Home-Loan Banks Draw Focus Amid Rescue Plan

RDX : Simply FYI

By JAMES R. HAGERTY
September 9, 2008; Page A21

The Fannie Mae and Freddie Mac takeover raises questions about another set of institutions set up by Congress to help finance housing: the 12 regional Federal Home Loan Banks.

Like Fannie and Freddie, these banks have long been able to borrow money inexpensively on the bond market because investors assume that the government would rescue them in a crisis. But will the Treasury have to bail out the home-loan banks eventually? And should they benefit from the implied backing of the government?

Their regulator plays down the risks. James Lockhart, director of the Federal Housing Finance Agency, or FHFA, which oversees Fannie, Freddie and the home-loan banks, said Sunday that the banks "have performed remarkably well over the last year." When asked Monday whether he saw any need to overhaul the home-loan banks, he said: "The structure works."

Fannie, Freddie and the home-loan banks all are known as government-sponsored enterprises, or GSEs -- entities owned by private shareholders but chartered by Congress to perform a public mission.

Treasury Secretary Henry Paulson called this GSE model "flawed" Sunday and said government backing for companies "needs to be either explicit or nonexistent." A Treasury spokeswoman said later that Mr. Paulson was referring only to Fannie and Freddie.

The home-loan banks are among the world's biggest borrowers, with about $1.3 trillion of debt outstanding, compared with a combined $1.7 trillion for Fannie and Freddie. The home-loan banks' debt has ballooned 34% since the end of 2006 as they have taken on a bigger role in funding banks and thrifts amid a credit crisis that has choked off other sources of money.

Congress created the home-loan banks in 1932 to prop up thrift institutions during the Depression. Today, the home-loan banks' main business is to make low-cost loans, known as "advances," to their more than 8,000 owners, which include commercial banks, thrifts, credit unions and insurance companies. The home-loan banks' government-sponsored status, which allows them to borrow inexpensively, amounts to a subsidy for the banking industry.

Unlike Fannie and Freddie, the home-loan banks generally have been profitable despite the mortgage-default crisis. They reported combined net income of $718 million for the second quarter, up 14% from a year earlier. But one of them, the Federal Home Loan Bank of Chicago, reported a loss of $152 million for the first half. The Chicago bank has been hurt by losses on mortgage investments caused partly by hedging costs related to interest-rate risks. The Seattle home-loan bank had a $9.1 million loss in the 2005 final quarter, also involving mortgage investments, but has returned to the black.

Advances from the home-loan banks have gone to some shaky firms, including IndyMac Bancorp Inc., a big Pasadena, Calif., mortgage lender seized by regulators in July. But the advances are backed by collateral, and the home-loan banks have priority over other creditors and even over the Federal Deposit Insurance Corp. when a bank fails. The Federal Home Loan Bank of San Francisco, where IndyMac was a big customer, has said it expects to "collect all amounts due" from that bank.

As part of the rescue of Fannie and Freddie, the Treasury announced a "lending facility" available through the end of next year to provide short-term loans, if needed, to those companies as well as to the home-loan banks.Defenders of the home-loan banks note that, unlike Fannie and Freddie, they don't have publicly traded shares. Only the members, or customers, own stock in home-loan banks, and those shares always change hands at par, or face, value. Thus, home-loan bank executives don't need to worry about pursuing risky growth to please Wall Street. Even so, the implied government backing makes it easy for the home-loan banks to borrow money, and that alone could encourage risky behavior.

John von Seggern, president of the Council of Federal Home Loan Banks, an association of the regional banks, said those institutions "are doing what we were chartered to do in a safe and sound manner." But Prof. Lawrence White, an economics professor at New York University, argued that the goal should be to cut the links between the government and the home-loan banks. They perform a useful function, he said, but "they've got to be doing it on their own nickel and not any government's implicit guarantee."