Few Americans have ever heard about Federal Home Loan Banks (FHLBanks). Even many housing advocates continue to have questions about the inner workings of this government-sponsored enterprise. Last year, the Federal Housing Finance Agency (FHFA), the federal agency that regulates the FHLBank system, started soliciting feedback on this system from stakeholders and experts from across the nation. The FHFA recently published their findings in a comprehensive report “FHLBank System at 100: Focusing on the Future.” Indeed, there is a growing consensus among affordable housing experts, advocates, and mission-oriented lenders that this system is long overdue for reform.

The FHLBank system was founded in the 1930s to help address the acute housing crisis during the Great Depression and its members today include banks, credit unions, insurance companies and community development financial institutions. Unfortunately, it has since evolved to focus on best serving the financial interests of its members rather than on addressing the dire housing needs of our country.

One reason that the FHLBank system has long evaded critical scrutiny (it was last reformed in 1989), is that it has historically kept a low-profile. The operations of this system are often shrouded in technical language and limited public data is available on its financial workings. This blog answers some commonly asked questions, to help people better understand what is at stake and why the Federal Home Loan Bank system demands reform.

 

How do FHLBanks make money?

This seems like a simple question, but FHLBanks have not been forthcoming about their financial model. Researchers at the Coalition of FHLBank Reform collected data for all 11 regional banks and made available financial information on the system. We found that FHLBanks operate on a very simple business model: they make their money by making loans (advances) to their members and through returns on their short- and long-term investments.

As a government-sponsored enterprise (GSE), the FHLBanks can borrow cheaply in the global capital market: investors see very low risk, knowing that the US government will stand for FHLBanks debt in case of default. This is also called an “implied guarantee” and translates to an estimated 40 basis points (0.4%) discount on FHLBank-issued debt (close to what the Treasury itself pays for its debt). FHLBanks pass this discount on to their members, by offering them discounted advances. Members, who include commercial banks and insurance companies, must purchase FHLBank stock and post collateral when they borrow.  They can use these below-market-rate loans for any business purposes they see fit. This often results in higher profits for the member but does little to support affordable housing.

FHLBanks also make money by investing their member stock capital plus earnings they have retained over the years into short-term and long-term investments. Indeed, 2023 will likely be the most profitable year for FHLBanks on record, with a projected $7 billion annual earnings, shaped in part by the high-interest rate environment.

 

What does it mean that FHLBanks are a government-sponsored enterprise (GSE)?

GSEs are congressionally chartered and privately owned institutions that are founded to fulfill a public mission. Fannie Mae and Freddie Mac are also GSEs although much larger and under much more scrutiny.  These latter two GSEs are also different as they have been under conservatorship since 2008 and remain under direct control of the US government. GSEs are backed by the financial strength of the US government, even though their (potential) costs do not directly show up on the government’s balance sheet. In addition to their implicit guarantee which enables them to raise funds very cheaply, they are tax exempt.

FHLBanks are very focused on their fiduciary responsibilities to their member stockholders (who get cheap funding and high dividends) but they largely ignore their duty to serve the broader economic needs of the country. Mission-driven business is at the center of FHLBank reform. There is no reason why FHLBanks should exist as vehicles to funnel government subsidies to buttress the profits of banks and insurance companies.

 

What are FHLBanks currently doing to help alleviate our nation’s housing crisis?

Many of FHLBank members, including commercial banks, are not even in the mortgage business anymore, despite benefiting from Home Loan Bank advances. A recent Bloomberg investigation found that 42 percent of FHLBanks’ 6,400 members had not originated one single mortgage in the last five years. Currently, while larger bank members face minimal requirements to support housing, many members, including some of the largest insurance companies in America, face no test at all. There is no ongoing membership test to assess whether financial institutions indeed use their membership to advance affordable housing and community development goals.

Members do post housing-related collateral to secure cheap advances from the FHLBanks, most notably residential and commercial mortgages and mortgage-backed securities (MBS) – which are packages of mortgage bundled and sold on the secondary market. One could make the argument that members’ need for housing-related collateral could drive up members’ demand for mortgages and MBS, and so may drive down mortgage costs for consumers downstream. But this pathway is indirect at best. Even without FHLBanks, and with the strong foundation of Fannie Mae and Freddie Mac alongside Dodd-Frank regulations, the market for mortgages loans is many multiples of FHLB collateral and there is widespread, global interest in buying American mortgage-backed securities as an investment instrument. This minimal FHLBank “involvement” in housing does not move the needle on mortgage affordability or housing supply.

Finally, since they were last reformed in 1989, FHLBanks are required to allocate 10 percent of their net income every year to affordable housing programs (AHP). The majority of AHP grants are awarded as gap financing for the new construction of affordable, multifamily rental properties, usually Low-Income Housing Tax Credit (LIHTC) projects. AHP also supports downpayment assistance programs. Some of the FHLBanks also engage in “voluntary programs,” which they call affordable housing and community development contributions that exceed the 10 percent minimum that Congress set. We found, however, that these voluntary programs are very small, while being heavily advertised: until just this year most FHLBanks have spent less than 1 percent of their net income “voluntarily” every year – with 2023 generosity undoubtedly the result of increased FHFA and Congressional scrutiny.

 

How can FHLBanks be reformed to better support affordable housing?

There is unique momentum today to bring this system back to its founding mission of supporting affordable housing and community development. Some of the most promising proposals include:

• Raise the percentage of net income that each FHLBank needs to contribute to Affordable Housing Programs (AHP) every year from 10 percent to at least 20 percent. Historically, FHLBanks have shown that they can sustain themselves profitably with a 30 percent annual deduction from their profits (they did so from 1989 until 2011). An increase to 30 percent in AHP contributions would have led to $1.4 billion dollars in additional funding for affordable housing in 2024, all without requiring Congressional appropriations.
• Renew the FHLBanks mission focus on housing beyond mandatory AHP contributions. This includes a critical examination of membership (and whether it is appropriate for members who no longer originate mortgages to benefit from Home Loan Bank advances). This also means leveraging all the unique strengths and capacities of the FHLBank system towards housing, such as by strengthening Community Development Financial Institution (CDFI) membership and their access to cheap advances for mission-consistent activities. The FHLBanks should apply their role as wholesale banks and their capital market strength to support less expensive funding for affordable housing. Finally, FHLBanks can better leverage their capital investments for mission activities as well, such as by establishing a revolving loan fund, which can help finance affordable housing activities over the long-term.
• Pilot new housing programs through the FHLBank system. As a regional system, the 11 FHLBanks are also uniquely positioned to respond to local financing needs and to develop new pilot programs: especially to provide financing needs that remain underserved, such as through shared equity financing, mortgages for manufactured homes, and small-dollar mortgages. Indeed, FHFA recommended that FHLBanks establish “centers of excellence,” which can help promote best practices across the system. We also recommend that FHLBanks foster even stronger partnerships with the communities they serve, to make sure they serve all communities in their jurisdiction.