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CHANA SCHOENBERGER: Welcome to BankShot, a podcast from American Banker where our journalists report the stories behind banking, finance, and the economy. I'm Chana Schoenberger, editor-in-chief of American Banker. The banking crisis in the spring of 2023 brought to the fore questions about how the government is lending to banks. Claire Williams is our reporter who covers Congress. In this episode, she takes a look at one quirky system that played a major role in the turmoil.
HERBERT HOOVER: My fellow citizens. From the congressional elections in 1930, down to the present moment, the strategy of the Democratic party has been an effort to implant in the unthinking mind through deliberate misrepresentation the colossal falsehood that the Republican party is responsible for this worldwide catastrophe.
CLAIRE WILLIAMS: That's President Herbert Hoover, in St. Louis, Missouri, November 4th, 1932.
For Hoover, it's just days before he'll face off in the presidential election against Franklin Delano Roosevelt.
It wasn't even close.
Roosevelt won in a landslide.
Hoover faced a brutal campaign.
The public was outraged by what they saw as his indifference to the suffering caused by the Great Depression, and his failure to mitigate the fallout.
I think — with the sharpness of the cold November air in St. Louis — you can feel his frustration in that campaign speech.
HOOVER: A circular placed in my hand since coming to this state by the Democratic National Committee says this depression was man-made, and I agree with that.
But they say the man who made it was myself personally.
They express no gratitude that in my manufacture of this world crisis I have let this country off easier than Russia, or Western Europe or South America.
WILLIAMS: It is sometimes forgotten by history, but Hoover did try to implement programs that would alleviate parts of the human suffering caused by the Great Depression.
Roughly four months before that speech, Hoover notched one of his major legislative wins — a bill to his desk that he fought for and signed — that established a system to streamline the mortgage finance system, helping people hold on to their homes and their farmsteads.
The final piece of legislation that Hoover signed isn't exactly what he wanted.
It, for example, put stringent restrictions on the loans that could be financed.
Later, in his memoirs, Hoover would complain that thousands of people could have been saved from what he called the "poignant American drama" of losing their home or farm if Congress would have approved a mortgage discount institution at the time and along the lines of what he had originally proposed.
But luckily for Hoover, his legacy doesn't end with his 1932 defeat, and this isn't just a history lesson.
That program is still around, and some of those same questions about its scope and purpose are at the center of some of the most important debates happening in the bank policy space today.
I'm talking, of course, about the Federal Home Loan Bank System.
From American Banker, I'm Claire Williams, and this is Bankshot, a podcast about banks, finance, and the world we live in.
WILLIAMS: So what is the Federal Home Loan Bank System, and why are we talking about it now if it's been there for almost 100 years?
MARK CALABRIA: The relevancy of that is, you know, if we were starting from scratch, we'd look at it and say most of the problems that the Federal Home Loan Bank system was created to fix don't really exist anymore.
WILLIAMS: This is Mark Calabria, previously the director of the Federal Housing Finance Agency, and former chief economist to Vice President Mike Pence.
He's talking about a review that the Federal Housing Finance Agency announced last year.
It's meant to be the first comprehensive review of the Federal Home Loan Bank System in the 90 years since it was created.
That report has not yet been released as of this recording, but it will likely have a significant impact on how the system operates for decades to come.
CALABRIA: In terms of relevance today, they were created not by Roosevelt, but by Hoover, in 1932, and were their first response to what was the Great Depression, in which was, we forget that [was not] concentrated in the stock market, but actually concentrated in the housing market. You have a significant number of defaults and delinquencies starting as early as 1926, the housing market had started deflating. So you had a very different mortgage market. We didn't … big institutions like Chase or Bank of America did not exist in the same way. It was very fragmented. You know, in many states you could only have one location as a bank. So you had a very fragmented multiples of the number of banks we have today, with no real way for these institutions to access our capital markets. You also had mortgage rates differ significantly by location, partly because of this. And so the federal loan banks, I think, were important to offset what were very severe restrictions on diversification that mostly came out of the state government. And of course, it's also important to remember the Federal Home Loan Bank system was created a kind of the Federal Reserve for thrifts, because thrifts and insurance companies were not allowed at the time to the members of the Federal Federal Reserve System So you don't have the geographic lack of diversification. You access to the Federal Reserve, almost everybody who's the federal event member is today is likely to have access to the Federal Reserve. So almost all the reasons that the system was created are gone. Now, of course, like any good government program, the system finds ever new ways to, you know, justify its existence.
WILLIAMS: Over the years, the Federal Home Loan Bank System has undergone some changes, usually as a response to an event like the Savings and Loan crisis of the 1980s, or the 2008 financial crisis. For some, it's strayed far from its original goal.
One of the people who think that is Cornelius Hurley, currently a lecturer at the University of Boston School of Law and formerly an independent director at the Federal Home Loan Bank of Boston.
HURLEY: First off, I was a very active, independent director of one of the Home Loan Banks for 14 years, the Home Loan Bank of Boston, and I advocated for various programs and was helpful in recovering $500 million in in losses that we incurred by buying investment securities that we should not have in the leadup to the financial crisis. So I've been involved with the Home Loan Banks for an extended period of time. My views of the Home Loan [Banks], because they have evolved over time, I have always felt that they have great potential to do good. And by good, I mean, public benefits. Unfortunately, it's well documented that the public benefits produced by the Home Loan Banks are very low in proportion to the subsidy that the Home Loan Banks get from the taxpayers.
WILLIAMS: And then came the bank failures of March 2023.
Unwittingly to many of us, it was a test of just how integrated the Federal Home Loan Bank System has become in the inner workings of our financial system.
Amid the chaos of that weekend, some incredible numbers started to come out.
Silicon Valley Bank, Signature Bank and Silvergate Bank were among the largest borrowers last year of the Home Loan Bank System.
The three banks, one of which self-liquidated, received a combined $30.6 billion from the Home Loan banks last year, just months before their collapse.
These institutions catered to wealthy tech investors, stablecoin and crypto clients — hardly reflective of Hoover's vision of saving the family farm.
SHERROD BROWN: The Senate Banking Committee on Banking, Housing, and Urban Affairs will come to order. In the days after the run on Silicon Valley Bank, which was closed by California banking regulators and taken over by the FDIC, many in Washington and New York and California asked how did this bank, and Signature Bank soon after fail so spectacularly?
WILLIAMS: At a Senate Banking Committee hearing, Greg Becker, the former CEO of Silicon Valley Bank, talked about the chaotic Friday that his bank went under, and the role that the Federal Home Loan Bank System played.
GREG BECKER: As we looked at liquidity overall, relative to the size of bank we were, we certainly felt that we had ample liquidity. And were able to, even with the fastest bank run in history, $41 of the $42 billion outflows were covered by SVB. We could have handled even more. We were moving collateral from the Federal Home Loan Bank, to the Federal Reserve.
WILLIAMS: His comments demonstrate what many critics see as a flaw of the Federal Home Loan Bank System — the possibility that the system increases the appetite for risk in unsteady institutions.
The Home Loan Bank System disburses liquidity in the form of so-called advances or short-term secured loans via its 11 regional branches. The system is often referred to as a "lender of next-to-last resort," largely because banks are more likely to tap the Home Loan banks than the Federal Reserve's discount window, which has a stigma associated with it among financial institutions and the public.
HURLEY: This year, the Home Loan Banks have provided massive liquidity to the likes of Silicon Valley Bank, First Republic, Signature, and a little crypto bank in California called Silvergate — massive amounts, having nothing to do with housing. And yet it was these massive amounts of liquidity of advances to these failed institutions that kept them alive, in some cases for a year or more, when they probably should not have been kept alive. And to me and to others, this represents a gross misuse of the charter that Congress envisioned 90 years ago. The Home Loan Banks were never intended to be a lender of last resort nor a lender of second to last resort. They were intended to be, as I said, catalysts for the housing industry. And it's not no secret that we have a housing crisis in this country right now, particularly in the affordable housing areas. So for the Home Loan Banks to be whistling past the graveyard of this housing crisis, it seems to seems unconscionable. Now, if you ask someone from the Home Loan Banks what the purpose of the system is, they will probably tell you the that the system is intended to provide liquidity to member banks, full stop — and they conveniently leave out the housing part of it. And they will probably go into the weeds and cite specific language from a statute that was passed in 2008 in the financial crisis as their rationale. But that statement is not credible. It's not credible in Congress. It's not credible among academics or regulators.
WILLIAMS: Conveniently, I did ask someone from the Home Loan Banks what the purpose of the system is.
RYAN DONOVAN: Let's keep in mind, the whole purpose of the Home Loan Bank System is to provide liquidity to our members in all market environments. And, you know, that means when, when the weather's nice, we're there for them to help them meet their needs. And when the storm is on the horizon, we're there to help them meet their needs.
WILLIAMS: That's Ryan Donovan, president and CEO of the Council of Federal Home Loan Banks, which serves as the public voice for the system.
DONOVAN: I mean, even Costco sells more water when there's a storm coming. Right? And so we can expand our balance sheets to meet our members' needs during those times. And that's what happened in the middle of March this year. And what we've seen since then, is that members have repaid those advances, our balance sheets have gradually gotten a little smaller. And that's what you would expect. That's the system working as it was intended to work.
WILLIAMS: Another big problem for critics is the Federal Home Loan Bank System's super lien priority.
In 1987, at the height of the Savings and Loan crisis, Congress said that any security interest granted by a member to a Federal Home Loan Bank would have priority over the claims of any other unsecured party, including the FDIC.
HURLEY: When one of their member banks fails, like Silicon or First Republic, the Home Loan Banks take immediate first position in the liquidation. So they never lose. They never lose. Okay, now that has two very, very serious consequences. Number one, it allows them to continually perpetuate this myth, that they've never lost the loan. But just as importantly, it removes any sense of underwriting discipline in extending loans. If you're the CEO of a bank, and you know that your customers are always going to pay back their loans, you don't need to be very careful about the underwriting of those loans. Right? And that's, and that's what the super lien does, is it allows the 11 Home Loan Banks to be completely careless in making advances to their members.
WILLIAMS: The Federal Home Loan Banks say that the super lien simply makes them like other creditors.
DONOVAN: The super lien is, I think, very misunderstood. It was originally put in law at a time when there really wasn't another way to perfect a security interest in collateral. But since 2001, it has taken on a significantly less important role, you know, the Home Loan Bank perfect security interest in the collateral that they accept for advances. And they do that under the auspices of the Uniform Commercial Code, and it's the same authority that any securitized lender would have access to. And that's really what gives Home Loan Bank the position that they have, in the event of a bank failure.Because it's part of the Competitive Equality Banking Act is much less significant today than the fact that the Home Loan Bank perfect a security interest in the collateral that they accept in a manner that is the same as any other securitized lender. We just do it on a bigger scale.
WILLIAMS: So the FHFA review of the Home Loan Bank System is happening against the backdrop of all this drama.
What happens, once we've all had time to read and digest the report? Reform doesn't tend to happen easily or quickly in Washington.
For the Federal Home Loan Banks themselves, the ideal solution would be to simply strengthen their ability to contribute to affordable housing and expand their ability to make loans that help local communities.
Donovan said that's the impression he got from the listening sessions leading up to the FHFA's release.
DONOVAN: The overwhelming message from the review, was that the system's working, that have worked as it was intended in March, and that, you know, folks on all sides of the of the discussion are really looking to find ways to get more, not less out of out of the system.
WILLIAMS: And in a divided Congress, it'd be difficult to get any kind of meaningful legislation passed.
Some, like Hurley, though pessimistic, want to see legislation or rulemakings that make concrete changes to the system, focusing it more keenly on affordable housing.
WILLIAMS: Help me walk through the dominoes that fall if at some point in the future, we get a bill or we get a rulemaking essentially, that says, you know, this money has to be specifically earmarked for housing things?
HURLEY: So … great question. Here's, here's, here's my response. There is no other country that I'm aware of that has two lenders of last resort or second to last resort. And we do have the Fed with the discount window. And that was what the Fed was intended to do, and does do to have a second secret source of funds. It really is duplicative and destructive. So here's the way I think it should work. I'm a big fan of market discipline. And I'm also a big fan of transparency. If a borrower from a Home Loan Bank, a member bank, had its advances disclosed to the public at the time that those advances were made, that information in the marketplace would allow players to make judgments about the condition of that bank. That's the way it's supposed to work. And that's the way I think it would work. If the FHFA were to make that change in how it operates, this change could be implemented by FHFA, either through its soft power or its rulemaking power. But either way, if it were to do that, I think it would go a long way to introducing market discipline to the equation.
WILLIAMS: There is some legislation floating around, and growing momentum on Capitol Hill to implement meaningful reforms. Senator Catherine Cortez Masto, a Democratic Senate Banking Committee member from Nevada, introduced legislation that would require the Home Loan Banks to double their affordable housing commitments.
CORTEZ MASTO: I have concerns that the Federal Home Loan Banks are not meeting the needs of all their communities. Let me just give you an example, in previous years only one bank has any goal for Native Americans in the community.
WILLIAMS: The Chairman of the Senate Banking Committee, Sherrod Brown, pressed Federal Housing Finance Agency Director Sandra Thompson on the alleged use of the Federal Home Loan Bank System as a lender of last resort for banks in trouble.
Earlier, Senators Elizabeth Warren, Roger Marshall, and John Kennedy separately wrote to Silvergate about the bank's connection to the failed crypto exchange FTX, asking how the bank planned to use the $4.3 billion it received from the Federal Home Loan Bank of San Francisco.
Still, experts are skeptical about legislation moving through Congress.
CALABRIA: So all that said, you know, I, the betting man, would I say a lot's going to get done? No, I think there'll be recommendations to Congress that largely will be a hearing or two that largely, you know, head nod. Yeah, the system doesn't do much for affordable housing, and then they move on. I don't really see legislating going on, not in the near-term. Again, most of what FHFA can do is fairly targeted in the safety and soundness space. And since most of the stakeholders in this review process have not called for greater safety and soundness restrictions. I don't expect to see a lot coming out of FHFA. So perhaps I'm the minority to say, I'm not sure all this whole process is really going to result in a lot of change. And I think ultimately, you know, I'm willing to bet that in two years time the federal home loan bank system is going to look a lot like it does today.
SCHOENBERGER: This episode of BankShot was reported and written by Claire Williams and edited by John Heltman. Our audio producer is Kellie Malone Yee. Special thanks this month to Mark Calabria, Cornelius Hurley and Ryan Donovan, as well as the Council of Federal Home Loan Banks, CSPAN, and Forbes. If you liked this episode, you should subscribe to American Banker, which you can do by visiting www.americanbanker.com/subscribe. For American Banker, I'm Chana Schoenberger, and thanks for listening.