Surviving the Thrift Crisis The thrift industry's return on assets reached a peak in 1978. Then it was hit by two successive crises. The first was caused by the soaring interest rates of the late 1970s and early 1980s. The thrift model involved making long-term, fixed-rate mortgages funded by short-term deposits. This model proved highly profitable in the post-war period characterized, as it was, by relatively stable interest rates. But when interest rates climbed to unprecedented heights beginning in the late 1970s, thrifts were squeezed between the higher rates of interest they were paying on their deposits and the much lower rates they were receiving on their long-term mortgages. Virtually the entire industry started losing money and many institutions failed. Both the federal government and, more particularly, several of the states tried to rescue the ailing industry by authorizing new powers for thrifts. With weak supervision over the industry, many hundreds of thrifts misused their new powers, gambling on high risk loans and investments, and causing the second thrift crisis-which lead to an eventual $150 billion cleanup bill for taxpayers. Other thrifts, however, continued with their traditional home-lending orientation. These institutions recovered when interest rates declined and they constitute the healthy thrift industry that remains to this day. Notable in this maelstrom was the resiliency of the Bank System. Membership was almost halved, falling from 4,250 in 1979 to 2,337 in 1992. Similarly, the loans FHLBanks make to members (called “advances") fell by 48% between 1988 and 1992— from $153 to $80 billion. But the System proved to be remarkably flexible and it is telling that it survived, like the now-healthy part of the thrift industry, by sticking to its traditional business of making advances to members secured by mortgage loans. In spite of the turmoil in the industry of which it was an integral part, the FHLBanks didn't suffer a single credit loss. In addition, by opening membership to banks and credit unions, Congress was able to restore a stronger business footing for the System. In fact, the FHLBanks made a net contribution to the cleanup of problem thrifts when Congress redirected over $3 billion from the retained earnings of the Banks to help defray some of the cost of dealing with so many failed institutions. Gramm-Leach-Bliley Act In 1999, the Gramm-Leach-Bliley Financial Services Modernization Act11 (GLBA) made further changes in the System's structure. These changes addressed growing problems with the capital base of the FHLBanks and re-emphasized congressional support for the System's mission to serve community-banking institutions. Existing rules allowed any member, except a federally chartered thrift, to exit the System with six months' notice, redeeming its investment in FHLBank stock when it left. 11 Pub. L. No. 102, 113 Stat. 1338 (1999) thrifts provided the only stable source of capital because of the fact ney, were enjoined from leaving. As membership in the System qual approach was difficult to sustain. dilemma with an elegantly simple solution. It made membership provided for stability of the System's capital base by allowing the lize themselves with stock that couldn't be withdrawn for five years. al restructuring, GLBA also directed the new regulator-the Federal expanded membership to include "community financial institutions" The Current FHLB System stem's business has grown significantly from its low level in 1992. Its drastically in the early 1990s, the FHLBanks changed the composition overnment sponsorship permits the FHLBanks to borrow at ed rates, most of their investments constitute an arbitrage of credit the capital markets-borrowing funds in the capital markets at s are: Seattle, Pittsburgh, Cincinnati and Indianapolis. 2002 Annual Report, at 6. 7 SRA ES below-market rates and investing them in securities at market rates. ... We As the balance sheet of the System has changed, the percentage of the System's balance sheet made up of advances has declined significantly. In 1980, prior to the unfolding of the S&L crisis, outstanding advances represented 90% of total assets. But by 1992, that percentage had declined to 64% and has ranged from 48.5% to 68% over the past decade. As shown in the following chart, non-advance investments had been declining as a percentage of total assets from 1995 until 1999, when the first mortgage purchase program approved by the FHFB began to grow. In fact, the FHFB expressly limited each FHLBank's MBS investments to 300% of its previous month's capital. That limitation, however, did not apply to the new mortgage purchase programs: the Mortgage Partnership Finance program (MPF) pioneered by the Home Loan Bank of Chicago begun in 1999, followed by the Mortgage Partnership Program (MPP) instituted by the Cincinnati, Indianapolis, and Seattle Banks in 2000. From 2000 to 2002, the System's cash and non-advance investments declined as a percentage of assets, from 29% to 27%. However, mortgage purchases under MPF and MPP exploded. In 2000, the first year both programs became operational, $16 billion was invested in mortgage purchases. By the 13 Testimony of Assistant Secretary of the Treasury Rick Carnell before the House Subcommittee on Capital Markets, Securities, and Government Sponsored Enterprises “Federal Home Loan Banks” (Sept. 24, 1998) at number had climbed to $60 billion. At the end of 2002, mortgages ccounted for 7.9% of assets, up from 4.0% in 2001.14 le balance sheet of the System has been accompanied by proposals to The Push For Multi-District Membership ne Loan Bank Act of 1932 established the Federal Home Loan Bank prized it to establish and oversee eight to twelve regional Banks. Pursuant , the Board created twelve districts. The 1932 Act, as amended, stated tution eligible to become a member or a nonmember borrower a district adjoining such district, if demanded by convenience and nual Report, at 22 HE RA ES RA RA ESS Currently, each member of the System is a member solely of the district Bank where the member maintains its principal place of business. No single institution has been a member of more than one district Bank, though some holding companies own separately chartered subsidiaries that are members of different Banks." 15 Consolidation has led some System members to seek out multi-district memberships to allow them membership in districts where they are not headquartered or to avoid what they view to be unnecessary and excessive costs attendant with maintaining separate charters within a holding company. 16 In response to these petitions, the FHFB started a formal process of soliciting comments, with the comment period expiring in the spring of 2002. The FHFB received several comments questioning its legal authority to permit multi-district memberships, (including a letter by the author when I served as Assistant Secretary for Financial Institutions)." The FHFB then took the somewhat unconventional step of contracting with an outside law firm, Morrison and Foerster, (instead of relying on its in-house legal staff) to provide it with a legal opinion as to whether it had the power to extend multi-district membership privileges. An agency's own legal staff is generally viewed as the leading source of expert advice regarding that agency's authorizing statute. When an agency is uncertain about the scope or meaning of its authorizing legislation, the more typical course is to seek an opinion from the Justice Department's Office of Legal Counsel, or to seek clarifying legislation from Congress. 17 The outside legal opinion reached the astonishing conclusion that not only did the statute authorize the FHFB to permit multi-district membership, but required it to do so if necessary to carry out the FHFB's mandate that the FHLBanks operate in a safe and sound manner." The FHFB then adopted a resolution requesting information from the twelve Federal Home Loan Banks “regarding the changing financial services industry, and its effect on terms of membership in the Banks. "18 Upon issuing the resolution, Chairman Korsmo indicated his hope to present "a final regulation to modernize membership terms" no later than the FHFB meeting in June 2003.1 19 The question of multi-district membership has been highly controversial among the FHLBanks' Presidents. Less than half have expressed support for it: Chicago, Dallas, New York, Pittsburgh and Seattle. Four have vigorously weighed in against the petitions: 15 See the FHFB's Solicitation for Comments on Multi-District Membership, at p. 2. The FHFB reports that 104 depository institution holding companies have subsidiaries that are members of different district Banks. 16 "[T]he statutory language of Section 4(b) as well as the legislative history of the provision raise considerable doubt as to whether the Finance Board has the authority to approve multi-district membership." Letter Sheila Bair, Assistant Secretary for Financial Institutions, Treasury Department, to Elaine Baker, Secretary to the Board, Federal Housing Finance Board, April 9, 2002. 17 Letter from Morrison and Foerster to John Korsmo (December 9, 2002). 18 Resolution 2002-63 (Dec. 20, 2002) 19 FHFB Press Release (December 20, 2002) |