The biggest story in financial regulation right now was supposed to be who President Joe Biden would nominate to the open seat on the Federal Reserve Board of Governors, now that former Vice Chair Lael Brainard has migrated to the White House.
Then Silicon Valley Bank and Signature Bank, which were major business partners with the venture capital and cryptocurrency industries respectively, both collapsed, triggering federal bailouts and earth-shattering new precedents for bank failure response. Since the Fed’s regulators allowed SVB’s balance sheet to be so mismanaged, and the Fed’s monetary policy triggered the bank’s liquidity crisis in the first place, it has plenty to rethink in the months ahead, as The American Prospect’s David Dayen covered.
There is one weird quirk that ties the SVB/Signature story and the Fed nominee story together, however. The current reported frontrunner for the job is Janice Eberly, whose apologias for Geithner-era evictions policies I wrote about previously for the Prospect. Eberly also sits on the Board of Directors for the Office of Finance at the Federal Home Loan Bank system (which are inexplicably abbreviated as the “FHLBanks,” because Washington hates consistency.) She was previously an Independent Director at the FHLBank of Chicago.
One of the flashing-red warning signs about SVB’s bad balance sheet was the huge cash advances it was taking out of the FHLBank system. In the wake of the SVB and Signature implosions, mid-size regional banks have been tapping the FHLBank system like never before. According to The American Banker, the system made its largest single debt issuance in one day in March, as banks scrambled for cash to protect against any sort of residual bank runs or panics.
All of this might have readers wondering: “What the hell is the FHLBank system?” An excellent question.
Oh Yeah, Remember That Herbert Hoover Thing?
The FHLBank system is sort of the red-headed step-sibling of the Federal Reserve system. Herbert Hoover created the FHLBanks in 1932 as part of his plan to end the Great Depression. Their goal was to provide cash advances to small, regional banks so that those banks, in turn, could offer mortgages (and get people out of the infamous Hoovervilles). Hoover was famously spiteful of any effort to expand government or change the financial system, so he thought the biggest problem with the Depression was just getting some money into regional banks so they could get back to business as usual.
Surprise: Hoover’s anti-Depression policies didn’t work so well. Four months after Hoover created the FHLBanks, the country elected Franklin Delano Roosevelt. One year later, Roosevelt created the Homeowners Loan Corporation (HOLC) and followed up in 1938 with the Federal National Mortgage Association (nicknamed Fannie Mae…again, Washington hates consistency.) Both of these institutions served the FHLBanks’ goal faster, more efficiently, and more effectively.
HOLC, Fannie Mae, and the rest of the New Deal reforms created a new, far safer financial system. But Congress never went back and got rid of the FHLBanks, and neither Roosevelt, nor any subsequent President made it a priority. There were always far more important things to do, and it’s not like the FHLBanks were hurting anyone. They were just created to do a job that other institutions now do much better. This left the FHLBanks themselves wondering how to spend their time and money.
The Lender of Second-To-Last Resort
As the FHLBanks were trying to figure out their next steps, they probably looked at their bigger, flashier step-sibling, the Federal Reserve. The Fed is America’s “lender of last resort” for commercial banks, which was actually its original, core purpose. (The Fed stumbled into the anti-inflation and pro-employment roles with which we now associate it practically by accident — though those are now its statutory mandates.)
If you’re a bank in need of a short-term loan to handle immediate cash-flow issues — maybe you don’t want to handle some tiny gaps in liquidity for a day or two after a minor shortfall — and you’re a member of the Federal Reserve system, you might ask another bank in the Fed’s system for a short-term loan. That loan would be at the federal funds rate, which is the main interest rate people are talking about when they discuss the Fed raising or lowering rates.
But another option is to borrow from the Fed directly, through a facility called the discount window. (The name “discount window” refers to how borrowers need to post collateral to access these loans, and the Fed often lends less capital than the collateral is worth.) The discount window typically charges a higher interest rate than the federal funds rate, but it’s always available, so it can be convenient for a bank to take out a short-term loan through the facility instead of haggling with other private banks.
But the discount window’s most crucial role is as a lender for banks which, for whatever reason, can’t get credit at all from other banks. When people talk about the Fed being a “lender of last resort,” they’re talking about how truly struggling banks can take out a large loan — much larger than those short-term, overnight ones — through the discount window.
However, for a truly struggling bank, getting a loan via the discount window can be a bit pyrrhic. A bank which takes out an unusually large loan from the Fed signals to other private financial actors that it’s in dire straits and can’t find other lenders. The onlookers often infer that the bank is circling the drain, and thus refuse to offer the bank additional support — or worse, pull their money out of the bank if they hold any deposits there.
As a result, while the discount window serves a crucial function, using it heavily has traditionally been highly stigmatized. That said, ever since the Covid-19 pandemic threw the economy, and thus, the financial system for a loop a few years ago, many more banks have been borrowing through the discount window.
But what if there was another, more discrete government-backed intra-bank lending system? If that other system could just keep a lower public profile, it could provide capital to banks which were struggling, but not quite ready to go to the discount window yet, due to the stigma. That might prove a lucrative niche.
The FHLBanks spotted this opportunity and reinvented themselves as the low-key “lender of second-to-last resort.” Today, the FHLBanks are the second-largest issuer of dollar-denominated debt, behind only the U.S. Treasury Department. Leading the FHLBanks is also lucrative: the CEO of the FHLBank of New York made over $2.7 million in 2021, more than six times what the highest-paid New York Fed Bank executive received.
Moreover, the FHLBank system now has almost nothing to do with its original purpose of backstopping mortgages and supporting homeownership. Most mortgages today come from either Fannie, Freddie, or Ginnie Mac; or from non-bank private actors, to which the FHLBanks cannot lend. Congress does require the FHLBanks to contribute 10 percent of their revenue to the Affordable Housing Program, but the FHLBanks are also tax-exempt. They’d end up paying far more into government services as a whole, including for affordable housing, if they just paid taxes.
Eberly Should Answer Some Questions
This doesn’t necessarily mean the FHLBanks need to be destroyed outright. Americans for Financial Reform recently led a coalition of housing and consumer advocacy groups, including ourselves, which argued in a letter for a thorough review of the FHLBanks, including executive compensation reform and major increases to the system’s contribution to affordable housing.
But the fragility and greed of the financial system is, of course, a lot larger than just the FHLBanks. As the SVB/Signature fallout shows, having a lender of second-to-last resort can be helpful in times of stress. Sure, that isn’t what the FHLBanks were originally supposed to be, but they didn’t do their original job very well in the first place. And practically every part of the federal bureaucracy has shifted and evolved over time as underlying conditions in the country have changed.
But if the White House does nominate Eberly for the Fed Board, she should face questions in Congress and the media about her time on the FHLBanks Office of Finance Board of Directors. What was her compensation for the role? Why did she agree to take it in the first place? How does she think Congress should reform the FHLBanks — or does she think it’s time to talk about getting rid of them altogether?
I’ve already written that I think Eberly ought not to be nominated to the Fed due to the Geithner-era housing policies to which she attached her name. But especially amidst an historic housing crunch, and as attention turns back to the FHLBanks for the first time in years, her involvement is at least a bit curious.
PHOTO CREDIT: “Herbert Hoover’s birthday celebration, Herbert Hoover National Historic Site, 1874” is a public domain image.