Dean's Professor of Financial Regulatory Policy, Isenberg School of University of Massachusetts-Amherst and Associate Professor at the ic Policy and Administration. She specializes in financial services issues. ormerly the U.S. Department of the Treasury's Assistant Secretary for utions (2001–2002) and Commissioner of the Commodity Futures Trading 991-1995). supported by a grant from Fannie Mae. The views expressed are entirely hor. Introduction Growing up in rural southeast Kansas, my first impressions of the Federal Home Loan Bank System were formed by those of my parents and their depression-era contemporaries. Living through the Great Depression, they remembered the System's role in helping cash-strapped savings and loans stay afloat, and thousands of families stay in their homes. Moreover, in the pre-branching era of my youth, the thrift institutions serving rural communities in Kansas and elsewhere, were, for the most part, independently owned, community-based institutions, which relied on the System as a vital source of funding through the cyclical ebbs and flows of deposits. The Federal Home Loan Bank System was viewed as a stable, respected American institution, one of the keys to rural America's survival through the depression, and an important source of funding for mortgage lending to facilitate achievement of that quintessential American dream, home ownership. So it is that with those early impressions, I have retained a favorable bias toward the System in its role as a regionalized funding source for smaller, community-based lenders, though I concede the importance—up to a point—of its support for larger lenders as well. Perhaps it is because of that bias, and nostalgic fondness, that I feel compelled now to raise the alarm over a trend that I find disturbing: the transition of the System into a centralized provider of funds and services for large mortgage originators. And, if current trends continue, it could become a major player in the business of purchasing and securitizing home mortgages—a line of work much riskier than the System's traditional job of making heavily collateralized loans, and less responsive to the needs of small community lenders. Such a transformation poses safety and soundness risks to the FHLB System. These changes are not sanctioned by the FHLB System's authorizing statute and legislative history. In addition, no compelling public policy rationale has been proffered to justify this new, expanded use of the System's status as a government-sponsored enterprise (GSE). When Congress last acted on the Bank System in the Gramm-Leach-Bliley Act of 1999, the only major new power granted was targeted at smaller members: a directive to the FHLBanks to use their GSE-favored status to support additional forms of lending by community banking institutions. Congress didn't see fit to shift the emphasis toward the needs of larger institutions nor grant the System the right to enter the complex, higherrisk secondary mortgage market. There are two other established GSEs created expressly for the latter purpose, with capital and ownership structures tailored to that mission. Congress also decreed that a financial institution may belong only to one FHLBank. The recent attempts at the regulatory level to allow multiple memberships would introduce a potentially revolutionary change to the System—a change that is at war with its 70-year history as a cooperative, is legally unsound, and has not been the subject of either public or Congressional review. d their regulator want to transform themselves, they should ask e made? It is my hope that this paper will help facilitate vigorous d securitization can be justified based on sound public policy and History of the Federal Home Loan Bank System "The benefits of FHLB membership are vitally important to Independent Community Bankers of America1 "ACB strongly supports the cooperatively based FHLBank System with access to advances for housing and community development lending.” America's Community Bankers2 "There are numerous forces at work that may drive the System to consolidation into a single, massive and very powerful government-sponsored enterprise, one that is engaged in a business and serving a function very different from the business and function it has historically performed, and more like those performed by the other two housing GSEs. By eliminating local control of the FHLBanks and undermining the regional nature of the System, it seems likely that such consolidation would reduce the System's responsiveness to the needs and priorities of local businesses and communities.” 2002 Annual Report San Francisco Home Loan Bank The Federal Home Loan Bank System was created by the Federal Home Loan Bank Act of 1932.3 It was the result of a proposal unveiled by President Herbert Hoover in 1931 as part of a package of economic reforms to respond to the financial crises created by the Great Depression and, in particular, to provide relief to economically distressed savings and loans,* and the urban and rural home owners who relied upon them for mortgage loans. Hoover's memoirs make clear that he intended the System to make mortgage money more available in good times and bad, assuring a constant flow of funding when deposits dwindled due to national or regional economic conditions." 4 Hoover's proposal was controversial, opposed by commercial banks and insurance companies, and viewed with trepidation by fiscally conscious legislators concerned about the government's potential exposure to System losses. The bill took seven months to 1 ICBA's 2003 Policy Resolution on the Federal Home Loan Bank System, available at http://www.icba.org/ /news_views/news_views_fr.html 2 2003 Policy Position on the Federal Home Loan Bank System, available at http://www.acbankers.org /government/03 PolicyBook.pdf 3 12 U.S.C 1421, et seq. Or building and loans as they were then called. The Memoirs of Herbert Hoover, 1929-41 The Great Depression (MacMillan 1952) at 111-115. es dards of the day—but the fundamental design that was adopted has years. authorized the creation of eight to twelve Banks, and established the Bank Board (FHLBB) to oversee the Banks. The purpose of the end money to building associations, savings banks, and similar y engaged in the business of making loans to homebuyers. The ed to require the Banks to over-collateralize the loans they made nent of mortgages held by the borrowing institution, and to further en on the borrowers' capital stock. 7 8 6 ed in 1932, the FHLBank Act temporarily authorized the FHLBanks tgage lenders of last resort. Significantly, Congress repealed this onths later, on June 13, 1933.* Instead, the Reconstruction Finance red the Federal National Mortgage Association (Fannie Mae) in 1938 d mortgages. By 1939, Fannie Mae had purchased 26,726 mortgages, han $100 million." years of its existence, the Federal Home Loan Bank System matured new corporation, called the Federal Home Loan Mortgage Corporation was owned by the FHLBanks (and, therefore, indirectly by their thrift Board was composed of the same officials who made up the FHLBB. authorizing the FHLBanks to conduct secondary market operations, hed a distinct, specialized corporation within the System to perform Eventually, in 1989, investment in Freddie Mac was opened up to the public and an independent, shareholder controlled Board of Directors anization" (The Brookings Institution 1934) at pp 40 - 42. Over-collateralization has FHLBank Act of 1932. A "sunset provision" in the 1932 statute would have gage lending authority once the FHLBanks were fully capitalized by their members. an Act, ch. 63 §3 (1933). The 1933 repeal came before the sunset date set in the 1932 on Dollars" (MacMillan 1951) at pp 149-152. See also, Stanton, "A State of Risk" nied retail lending power to the FHLBanks in 1969, when it rejected a provision in a bill |