Earlier this week the GAO (U.S. Government Accountability Office) publicly released a new report that evaluates the actions that the Federal Home Loan Banks of San Francisco and New York (FHLBank SF and NY) took leading up to the regional bank failures of spring 2023. GAO wrote this report in response to a request from the House Financial Services Committee, as its members sought to better understand the role of the Federal Home Loan Bank system in this banking crisis.
Narrow in scope, this report focused on whether FHLBanks had engaged in adequate risk management and fulfilled minimal bank reporting requirements. The GAO concluded that the FHLBanks of SF and NY had acted according to established regulatory guidelines during this banking crisis. Others have previously written on this issue, notably Professor Kathryn Judge, who asked whether FHLBanks were motivated to act responsibly by continuing their lending of “advances” to failing institutions, given lots and lots of red flags about these small banks’ long-term sustainability.
However, I’d like to look at some of its findings with a broader perspective. The Federal Housing Finance Agency (FHFA), in publishing the “FHLBank System at 100: Focusing on the Future” report last year, has started to examine what the appropriate role of FHLBanks would be within our banking and housing finance system moving forward.
I see two key takeaways.
First, the GAO’s findings are consistent with the underutilized role of Federal Reserve’s system “discount window borrowing,” which should be the lender of last resort for failing banks. The GAO found that Silicon Valley Bank, Signature Bank, and First Republic Bank all significantly expanded their short-term advance lending from the FHLBanks when they started to face liquidity pressures during the 4th quarter of 2022 and 1st quarter of 2023: they did not step up “discount window” borrowing from the Federal Reserve during this liquidity crunch. Indeed, the report (p. 8) described how Silicon Valley Bank only tried to access discount window borrowing during its very last weekend in existence (and probably only so because FHLBanks do not lend over the weekend), before failing on Sunday March 12, 2023.
The FHFA previously flagged this issue in its “FHLBank System at 100” report, noting that many banks did not have agreements or collateral in place to borrow from the Federal Reserve’s discount window, and consequently, misused FHLBank advances as lender of the last resort.
Second, the GAO raises questions about “moral hazard” in advance lending to failing institutions, as FHLBanks feel insulated from credit risk and given the high profitability of lending billions to failing banks. After all, FHLBanks know that they will be paid for their outstanding debt first through the posted collateral of failing banks, even before FDIC collects its claims. This is also called FHLBanks’ “super” lien status and one of the unique statutory benefits of their status as government-sponsored enterprise (GSE).
Indeed, lending to failing banks drove up advance-use and profits for FHLBanks, with 2023 turning out to be their most profitable year on record: they generated $6.7 billion in net income, and paid out $3.4 billion as dividends to their membership of insurance companies and banks. In what is new information to the public, GAO highlighted that at the FHLBank of San Francisco, First Republic Bank represented 24% of outstanding advances and Silicon Valley Bank represented 28% of outstanding advances in mid-March 2023: meaning that over half of advances (or almost $50 billion) at the time were going to two failing banks (see P. 7-8)! Surely the FHLBank system would think twice about doing so if they burdened that credit risk.
Ultimately, the FHLBank system is not meant to generate profits over failing banks. Today it seems to talk about its mission as being about anything and everything, and FHLBanks are willing to provide liquidity for any purpose, as long as they keep profits and dividends flowing. But from a statutory and regulatory perspective, its place in our financial system has always been in housing – this GSE was founded to meet unmet credit meets in housing finance and to expand the availability and affordability of mortgage credit.
I look forward to ongoing reform of this system by the FHFA and Congress, as we once again bring “housing” into Home Loan Banks.