The Federal Housing Finance Agency is undertaking a comprehensive review of the appropriate role of the Federal Home Loan banks. Such a review is needed and long past due. With the recent failures of Silicon Valley Bank and Signature Bank, and the $250 billion in new Home Loan bank advances made just this week, the need for such a review is even more pressing.
The Federal Home Loan banks have been abusing their authority for years. I know. I took over as the CEO of IndyMac when it entered Federal Deposit Insurance Corp. conservatorship in 2008. Many know that IndyMac was the most expensive bank failure in the FDIC's history. Not as many know that part of the reason was because of the Federal Home Loan Bank of San Francisco.
The mandate of the Home Loan banks is to provide funding to support mortgage lending and related community development. IndyMac was a home mortgage originator that borrowed heavily from the San Francisco bank over the years. Initially, that wasn't an issue, but as the subprime crisis grew and IndyMac fell deeper and deeper into trouble, the Home Loan bank continued to lend to it extensively, supporting its rapid-growth strategy.
IndyMac was paying depositors higher interest rates than any other bank in the country, a sign, among others, that the bank was having financial difficulty. Nevertheless, the Federal Home Loan Bank of San Francisco continued its lending to IndyMac, demanding even higher rates than what the bank was paying to its rate-chasing depositors. Moreover, the Home Loan bank also required a blanket lien, using all of IndyMac's assets as collateral. When IndyMac was closed, the San Francisco bank's loans had a remaining balance of about $10 billion — one-third of IndyMac's total liabilities.
After taking over IndyMac in July 2008, the FDIC began reducing the bank's operating costs, including reducing deposit interest rates. As expected, many depositors left, looking for greener pastures elsewhere. These high-cost deposits were replaced with low-cost FDIC funding, saving the bank and, ultimately, the FDIC a substantial amount of money.
As CEO, I approached the Federal Home Loan Bank of San Francisco with the same idea in mind — have the conservatorship pay off the Home Loan bank loans and replace them with lower-cost funding. The San Francisco bank refused. Their loans to IndyMac had an average remaining maturity of about two years, and they were getting well above market interest rates. They did not want to give that up. In virtually any other situation, the FDIC can end burdensome contracts when a bank fails and no longer exists. But not here. I know of no other privately owned companies with such powerful legal authorities as the Home Loan banks'.
The only way the FDIC could rid itself of the Home Loan bank's high-cost money was to pay a "prepayment penalty" of $340 million to cover forgone interest payments. That wasn't counting the $20 to $30 million "administrative fee" to compensate for the burden the FDIC would create by forcing the Home Loan bank to reinvest so much money. Stunned by their demands, I asked the San Francisco bank to consider the broader context and waive any prepayment penalty. Again, they refused.
I pointed out that not only was the FDIC losing money because of their actions, so too were IndyMac's uninsured depositors. The San Francisco bank responded, "Why should we subsidize uninsured depositors who had made dumb choices?"
Shortly after this discussion, the Home Loan bank demanded that the FDIC provide it with additional collateral, preferably cash. Presumably, their auditors weren't sure IndyMac's $30 billion (book value) in remaining assets, for which they had the first claim, would generate enough revenue to cover their $10 billion in advances. I again refused. IndyMac's assets were bad, but not so bad that the Home Loan bank was at risk. The FDIC did offer to indemnify the San Francisco bank against any losses, believing this would solve the problem. However, the Home Loan bank claimed it wasn't legally permitted to accept indemnities.
When IndyMac was sold, the remaining Home Loan bank advances were transferred to the acquiring bank, rates intact. Presumably, the acquiring bank lowered its bid accordingly, meaning, in effect, the FDIC had paid the San Francisco bank's exorbitant prepayment penalty, just in a different way.
History has shown (e.g., the S&L crisis) that when a bank is failing, early government intervention is critical. Otherwise, the damage only grows as banks take on more risk to remain afloat. Providing Home Loan bank advances to a failing institution is the opposite of what is meant by early intervention. It prolonged IndyMac's life, adding to its overall cost.
The Federal Home Loan Bank of San Francisco did not care if IndyMac was failing. The FDIC provided it with protection against any losses. The FDIC would not take this risk voluntarily, and the Home Loan banks would not make these loans without protection against losses. But the Home Loan banks seem to have no hesitation about making such loans at the FDIC's expense.
This is not a zero-sum game. By extending the life of a failing bank, for every dollar of additional profit the Home Loan banks generate for themselves, more than a dollar of additional losses are placed on the FDIC. The Home Loan banks receive government subsidies. They do not pay federal, state and local corporate income taxes. They have an implicit government guarantee that lowers their borrowing costs, and Congress has granted them extraordinary legal authority. Moreover, the Home Loan banks are more than capable of determining a bank's financial condition. With that knowledge and government support, they should not work against the public interest.
The Home Loan bank's behavior at IndyMac was perfectly legal but, as a government-supported entity, unconscionable.
Perhaps the Federal Home Loan Bank of San Francisco's $15 billion in loans to Silicon Valley Bank and the Federal Home Loan Bank of New York's $11 billion of loans to Signature Bank were honest mistakes, but they should have seen it coming, and regardless, they never had to worry.
