Don't fix what isn't broken at the Federal Home Loan banks

The Federal Housing Finance Agency’s ongoing review of the Federal Home Loan banks has already led to some very real consequences for the local banks that use these entities for their founding purpose of supporting housing finance and community investment. 

As the FHFA begins to implement the recommendations that came out of its yearlong study of the Home Loan Bank System and federal banking regulators pressure community banks away from Home Loan bank advances, the crackdown on this vital facilitator of local lending threatens the housing finance system at a time of high prices and limited supply. 

The Home Loan banks are an important source of financing to their member-owners, including most of the nation’s community banks. Community banks use mortgages they hold in portfolio to fully collateralize advances that provide liquidity, which allows them to make more mortgage loans and further invest in their communities. 

This is how the Home Loan banks were designed to work when they were established in 1932, and the system continues to promote access to the housing market in local communities across the nation. In addition to fueling local lending, the Home Loan banks are required by law to apply at least 10% of their earnings to the system’s Affordable Housing Program, which is one of the nation’s largest sources of private-sector grants for housing and community development. 

The result is a proud record of supporting the housing finance system. A University of Wisconsin study found the Home Loan Bank System increases mortgage originations by $130 billion and saves borrowers $13 billion in mortgage interest payments per year. And the Home Loan banks last year assisted 65,000 low- or moderate-income households and supported more than 400 targeted economic development projects via the Affordable Housing Program and the system’s Community Investment and Community Investment Cash Advance programs, according to the FHFA. 

Not all Home Loan bank member financial institutions directly access advances, but they know those funds are there as a backup source of liquidity. Throughout the financial crisis, the Home Loan banks continued to provide advances to their members without disruption, while other segments of the capital markets ceased to function. This strong support system serves a vital role in the nation’s housing finance system. 

All of this is done without any direct federal appropriation or a government guarantee of the securities issued by the Home Loan banks, which is bought by private investors using private funds due to the relative security of the debt. 

Unfortunately for the local communities that depend on the Federal Home Loan Bank System, these successful fundamentals are at risk of being undermined by a regulatory crackdown that could impede access to home loans. 

Even before the FHFA issued a recent advisory bulletin laying out new expectations for how the Home Loan banks should conduct credit reviews of their member banks, community bankers had witnessed rising regulatory scrutiny of advances. For instance, the Federal Home Loan Bank of New York this summer issued a message to its member banks that it will impose additional qualitative and quantitative information reporting requirements to align with the FHFA’s more restrictive approach to lending — an unnecessary burden for a system of advances fully collateralized by residential mortgage loans. No member should be denied an advance that is fully collateralized because of their business model or strategy, especially since all members are owners of the Home Loan Bank System.

Meanwhile, community bankers are reporting that they are being penalized by bank examiners for including access to Home Loan bank advances in their liquidity stress testing scenarios. Instead, prudential regulators are directing banks to the Federal Reserve’s discount window, which is presenting technical and operational challenges and delays for many community banks.

Ultimately, the combined regulatory pressure from the FHFA on the Home Loan banks and from the prudential regulators on the system’s member-owners could severely hamper access to mortgage credit at the worst possible time.

To avoid hindering mortgage lending, the FHFA should ensure its review does not create additional requirements that restrict advances to members in good standing and with eligible collateral. Any new arbitrary standards for member-owners threaten to cut off community banks from the system, which would restrict local investment. 

While the FHFA is reviewing the Home Loan banks’ mission, their statutory mission of “providing liquidity to their members to support housing finance and community development through all economic cycles” is clear and does not need to be substantially changed or clarified. Congress defined the mission in 1932, has modified it in subsequent legislation and is the only entity authorized to change it today. 

Instead, regulators should work together to maximize access to the system. For instance, the FHFA should align the capital requirements for Home Loan bank member advances with the prudential regulators to avoid disruption and possible liquidity problems for otherwise well-capitalized community banks.

The Federal Home Loan Bank System has worked well for over 90 years, providing community banks with liquidity to fund mortgage lending and community development projects. Given current challenges in the housing market, this system must remain a strong, stable, reliable source of funding based on a regional and cooperative structure that best addresses the diverse needs of its members and the local markets they serve.