Silvergate’s silver lining: Federal Home Loan Bank flaws are exposed

It has not been a happy new year for the Federal Home Loan Bank of San Francisco or for the $1 trillion government sponsored enterprise (GSE) of which it is a part. 

Revelations that the $109 billion asset bank funded the crypto industry were followed by charges of “systemic racism” leveled against it by its own members. All this while its regulator in Washington is conducting a comprehensive review of the GSE.

Earlier this month, reports broke that the bank had loaned one of its members, Silvergate Bank, $4.3 billion at a time when Silvergate was experiencing a bank run by its depositors. Bad as that was, it turns out that Silvergate’s run on deposits was prompted by the implosion of crypto operator FTX and its indicted founder, Sam Bankman-Fried. There followed credible accusations in American Banker by one of its own members that the bank is engaged in “wholesale redlining” and is reaping “windfall profits.”

If the Federal Home Loan Bank (FHLB) of San Francisco were a bank (it is not), examiners would have arrived on site immediately asking pointed questions. Questions such as: “Did you know Silvergate was rapidly losing deposits when you loaned it $4.3 billion of taxpayer-subsidized money? If you knew, did you think your organization had replaced the Fed as the taxpayers’ lender of last resort for failing banks? If you did not know, what kind of due diligence are you running? Did you know that Silvergate reportedly is a key player in the cryptocurrency industry? If you did know, how do you square lending to a crypto bank with your housing mission? If you did not know, let us introduce you to a term familiar to all other bankers: Know your customer.”

If FHLB of San Francisco was a publicly traded company, its stock price likely would be in a tailspin, a search would be on for new leadership and investment bankers would be retained to explore the company’s strategic alternatives.

But FHLB of San Francisco is neither a bank nor a publicly traded company. It is an arm of the federal government created by Congress in 1932 to stimulate housing finance. Its support by the taxpayers is deep and undeniable. 

For example, it has a line of credit from the U.S. Treasury Department. FHLBanks and interest on their debt issuances are exempted from federal and state taxes. Congress gave FHLBanks a “super lien” over the FDIC so whenever one of its member banks fails, it never loses a penny. Lest there be any doubt about the government’s backing, Congress inserted the word “federal” in the names of each of the 11 FHLBanks.

The FHLBanks could not issue one dollar of debt without the taxpayers’ support. That support is the basis for their elevated credit ratings. It is their sine qua non. 

Now, the cardinal rule of crisis management is “Tell the truth.” That rule went out the window when FHLBank of San Francisco claimed it receives “no taxpayer assistance.” This disingenuous attempt to distance itself from the taxpayers that nurture it was believed by no one. The bank was forced to mount a second line of defense days later. 

In a carefully groomed public statement, FHLBank of San Francisco next claimed to have no “oversight responsibility” over crypto-lender Silvergate’s operations, thus apparently no awareness of its crypto activities. Call this the bank’s “Casablanca” defense: To paraphrase Claude Rains’ character from the movie, “I’m shocked, shocked,” that crypto trading was going on here, as the croupier handed him his winnings. 

It is tempting to dismiss the Silvergate fiasco and the bank’s ham-handed response to the ensuing crisis as just one Federal Home Loan Bank gone rogue. That would be a mistake.

FHLBank of San Francisco did not invent the fiction of no taxpayer assistance. It got that propaganda from the Council of FHLBanks, its Washington lobbyist, which heralds on its website, “Each FHLB is operated independently and receives no taxpayer assistance.” It speaks for all 11 FHLBanks in defending this elaborate system of what critics have called “corporate welfare.“

Detachment from reality is a strategic weapon of all 11 FHLBanks. Belief in their own rhetoric causes them to act in ways that are antithetical to the interests of the taxpayers who fund them and to turn their backs on the communities they were intended to serve.

When the Federal Housing Finance Agency (FHFA) that regulates the FHLBanks announced its “comprehensive review” of the system last summer, it was responding to simmering discontent that the FHLBanks had become “largely irrelevant.” Many dismissed the exercise as a bureaucratic waste of time. Even reformers were skeptical that the FHFA had the authority under its governing statute to make meaningful reforms.

Silvergate has changed all of that. Now, it is obvious that the FHLBanks are not just irrelevant, they can be dangerous. Silvergate has managed to bring the flaws in this 90-year-old system into sharp focus.  

There’s an old saying in Washington that goes, “Something is impossible until it becomes inevitable.” Sandra Thompson, who leads FHFA, no longer has the option of making meaningful changes to the FHLBanks. Silvergate has given her the mandate to do so.

For decades, the FHLBanks have fed off complacent regulators and a protective Congress. Their regulator is no longer complacent. Congress will soon tire of defending the indefensible. 

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