Unveiling the Enigma of the Federal Home Loan Bank (FHLB) System

Revamping the Federal Home Loan Bank System

The Federal Home Loan Bank (FHLB) System, a government-sponsored enterprise, ensures that there is abundant capital available for qualified home mortgage loans through a network of 11 banks. These banks operate both independently and collectively to provide lending capital to thousands of member financial institutions reliably and securely.

The Function & Structure of the FHLB System

Established in 1932 during the aftermath of the Great Depression, the Federal Home Loan Bank (FHLB) System is monitored by the Federal Housing Finance Agency (FHFA) and comprises 11 banks situated in major U.S. cities. Approximately 80% of lending institutions in the country rely on the FHLB System. Each FHLB lends to member financial institutions that issue real estate loans, enabling these institutions to offer low-cost mortgage loans to customers through access to affordable capital. As part of their membership, these institutions purchase stock in their respective regional bank.

In addition to owning stock in the FHLB, member banks are required to purchase or originate mortgage loans and maintain at least 10% of their total assets in residential mortgage loans. Unlike entities like Fannie Mae and Freddie Mac, the FHLB System does not guarantee or insure mortgage loans, focusing instead on providing a cost-effective source of capital for banks and credit unions to continue issuing mortgage loans without encountering cash flow challenges.

Operational Mechanisms of the FHLB System

To remain self-sufficient without reliance on tax funds, the FHLB System is funded by the stocks member institutions acquire and through issuing a unique type of debt security, known as a "consolidated obligation," in capital markets. The 11 banks located in cities such as Atlanta, Boston, and New York operate independently with their boards of directors but collaborate as a system to issue consolidated obligations on behalf of the FHLB System.

Regulated and overseen by the FHFA, these banks play a critical role in expanding access to mortgage capital, particularly for underserved populations. By facilitating loan provision to these groups, the FHLB System contributes to increasing homeownership among individuals who have historically faced barriers to obtaining mortgage loans.

Pros and Cons of the FHLB System

Since its inception in 1932, the FHLB System has provided a stable source of funding through bonds and discount notes, considered secure investments. While government-sponsored enterprises like Fannie Mae and Freddie Mac required taxpayer assistance during the 2008 housing crisis, the FHLB System managed to navigate the recession without government aid due to its unique funding structure.

Despite its resilience, there are concerns about the potential vulnerability of financial institutions relying heavily on the FHLB System and the impact of bank failures on the economy. The merger of the Seattle FHLB with the Des Moines FHLB in 2015 exemplifies the response to such risks. Monitoring by economists and government agencies like the FHFA is essential to ensure the system's stability and mitigate any adverse effects on the economy.