About six months ago I co-wrote a Article by Bank Think stating that, in light of his declining fortunes and inability to adapt to a changing market, the mission of the federal home loan system should be reassessed. I followed that up weeks later with a open letter to FHFA Designated Director Sandra Thompson, who regulates the system.
These articles led to a particularly useful meeting with Ms. Thompson and her senior staff on the subject. Later, at a public event, Mrs. Thompson commented favored the idea of establishing an advisory committee to explore the possibilities of modernizing the system of mortgage banks.
These calls for reform have been met with silence from the system and the federal mortgage banks. Then last week, a community banker who is also a vice president of the American Bankers Association, came to the defense of the system. His exhortation, “Don’t mess with success,” was a disappointment. Praising the dubious success of a deeply flawed system fails to recognize the system’s enormous potential.
Hit? It is this same system that had to be relieved of its regulatory responsibilities and its critical role of deposit insurer. Its underperformance in both areas contributed materially to the savings and loan crisis of the 1980s. It is the same system that also contributed to the financial crisis of 2007-2009 by lending to companies like Countrywide Mortgage , Indy Mac, etc. loans.
Resting on one’s dubious laurels is not a good strategy. Better to have embraced the future.
Instead, defending the system relies on the same tropes and half-truths that have underpinned it for decades. For example, we’ve heard the well-worn boast that “…no home loan bank has ever suffered a loss on an advance in the 90-year history of the system.”
To begin with, what would you think of a bank which, in ninety years of activity, has never suffered a loss on a loan? Would it evoke George Bailey… or Old Man Potter? He was the economist Allan Meltzerwho said: “Capitalism without losses is like religion without sin”.
But the half-truth behind the bragging is even more telling. The federal mortgage banks have a more than passing familiarity with losses. Advancements are only part of the system’s story. The whole truth reveals the horrible investments they made, especially in the run-up to the financial crisis of 2007-2009. These misguided PLMBS investments totaled more than $76 billion and caused enormous losses to the system that threatened the very existence of some federal mortgage banks.
As the late Paul Harvey would say, “Now you know the rest of the story.”
You might ask, “Why are the federal mortgage banks so conservative with their advances, yet so lavish with their investments?” Christopher Leonard, in his book, “Lords of easy money“, succinctly answers the question: the search for yield.
But reporting for whose benefit? Consumers? Taxpayers? No, the yield proceeds go to the same financial institutions that own the eleven federal mortgage lending banks and, of course, to the executives of those banks who are generously compensated for running those government-sponsored enterprises.
This explains why bankers are so enamored with the system and why, unsurprisingly, the system’s generous dividends were not mentioned in the article. For the banks that own them, mortgage banks are a reliable source of dividend income. This is a very simple business model: borrow funds in the capital markets at below-market rates, subsidized by taxpayers, and invest those funds in securities at market rates.
Now I am in favor of banks being liquid and having strong earnings. But not at the expense of taxpayers. This brings us to another glaring omission in the bankers’ defense of the system: taxpayer support.
The system would not be able to sell any of its consolidated debt securities were it not for the implicit taxpayer support for these instruments. At least some acknowledgment of the role of taxpayers is necessary in any anthem to mortgage banks. After all, long-suffering taxpayers are the catalysts of the system. Shouldn’t they be getting a return on their investment rather than the silent treatment?
In support of the highly inefficient network of 11 banks, Federal Home Loan Banks are reminded that they are close to their communities and their mandatory payments for affordable housing are highlighted. There is, however, a contradiction here. On the one hand, it is claimed that every home loan bank knows the communities in its multi-state district. But at the same time, it is recognized that these banks are “misknown” and “misunderstood” in the very communities they serve. Which is it? If they are so valuable to their communities, why the anonymity?
As for affordable housing, the financing of these efforts by mortgage banks is derisory. Of course, the law requires them to devote 10% of their net income to affordable housing. With their dwindling fortunes, however, even these modest contributions have dwindled. From 2019 to 2021, contributions to affordable housing programs have decreased by 44%. In 2021, only 0.28% of system assets were dedicated to affordable housing. The outlook for 2022 based on Q1 data is not encouraging. Is it a badge of honor or a fig leaf?
Now consider that home loan banks are exempt from paying federal, state, and local income taxes. Their affordable housing efforts far outweigh the value of their tax-exempt status. The difference goes to their proprietary banks. Imagine what could be accomplished if the system’s massive $723 billion track record were more focused on the country’s affordable housing issues.
Finally, there’s the trope that mortgage banks have become the “lender of first resort” for their bank owners. Let’s accept this point. What law or regulation confers this role on mortgage banks? Aren’t private capital pools supposed to be the first lenders to private banks? Aren’t FDIC deposit insurance and the Fed’s discount window enough to subsidize taxpayers? Like a study by the Federal Reserve Bank of New York noted, the government’s many liquidity facilities, including those in the system, are already fragmented and need to be streamlined.
Congress intended the system to serve a public purpose, namely housing, not the lender of first resort. However, the system was co-opted by the banks to serve their own interests. It was the abandonment of the system’s public utility that prompted the General Accountability Office to conclude: “Furthermore, there is little empirical information available regarding the extent to which the system fulfills its housing and community mission.”
Without any public purpose what is its goal?
The system can do a lot to become part of the modern financial system. The system could help address the pressing financial needs of the housing supply chain, low- and middle-income borrowers, climate change workers, emerging fintech companies, small businesses and corporate-owned businesses. to minorities, to name a few. To its credit, the system has demonstrated that it can make progress in a sustainable and conservative manner, meeting safety and soundness standards.
But change requires a will-power and an imaginative spirit which has not been the hallmark of the system. A new generation of system leaders, a new regulator, the voice of informed stakeholders, and meaningful congressional oversight can turn the tide.
Finally, the ABA’s belated defense of the system leaves the reader with some intimate New England advice: don’t pull out your furnace in the summer thinking winter will never come. As a New Englander myself, I agree with this advice. I would add, however, that if your furnace has been burning coal for 90 years, any season is the correct season for its replacement.