Federal Home Loan Banks: Unsung Heroes of the Financial Crisis?


An important part of the United States banking system — one that generally receives very little press — is the Federal Home Loan Banks system. In a November 2008 paper, researchers at the New York branch of the Federal Reserve called the system the “Lender of Next-to-Last Resort” because it was playing a “significant role at the onset of the ongoing financial crisis” by keeping financial institutions afloat.

The network of 12 Congressionally chartered banks were created in 1932, during the Great Depression, to provide savings-and-loan institutions a means to tap stable, low-cost funding. Now, their mission “is to support residential mortgage lending and community growth in all areas of the country,” the Council of Federal Home Loan Banks, the system’s trade group, told Bloomberg. These banks are cooperative institutions, owned by their borrowers — which range from large commercial banks like JPMorgan Chase (NYSE:JPM), with assets of $2.4 trillion, to smaller community banks — and are seeing lending growing at the fastest pace since the financial crisis began in late 2007.

While a typical member falls into the small, community bank profile — like the $139 million-asset Bank of McCreary County in Kentucky or the $40 million-asset Rural Cooperatives Credit Union – the lending spike has little to do with the 7,600 community banks, thrifts, credit unions, and insurers that are members. JPMorgan, Bank of America (NYSE:BAC), and Citigroup (NYSE:C) are the three largest borrowers, and if they were excluded, lending by the Federal Home Loan Banks (FHLB) systems would be decreasing, rather than increasing.

That peculiarity astounded Joshua Rosner, an analyst at research firm Graham Fisher and co-author of Reckless Endangerment, a 2011 book that focused on the role government-sponsored Fannie Mae played in the housing crisis. Massive lending to commercial banks, which was approved by Congress in 1989, “doesn’t seem to be in keeping with the system’s mission,” he told Bloomberg.

The fact that FHLBs served an important role at the onset of the financial crisis is not surprising, since they were originally designed to guard savings-and-loan institutions against failures caused by runs on deposits.

With outstanding FHLB debt climbing to $700.6 billion at the end of August from $687.9 billion on December 31 of last year, the banking system is the second largest borrower in financial markets after the U.S. Department of the Treasury. While borrowing increased during the run-up to the financial crisis, FHLB loans dropped to a 12-year low of $403.3 billion in 2011 from a year-end peak of $900.5 billion in 2008.

Together, the 12 regional banks raise money in the bond market in order to finance lending to its members. Because the banks are government sponsored, the belief is that the government will always step in to avoid a default, meaning FHLBs can sell securities at yields similar to Treasuries. They also carry the highest rating from Moody’s Investors Service and the second-highest rating from Standard & Poor’s. FHLB advances require collateral exceeding the amount borrowed, and the system has never suffered losses on the loans.

Citing figures compiled by Mesirow Financial strategist Ryan Graf, who based his estimate on bond issuance, Bloomberg reported that FHLB loans to member institutions — which are secured by mortgages and other assets, known as advances — increased $37.1 billion to $450.7 billion in the first six months of the year. Loans to Bank of America, Citigroup, and JPMorgan alone account for $44.6 billion of the total. Last quarter, loans rose another $19 billion.

JPMorgan Chief Executive Jamie Dimon, who led the bank through the financial crisis with not one quarterly loss darkening its balance sheet, has not shown himself to be too welcoming of new regulations aimed at ensuring that a similar meltdown would never be repeated.

But the international Basel III agreement set forth new liquidity requirements, prompting the bank to increase its borrowing so that longer-term funding could boost its cash levels. JPMorgan’s loans from the Cincinnati FHLB, one of the four government-sponsored banks of which it is a member, rose 64 percent to $42.7 billion in the first six months of 2013, while its total FHLB borrowing increased to $61.8 billion from $42 billion.

Bank of America, a member of five FHLBs, increased its advances by $19.4 billion to $33.8 billion in the same timeframe, while Citigroup, which belongs to three FHLBs, upped its borrowing by $5.3 billion to $25.7 billion, according to securities disclosures.

One reason why banks of varying sizes are expanding FHLB borrowing is to secure longer-term funding that better matches the duration of their assets, a practice that protects institutions against increasing deposit costs, which have bounced up from record lows, officials at the Federal Home Loan Banks of San Francisco and New York told Bloomberg. This FHLB function makes the financial system much safer, according to Alfred DelliBovi, president of the Federal Home Loan Bank of New York.

Former Federal Deposit Insurance Corp. Chairman Bill Isaac, who now chairs Fifth Third Bancorp. (NASDAQ:FITB), a member of the Cincinnati FHLB, told Bloomberg that as long as commercial banks like JPMorgan are using the funds to finance real-estate loans, the system is fulfilling its mission. But that banks see the system as having a government backstop is is “something that we’ve got to look at and debate” after the financial crisis.

However, as John von Seggern, president of the Council of Federal Home Loan Banks, the system’s trade group, told the publication, that perception is not a reality.

Follow Meghan on Twitter @MFoley_WSCS

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