Why Federal Home Loan Banks May Survive the Credit Crisis

In 1932, Congress created the Federal Home Loan Banks to prop up thrift institutions during the Great Depression. Today, there are 12 regional Federal Home Loan Banks. Their main business is low cost loans to their more than 8000 owners, which include commercial banks, thrifts, credit unions, and insurance companies. Like Freddie Mac and Fannie Mae, they are also Government Sponsored Enterprises, entities owned by private shareholders but chartered by Congress to perform a public mission. This special status enables them to borrow inexpensively on the bond market. Because of their special status, investors assume that the federal government would bail them out of any crisis.

The 12 regional Federal Home Loan Banks are among the world’s largest borrowers. They have about $1.3 trillion of debt outstanding. Ever since they have taken on a bigger role in funding banks and thrifts, their debt has ballooned 34% since the end of 2006 mainly because the credit crisis dried up other sources of funds for banks and thrifts.

The present credit crisis has already compelled the federal government to take over Freddie Mac and Fannie Mae. Many are now wondering if the federal government will eventually have to bail out the Federal Home Loan Banks as well. The Federal Housing Finance Agency, which overseas these home loan banks and acts as their regulator, is confident that the federal government will not have to step in.

Another worrying factor is that some shaky firms like IndyMac Bancorp, Inc., which was seized by regulators in July, also received advances from these home loan banks. But these advances are backed by collateral. When a bank fails, home loan banks have priority over other creditors, including the Federal Deposit Insurance Corporation.

Many experts have always criticized the concept of Government Sponsored Enterprise and called them flawed and unviable. The federal takeover of Freddie Mac and Fannie Mae have only strengthened this argument. Many are predicting that the Federal Home Loan Banks could be next. But it might just remain predictions.

Unlike Freddie Mac and Fannie Mae, the Federal Home Loan Banks have managed to remain profitable despite the present crisis. Their reported combined net income for the second quarter of the year is $718 million. This is a 14% increase from the figure for the same period last year.

But there are warning signs. One of them: the Federal Home Loan Bank of Chicago reported a loss of $152 million for the first half of the year. The loss was caused partly by hedging costs-related interest rate risks on mortgage investments. But the Chicago bank can take heart from the fact that another home loan bank – the Seattle Home Loan Bank – suffered a $9.1 million loss in the last quarter of 2005 but has since returned to the black. The loss in 2005 was also caused by mortgage investments.

These banks do not have publicly traded shares. Only the members or customers own shares in these banks, and these shares change hands only at face value.

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