Money, Banking and Financial Markets

Commentary

Commentary

 
 
Posts tagged Federal Home Loan Banks
Reforming the Federal Home Loan Bank System

We authored this post jointly with our friend and colleague, Lawrence J. White, Robert Kavesh Professor of Economics at the NYU Stern School of Business.

Some government financial institutions strengthen the system; others do not. In the United States, as the lender of last resort (LOLR), the Federal Reserve plays a critical role in stabilizing the financial system. Unfortunately, their LOLR job is made harder by the presence of the Federal Home Loan Bank (FHLB) system—a government-sponsored enterprise (GSE) that acts as a lender of next-to-last resort, keeping failing institutions alive and increasing the ultimate costs of their resolution.

We saw this dangerous pattern clearly over the past year when loans (“advances”) from Federal Home Loan Banks (FHLBs) helped postpone the inevitable regulatory reckoning for Silicon Valley Bank (SVB), Signature Bank, and First Republic Bank (see Cecchetti, Schoenholtz and White, Chapter 9 in Acharya et. al. SVB and Beyond: The Banking Stress of 2023).

From a public policy perspective, FHLB advances have extremely undesirable properties. First, in addition to being overcollateralized, these loans are senior to other claims on the borrowing banks—including those of the Federal Deposit Insurance Corporation (FDIC) and the Federal Reserve: If the borrower defaults, the FHLB lender has a “super-lien.” Second, there is little timely disclosure about the identity of the borrowers or the amount that they borrow. Third, they are willing to provide speedy, low-cost funding to failing institutions—something we assume private lenders would not do.

In this post, we make specific proposals to scale back the FHLB System’s ability to serve as a lender to stressed banks….

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Steve Cecchetti and Kim SchoenholtzFederal Home Loan Banks, FHLB, Lender of last resort, LOLR, Lender of next-to-last resort, Financial stability, Incentives, Externality, Illiquidity, Insolvency, Resolution, Bank, Bank failure, Collateral, Lien, Super-lien, Government-sponsored enterprises, GSE, Implicit guarantee, Transparency, Disclosure, Supervision, Federal Reserve, Federal Deposit Insurance Corporation, Federal Housing Finance Agency
Making Banking Safe

The regulatory reforms that followed the financial crisis of 2007-09 created a financial system that is far more resilient than the one we had 15 years ago. Today, banks and some nonbanks face more rigorous capital and liquidity requirements. Improved collateral rules for market-making activities can dampen shocks. And, some institutions are subject to well-structured resolution regimes.

Yet, the events of March 2023 make clear that the system remains fragile. The progress thus far is simply not enough. What else needs to be done?

In a new essay, we address this critical question. Our assessment of the banking system turmoil of 2023 leads us to several obvious conclusions, some of which clearly escaped both bank managers and their supervisors. Perhaps the simplest and most significant is that banks can survive either risky assets or volatile funding, but not both. Another is that supervisors are willing to treat some banks as systemic in death, but not in life.

We also draw two compelling lessons from the recent supervisory and resolution debacles. First, a financial system which relies heavily on supervisory discretion is unlikely to prove resilient. Second, authorities with emergency powers to bail out intermediaries during a panic will always do so. That is, policymakers are incapable of making credible commitments to impose losses on depositors and others. In our view, the only way to address this commitment problem is to prevent crises….

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Steve Cecchetti and Kim SchoenholtzFinancial stability, Regulation, Supervision, Resolution, Federal Reserve, Federal Deposit Insurance Corporation, Stagflation, Stress test, Federal Home Loan Banks, Capital requirements, Liquidity requirements, Liquidity risk, Systemically important markets, Lender of last resort, Lender of next-to-last resort
The Federal Home Loan Banks: Two Lessons in Regulatory Arbitrage

There is an important U.S. government-sponsored banking system that most people know nothing about. Created by an act of Congress in 1932, the Federal Home Loan Banks (FHLBs) issue bonds that investors perceive as having government backing, and then use the proceeds to make loans to their members: namely, 6,800 commercial banks, credit unions, insurance companies and savings associations. As the name suggests, the mission of the (currently 11) regional, cooperatively owned FHLBs is “to support mortgage lending and related community investment.” But, since the system was founded, its role as an intermediary has changed dramatically.

With assets of roughly $1 trillion, it turns out that the FHLBs—which operate mostly out of the public eye—have been an important source of regulatory arbitrage twice over the past decade. In the first episode—the 2007-09 financial crisis—they partly supplanted the role of the Federal Reserve as the lender of last resort. In the second, the FHLBs became intermediaries between a class of lenders (money market mutual funds) and borrowers (banks), following regulatory changes designed in part to alter the original relationship between these lenders and borrowers. The FHLBs’ new role creates an implicit federal guarantee that increases taxpayers’ risk of loss.

In this post, we highlight these episodes of regulatory arbitrage as unforeseen consequences of a complex financial system and regulatory framework, in combination with the malleability and opaqueness of the FHLB system.…

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Steve Cecchetti and Kim SchoenholtzFederal Home Loan Banks, FHLB, Government-sponsored enterprises, GSEs, Money market mutual fund, MMMFs, Securities and Exchange Commission, SEC, Floating net asset value, Floating NAV, Liquidity coverage ratio, LCR, Lender of last resort, LOLR, Regulatory arbitrage, Financial System Oversight Council, FSOC, Office of Financial Research, OFR