The FHFA is coming for the Home Loan banks

Government programs are not universally renowned for their efficiency. This fact is often cited by conservative-minded organizations — along with harrowing tales of $10,000 toilet seats and $1 million pens — as justification for eliminating those programs, while the government itself tends to study the problem and occasionally do something about it. 

So when the Federal Housing Finance Agency announced last year that it was conducting a review of the Federal Home Loan banks in order to "ensure they remain positioned to meet the needs of today and tomorrow," my expectations were somewhat low. I had no doubt that the FHFA would issue a fulsome report with many recommendations. But what those recommendations actually amount to at the end of what will surely be a grueling regulatory slog (notwithstanding whatever dim prospect there might be for congressional attention) remains an open question.

That open question got considerably narrower last Friday when FHFA Director Sandra Thompson expounded about the nature of that inquiry at a symposium at the Brookings Institution, saying flatly that "the status quo is not acceptable.

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"We are dealing with a huge housing supply issue," Thompson continued. "It's my job to position the system to be ready for what's to come. The mortgage landscape has changed. There's more that they can do on the mission side in a safe and sound manner."

But to understand what might change about the Home Loan bank status quo, it's important to understand what that status quo is. The Home Loan banks were created in 1932 by President Herbert Hoover at the height of the Great Depression and were conceived as a way of solving a then-pressing problem: Savings & loan companies and insurance companies — then the cornerstones of housing development — needed cash to build and finance homes. The Home Loan banks filled that gap by acting as a kind of liquidity spigot for those institutions just as the Federal Reserve's discount window serves as a liquidity spigot for banks. 

But, perhaps unsurprisingly, the housing market and the banking landscape have changed dramatically over the course of a century. The distinction between thrifts and banks is essentially nonexistent, and insurance companies, while still relevant to some multifamily housing markets, are not the players in housing that they once were. 

Yet the Home Loan Bank System still provides liquidity advances to member institutions at variable rates and duration, and on far more favorable terms than the repo market or the Fed's discount window. That makes the Home Loan banks a famously critical source of liquidity for many institutions, even those with little meaningful interest in the housing market. Add to the mix the tax-exempt nature of the Home Loan banks, their superpriority in getting repaid on any advances to a failed institution, cushy executive compensation and a relatively paltry 10% affordable housing mandate, and it's easy to see how it's time to take the status quo into the shop for a tuneup.

Politics and policy

Status quo 'is not acceptable' for Home Loan banks, FHFA chief says

February 13, 2023 9:00 PM

That being said, how one might change the status quo depends considerably on what one sees as the biggest problem. Former FHFA Director Mark Calabria, speaking at that same Brookings event as Thompson, said the problem with the Home Loan banks in significant part is that the system is so big, adding that the banks' practice of borrowing short and investing long makes the system essentially a tax-free hedge fund.

"There's absolutely no rationale for the [Home Loan] banks to have the size of balance sheets and investment portfolios they do today," Calabria said. 

But many others who follow the Home Loan banks closely are less bothered with the size of the system and/or the moral hazard it poses as they are with the fact that there seems to be an insufficient tangible public benefit to offset the very demonstrable private benefit that the system confers to its members. And that insufficient public benefit comes at a time when the administration is eagerly looking for ways to solve the ever-worsening housing shortage and affordability problem. Thompson seems to have put two and two together.

"Thinking about what they were designed for and are they fulfilling their mission — it's called the Federal Home Loan bank for a reason," Thompson said. 

There's still a long way to go before we know exactly what the FHFA has in mind and how far it is willing to go without explicit direction from Congress, but you can't change anything without changing something. It seems fair to say that, at least insofar as we can see into Thompson's thinking on whether to cut the system down to size or redirect its activities, she is leaning toward turning the Home Loan banks' firehose of money toward affordable and equitable housing. Why solve one problem when you can solve two?

The risk, of course, is that you ultimately solve nothing. And that's a bigger problem.