A rethink of America’s dysfunctional housing finance system is long overdue. The system’s most infamous exemplars are Fannie Mae and Freddie Mac, still critically undercapitalized after almost 15 years in government conservatorship. But the 11 regional Federal Home Loan Banks may be a better place to start.
Although they’re privately funded, the FHLBs do impose public costs. By one estimate, total subsidies for the system — including tax breaks, favorable regulation and the implicit backstop — amounted to about $5.5 billion in 2022. Their debt also benefits from privileged legal treatment. It’s fair to ask whether taxpayers are getting their money’s worth. More pertinently: It’s fair to ask whether this system still needs to exist at all.
Three concerns stand out.
One is that the banks’ founding mission — to support the housing finance market — is not as pressing as it once was. The homeownership rate has soared since the 1930s. Lenders today typically sell their home loans to Fannie or Freddie or private investors, freeing up cash to continue lending. Nonbank lenders, which are generally ineligible for FHLB loans, now make up most of the mortgage market.
This raises a second concern. As their role in the mortgage market has declined, FHLBs have expanded into other types of business. That includes providing advances to banks known for lending to riskier enterprises, such as cryptocurrency companies and technology startups. (Three of those banks collapsed earlier this year.) The system’s unusual design — in which members are both shareholders and borrowers, and public privileges accrue to private owners — virtually guarantees that they will continue to explore new ventures in search of profit.
A final, related worry is financial risk. The FHLBs have become the biggest lenders in the federal funds market, which banks use to make overnight loans to each other. At times of stress, they have also served as a “liquidity first responder” to their members and helped to stabilize the financial system. Yet they were never designed for either purpose. Unlike the Fed, the FHLBs depend on capital markets — money-market funds in particular — for their own funding. As they’ve increased their issuance of short-term and floating-rate debt, they’ve become more vulnerable to a sudden interruption of demand. In such a scenario, they could pull their ready cash from the fed funds market, potentially sending rates surging until the Fed stepped in. A privately owned emergency liquidity service — lacking the Fed’s resources and authorities — is not to be relied on.
Some changes are in the works. The Federal Housing Finance Agency plans to release a review of the system by the end of September. Bloomberg News reports that one proposal under consideration would be to limit how much the largest financial institutions can borrow from the FHLBs. Another idea is to suggest that Congress boost the percentage of profits that they must commit to affordable housing.
Such tweaks are worth entertaining, but they sidestep the fundamental problem. Congress has created — and generously subsidized — a $1.5 trillion pseudo-public banking network that is distorting markets and creating new financial risks as it casts about for a plausible purpose. Absent major reforms and a clearly articulated mission, it’s simply asking for trouble. Congress needs to specify what it wants the FHLBs to do, then give them the appropriate tools for that objective — and nothing more.
The Editors are members of the Bloomberg Opinion editorial board.
More stories like this are available on bloomberg.com/opinion