Is Federal Home Loan Bank reform a sure thing or a show?

Move over Fannie and Freddie. 

Until now, popular wisdom was that Sandra Thompson’s tenure as director of the Federal Housing Finance Agency would be judged by how she managed the enduring conservatorships of Fannie Mae and Freddie Mac. Little note would be taken of how she manages the sleepy Federal Home Loan Banks. 

Fannie and Freddie are the titans of the nation’s housing finance market. The FHLBs, in contrast, play little if any role in housing finance beyond their minimal statutory affordable housing contributions.

That calculus changed with Thompson’s recent testimony before the House Financial Services Committee. In her otherwise routine remarks, she outlined a bold and comprehensive plan to review the basic purpose and structure of the massive FHLBs. At the same time, she tamped down any expectations for Fannie and Freddie exiting their conservatorships soon.

She had telegraphed her thoughts about a comprehensive review of the FHLBs in public remarks at the Bipartisan Policy Institute where she endorsed the notion of establishing an advisory committee to conduct such a review. But her formal testimony for the first time challenges the very purpose of the FHLBs.

As Fannie and Freddie plod their way from $80 billion in capital to the target of $300 billion, the FHLBs now take center stage. How Thompson orchestrates the remake she has launched of this little-known $1 trillion government-sponsored enterprise (GSE) will be her enduring legacy.

How did this backwater GSE move to the forefront of the GSE debate? The answer is threefold: hubris, the Fed and public awareness.

For decades, the FHLBs have purposely flown under the radar. Exempt from congressional appropriations and oversight and enjoying a robust government subsidy, the “FLUBs,” as they have come to be known, carved out a profitable niche for themselves at taxpayers’ expense. Their members are banks and insurance companies that appreciate the dividends they receive from the FHLBs — again at taxpayers’ expense. Always inward-looking, the FHLBs have failed to adapt to a marketplace that has changed radically around them.

Starting with the financial crisis of 2008 and continuing with the COVID economic crisis of 2020, the Fed has infused the financial system with trillions of dollars of liquidity. Yet, liquidity is all the FHLBs offer. Even the FHLBs’ most ardent members no longer need the liquidity the FHLBs have for sale. Naturally, declining revenues are the result.

Finally, the public has caught up with the reality that the FHLBs are providing no public good in exchange for their government subsidy. As Ms. Thompson said in her testimony last week, “The FHLBanks’ core function is to provide liquidity in times of stress.”

Providing liquidity to privately owned banks; however, is not a public good. It is a private benefit. We already have a government agency, the Fed, which was created to serve as the lender of last resort. This glaring lack of any public good provided by the FHLBs has been brought to the fore by a variety of commentators in recent months.

In her written statement, Thompson struck all the right notes. Especially important is that “foundational questions about mission, purpose and organization” are ripe for reevaluation. Similarly, membership, and operational efficiency, i.e., consolidation and effectiveness, are on the table.

In sum, when it comes to the FHLBs all bets are off. 

A key question is whether her testimony launches a charette or a show. A charette would be a convening of all stakeholders in an authentic project attempting to resolve conflicts and map solutions. A show is, well, just performative.

Knowing Thompson by reputation and by her experience both at the FDIC and at FHFA, the smart money is on the process she is about to launch being a genuine effort to identify not just current stakeholders, but stakeholders who may have never even heard of the FHLBs. Small businesses that create jobs, infrastructure lenders, climate change enthusiasts and affordable housing players are some of the new and potential stakeholders that come to mind.

It is very early in her comprehensive review process, and she has signaled that a series of listening sessions are in order. An early indicator of the seriousness of this effort will be how the listening sessions are organized. If the 11 FHLBs are the conduit for arranging these sessions that will be a sure sign that the process is captive. However, if an aggressive, imaginative and independent outreach effort to potential stakeholders is undertaken then we are in for a very productive process.

Thompson was confirmed as director of the FHFA just over two months ago. Five of her predecessors presided over the conservatorships of Fannie and Freddie. None of them challenged the politically connected and intractable FHLBs. The quest to find a meaningful public purpose for the FHLBs is long overdue.

Thompson is exactly the right person to lead that quest. 

Cornelius Hurley was an independent director of the Federal Home Loan Bank of Boston from 2007-2021. He teaches financial services law at Boston University School of Law.