Proven Success of the FHLB System

It was very impressive the way the Federal Home Loan Bank (FHLB) system performed during the financial crisis in 2008 and in subsequent years. This government-sponsored enterprise had been established by Congress in 1932, but the system was not fully tested until the 2008 crisis. To say that it passed with flying colors would be an understatement. The system nearly doubled its size to provide needed advances to its member financial institutions, allowing them to satisfy liquidity issues for their customers. As a result, financial institutions were able to meet the demands of their customers, assuring confidence in our financial system and avoiding the runs on banks that plagued our nation during the Great Depression.

Perhaps even more amazing was that, after the crisis had abated, the FHLBs shrank their balance sheets down to pre-crisis levels. As individual financial institutions paid off their advances borrowed from the FHLBs, the FHLBs then paid off their borrowings in the capital markets. It was ingenious, and it represented government at its best. I had already been a fan of the FHLB system long before 2008, but I became an even bigger fan after seeing how well it worked under pressure.

Today there are 11 FHLBs across the country. They act independently, but cross-collateralize each others’ debt; thus, what affects one FHLB theoretically could affect all. Last week Mel Watt, director of the Federal Housing Finance Agency ‒ the regulator of the FHLB system ‒ disclosed that four borrowers of the FHLB system account for 24 percent of all advances. Director Watt believes that this concentration poses a potential danger for the system at large. While I understand his concern, I can’t help but remember the efficiency and effectiveness of the system during its most stressful economic time. This cross-collateralization certainly could pose a systemic problem, though, if one or more of those principal borrowers were to default.

The Federal Home Loan Bank of Indianapolis (FHLBI), historically one of the higher-earning FHLBs, does not do business with any of those four large borrowers. The community banks, credit unions and insurance companies which do business with the FHLBI are all located in Indiana and Michigan, and they rely heavily upon the advances available to them through it. In light of Director Watt’s concern, I hope that there is not a knee-jerk reaction in trying to solve a problem that may not exist.

A better approach would be to address this concern through thoughtful discussion and debate from all representatives who have interests in preserving FHLBs. I have for years feared that there would be an attempt to “fix” what isn’t broken with the FHLB system. Director Watt, it should be noted, also is the regulator for Fannie Mae and Freddie Mac, which do have structural problems. Unfortunately the FHLB system often is thrown into discussions about solving problems that afflict Fannie and Freddie, but do not apply to the FHLBs.

The many benefits of the FHLB system far outweigh any risks currently posed to the system through the heavy concentration of advances. Let us unite in support of whatever it takes to build upon the proven success of the FHLB system.

– S. Joe DeHaven

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