL Banks increasingly have begun to move into new activities, including the purchase of securitized mortgages (often from the other government-sponsored enterprises).
H.R. 3167 would give the FHL Banks a new and questionable mission. They would be renamed Enterprise Resource Banks, but would continue to operate largely within the same regulatory structure as the one within which the FHL Banks now operate. However, the new banks would enjoy a greatly expanded scope of operation. The newly constituted Enterprise Resource Banks would not be limited to mortgage-collateralized advances. They also could provide advances for small business loans, economic development project loans, and rural development project loans.
Although well-intentioned, H.R. 3167 is the wrong way to reform the FHLB System. Among the problems:
- Enterprise Resource Banks would enjoy an unfair advantage over
their private counterparts. It is widely held that bonds issued by
FHL Banks are insured by the federal government. This is because
the FHL Banks serve a perceived public interest, and taxpayers
likely would be required to foot the bill were the banks to default
on their loan obligations. This implicit guarantee allows FHL Banks
to raise funds in the capital markets at a lower cost than private
companies. Currently, this advantage is limited to the mortgage
lending market. However, H.R. 3167 would expand the FHL Banks'
advantage into other markets. In fact, some analysts believe the
only market prohibited by the bill to Enterprise Resource Banks
would be large commercial loans to suburban businesses.1 Private financial service companies in every
other market would be faced with increased competition from
advantaged, publicly supported Enterprise Resource Bank
members.
- H.R. 3167 would create an increasingly powerful and deleterious
government presence in the capital markets. The FHL Banks already
are the third-largest borrowers in the nation, trailing only the
Department of the Treasury and Fannie Mae. By enlarging the theater
of FHL Bank operations, H.R. 3167 would increase the share of the
capital market effectively controlled by the federal government. As
Enterprise Resource Banks moved into new markets, they might be
able to dominate those markets easily because of their advantageous
position, granted by implicit federal guarantee against default.
They would quickly become the "800 pound gorilla" of the capital
markets. Thus, federal statutes and regulations, rather than the
free market, increasingly would determine the allocation of
credit.
- Federal Home Loan Banks are not experienced in the proposed new
areas of responsibility. FHL Banks have been limited to
mortgage-collateralized advances for the past 60 years. Moreover,
until 1989 FHL Banks were limited to serving savings and loans. It
was only with passage of the Financial Institutions Reform,
Recovery and Enforcement Act of 1989 that other financial
institutions were able to apply for FHLB advances. H.R. 3167 would
expand the nature of advances that Enterprise Resource Banks could
make, as well as the structure of financial institutions that could
apply for these advances. But such a broad step is like allowing an
airline pilot to navigate a cruise ship. FHL Banks simply do not
have the experience to advance broadly collateralized funds to
various financial service providers, and H.R. 3167 does not give
them specific guidance in these matters. Moreover, many of the new
responsibilities, such as providing small business and community
development loans, already are carried out by other federal
programs. The new responsibilities of the Enterprise Resource Banks
would duplicate these programs, most of which are themselves in
need of serious reform.
- Taxpayers would incur increased risk. These problems would increase taxpayer exposure to risk if the new Enterprise Resource system were to fail. Because the system would remain a government-sponsored enterprise providing some public services, it is unlikely that the federal government would allow the Enterprise Resource Banks to fail. Taxpayers would be forced to pay the bill in the event of such a failure. Increasing the scope of the system's operations increases not only the potential size of such a bailout, but also its likelihood.
Instead of finding new and duplicative responsibilities for the FHL Banks, Congress and the President should privatize the banks and allow them to restructure as necessary, outside the umbrella of taxpayer protection. Privatization of the FHL Banks has broad support from experts, the banking industry, and the Administration. Indeed, in a letter to Representative Jim Leach (R-IA), chairman of the House Banking Committee, the Treasury Department's Under Secretary for Domestic Finance, John D. Hawke, states that privatization is a better answer to the problems of the FHL Banks than increasing their theater of operations.
If Congress truly wants to help distressed areas and increase the availability of credit, it should act to modernize the financial services sector by deregulating it. Representative Baker already has introduced legislation (H.R. 814) that would begin to do this. Allowing commercial banks to affiliate with investment banks and other commercial and financial companies would increase the availability of credit for consumers and the investment opportunities for all businesses, including those in distressed areas. On the other hand, H.R. 3167 would raise the level of government involvement in the credit markets. Rather than help distressed areas, this would place taxpayers of all income levels at a greater risk.
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