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….

Ninth Anniversary of the GSEs' Conservatorships: Not a Time to Celebrate

In the summer of 2008, Fannie Mae and Freddie Mac’s financial positions deteriorated sharply: the result of inadequate capital (equity financing) for the risks in the residential mortgages that they held and had securitized. On September 6, 2008, their regulator, the Federal Housing Finance Agency (FHFA), removed senior management and placed these government-sponsored enterprises (GSEs) into conservatorships. Since then, the FHFA and the U.S. Treasury (which extended almost $188 billion to keep them solvent through 2011) have run them...

Regulating Wall Street: The Financial CHOICE Act and Systemic Risk

With the shift in power in Washington, among other things, the people newly in charge are taking aim at financial sector regulation. High on their agenda is repeal of much of the Dodd-Frank Act of 2010, the most far-reaching financial regulatory reform since the 1930s. The prime objective of Dodd-Frank is to prevent a wholesale collapse of financial intermediation and the widespread damage that comes with it. That is, the new regulatory framework seeks to reduce systemic risk, by which we mean that it lowers the likelihood that the financial system will become undercapitalized and vulnerable in a manner that threatens the economy as a whole.

The Financial CHOICE Act proposed last year by the House Financial Services Committee is the most prominent proposal to ease various regulatory burdens imposed by Dodd-Frank. The CHOICE Act is complex, containing provisions that would alter many aspects of Dodd-Frank, including capital requirements, stress tests, resolution mechanisms, and more. This month, more than a dozen faculty of the NYU Stern School of Business (including one of us) and the NYU School of Law published a comprehensive study contrasting the differences between the CHOICE Act and Dodd-Frank.

Regulating Wall Street: CHOICE Act vs. Dodd-Frank considers the impact both on financial safety and on efficiency. In some cases, the CHOICE Act would slash inefficient regulation in a manner that would not foster systemic risk. At the same time, the book highlights the key flaw of the CHOICE Act—the failure to address systemic risk properly....

Better capitalized banks lend more and lend better

Many people seem to think that when authorities increase capital requirements, banks lend less. The advocates of this view go on to argue that, since credit is essential for economic growth, we should not impose overly tough constraints on banks. Put another way, a number of people believe that we have gone too far in making the financial system safe and the cost is lower growth and employment.

Treasury Secretary-designate Steven Mnuchin appears to share the view that financial regulation has restrained the supply of credit: in a recent interview, he is quoted as saying “The number one problem with Dodd-Frank is that it’s way too complicated and cuts back lending.” One interpretation of this is that Secretary-designate Mnuchin will support proposals like House Financial Services Chair Jeb Hensarling’s Financial CHOICE Act to allow banks to opt for a simple capital standard as an alternative to strict regulatory scrutiny.

Our reaction to this is three-fold. First, for most banks, which are very small and pose little threat to the financial system, a shift toward simpler capital requirements—so long as they are high enough—may be both effective and efficient; for the largest, most systemic intermediaries, higher capital requirements should still be accompanied by strict oversight. Second, we see no evidence that higher bank capital is associated with lower lending. In fact, quite the opposite. Third, given that the 2007-09 financial crisis was the result of too much borrowing—and that over-borrowing is a leading indicator of financial crises—it follows that not all reductions in lending are bad. We take each of these points in turn...

Dodd-Frank: Five Years After

On July 21, 2010, President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act (hereafter, DF), the most sweeping financial regulatory reform in the United States since the 1930s. DF explicitly aims to limit systemic risk, allow for the safe resolution of the largest intermediaries, submit risky nonbanks to greater scrutiny, and reform derivatives trading.

How to celebrate its fifth birthday? Well, if you are like us, it will be a sober affair, reflecting serious worries about the continued vulnerability of the financial system.

Let’s have a look at the most noteworthy accomplishments and the biggest failings so far. Starting with the successes, here are our top five:

Still Riding the GSE Train

Will the U.S. federal government ever exit mortgage finance? Not any time soon.Let us explain why.

In September 2008, as investors shunned the debt of Fannie Mae and Freddie Mac, the U.S. Treasury put these government-sponsored enterprises (GSEs) into federal conservatorship, kicking off the most intense months of the financial crisis. Not long after, the CBO estimated the fair value of the GSEs losses at $291 billion (or more than 5% of their end-2009 mortgage portfolios)...

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Money, Banking, and Financial Markets