Federal Home Loan Banks: The Housing GSE That Didn’t Bark in the Night?
From the onset of the financial crisis to today, Fannie Mae and Freddie Mac have frequented the financial headlines. Since these two housing-related government sponsored enterprises (GSEs) were taken into conservatorship by the U.S. Treasury on September 7, 2008, they have required $148 billion in taxpayer funds to cover the losses they incurred. Recent statements by the acting director of the Federal Housing Finance Agency suggest that the final bill to the U.S. taxpayer to resolve the insolvencies of Fannie and Freddie could exceed $400 billion.
However, the Federal Home Loan Bank system, another housing GSE, has fared somewhat better during the financial crisis. Created as part of Depression-era reforms to the financial system, the 12 Federal Home Loan Banks provide liquidity and funding to the housing and small business loan markets primarily through loans known as advances. Advances are generally secured by housing-related assets and the small-business-loan portfolios of their member institutions and qualified nonmember housing agencies. Federal Home Loan Bank advances can carry a fixed or variable interest rate and range in maturity from overnight to 30 years. During the market turmoil in 2007 and 2008, advances from the Federal Home Loan Banks served as an important source of funds for depository institutions.
From 2001 to 2005, the consolidated assets of the Federal Home Loan Banks increased on average 8.8 percent per year before they leveled off in 2006. This asset growth was driven by strong demand for Federal Home Bank advances, which grew at a rate of 7.3 percent over the period and accounted for 62.1 percent of Federal Home Loan Bank assets in 2009. As the financial crisis began to unfold in the summer of 2007, the volume of lending by the Federal Home Loan Banks took off, growing from just under $641 billion at the end of 2006 to $875 billion—an increase of approximately 38 percent. Advances accounted for most the growth in total assets for the Home Loan Banks in 2007—more than $23 billion of almost $26 billion. As financial markets returned to normalcy in 2008, both advances and total assets grew at around a 6.0 percent. They then declined sharply in 2009, and by the end of the year, total assets and advances outstanding had returned to 2006 pre-crisis levels. The decline was driven by a slowdown in advances; they fell 32 percent from 2008 to 2009.
Unlike Fannie Mae and Freddie Mac, the Federal Home Loan Banks hold less than 27 percent of their asset portfolio in the form of mortgages and mortgage-backed securities. The bulk of Federal Home Loan Bank assets consist of advances, which are secured by the collateral pledged against them and by a general lien, known as super lien authority, on all of the assets of the borrower. Consequently, the Home Loan Banks have faced noticeably less severe asset quality problems and credit losses than Fannie Mae and Freddie Mac.
The majority of funding for the Federal Home Loan Banks comes from the issuance of bonds known as consolidated obligations. The term consolidated obligations refers to the fact that when an individual Home Loan Bank issues debt, that debt is a joint obligation of the 12 Federal Home Loan Banks. In other words, consolidated obligations, irrespective of which Home Loan Bank issues them, are the collective liability of all of the Home Loan Banks. This feature of the debt reduces the risk associated with the default of any individual Home Loan Bank and contributes to the perception that the liabilities of the Federal Home Loan Banks have tacit government backing.
The rapid expansion of advances from 2007 to 2008 was financed with consolidated obligations, which grew more than 26 percent in 2007 and nearly 7 percent in 2008. Growth in total liabilities followed essentially the same pattern as consolidated obligations; however, over the same period, Federal Home Loan Bank capital grew at slightly lower rates. The inability of the Federal Home Loan Banks to accumulate capital as fast as their balance sheets were expanding in 2007 and 2008 put downward pressure on the system’s capital ratio, which dropped from 4.4 percent at the end of 2006 to 3.8 percent at the end 2008. A capital ratio below 4 percent falls below the threshold of core capital to assets that a commercial bank is required to hold under current capital adequacy rules in the United States. The ratio rose above the threshold again in 2009 (to 4.2 percent), even though the level of capital fell nearly 17 percent, because the shrinkage in the system’s balance sheet was large enough to offset the loss.