© 2024 Arizent. All rights reserved.

Fate of Home Loan Banks May Lie with Fannie and Freddie

The Federal Home Loan banks have always had an uneasy relationship with Fannie Mae and Freddie Mac, but the fate of the GSEs are more entwined than ever as Congress considers the future of housing finance.

The House Financial Services Committee will meet on March 2 to debate the future of the GSEs and the housing market more broadly. The conclusions lawmakers reach about Fannie and Freddie will have major implications for the Home Loan banks, including how they sell their debt and who regulates them.

"So much of what will happen to them depends on what Congress is going to do with Fannie and Freddie," said Bert Ely, an independent consultant in Alexandria, Va. "This gets back to the core problem of what do you do with Fannie and Freddie?"

Though Fannie and Freddie have become symbols of the financial crisis, the Home Loan banks have not gone unscathed. The state of the system will be clearer in the coming weeks when they release their 2009 annual reports. But the Home Loan banks have grappled with big losses related to private-label mortgage-backed securities; the system lost $165 million during the third quarter.
"They're out of control, too," said Paul Miller, a managing director at FBR Capital Markets Corp. "They don't have an effective regulator and they need to be reined in, because there's a lot of Home Loan bank debt out there."

But for all the system's woes, it never needed money from the Troubled Asset Relief Program. And while Fannie and Freddie have tapped a combined $111 billion from a credit line at the Treasury Department, the Home Loan banks have never borrowed a dime.

Home Loan bank leaders hope to use their success to their advantage by informing the debate over GSE reform — not become a victim of it.

"It's not possible to talk about GSEs without talking about the only successful housing GSE," said Alfred DelliBovi, the president of the Federal Home Loan Bank of New York. "You've got three housing GSEs, and now two of them are wards of the state. I'm not pointing fingers, but the natural thing is to point to what works and what doesn't work."

House Financial Services Committee Chairman Barney Frank said last month he supports "abolishing Fannie Mae and Freddie Mac in their present form and coming up with a whole new system of housing finance."

Though development of that new system is barely off the ground, Home Loan bank officials said policymakers should consider the advantages of a cooperative structure.

"We are a system built on a cooperative structure, in which the 12 Home Loan banks and their members have their own capital at risk," said John von Seggern, the president of the Council of Federal Home Loan Banks. "That's a core principle of any new financial structure."
Prospective Home Loan bank members must make a capital investment to join the system and provide additional capital when they borrow advances. DelliBovi said Fannie and Freddie could operate on a similar basis by requiring capital from institutions that pass their loans on to the GSE.

"Those organizations have to lend capital to the enterprise so you can't just dump the mortgage at the GSE," he said. "They should have to buy capital just like members of the Home Loan banks who take out advances do."

Outside observers agreed that a self-capitalization framework akin to the Home Loan banks might be the best solution for Fannie and Freddie.

"The big question for housing finance is how do we recapitalize the GSEs, and I think the Federal Home Loan banks offer a great answer to that question," said Fred Cannon, the co-director of research at KBW.'s Keefe, Bruyette & Woods. "The GSEs can essentially become cooperatives of banks who originate mortgages. Part of the mortgages would be a haircut that would go in and recapitalize the GSEs."

But even if Congress goes along with the cooperative structure, big changes could be in the offing for the Home Loan banks.

The system is regulated by the same agency as Fannie and Freddie — the Federal Housing Finance Agency — but the type of oversight could be changed if Fannie and Freddie are privatized or nationalized.

Since Home Loan bank debt is typically traded closely to debt issued by Fannie and Freddie, Cannon said financial markets would want to see the Home Loan banks treated in the same manner as the larger GSEs.

"Federal Home Loan banks are GSEs just like Fannie and Freddie are," Cannon said. "A best-case solution would be they would be structured very similarly."

While policymakers could seek to split oversight of the Home Loan banks from Fannie and Freddie, they were only combined two years ago, and breaking the banks off again could be problematic.

"For now that's unlikely, because we just melded them all together," said Jim Vogel, the head of fixed-income research at First Horizon National Corp.'s First Financial Capital Markets Corp.
"To split them back up is going to be overly complicated. The idea that there's a Home Loan wing of FHFA and a Fannie/Freddie wing of FHFA seems to sit well right now."

DelliBovi said he would not oppose separating Home Loan bank oversight from supervision of Fannie and Freddie. But he said that must be done in a way that does not spook debt investors.
"We wouldn't want the debt investors to think we are in any way inferior to" Fannie and Freddie, he said. "Debt has to be a consideration that we wait and watch carefully."

Still, he said he expects changes to Home Loan bank oversight in the coming years. Since the Treasury has given so much money to Fannie and Freddie, DelliBovi predicted the Finance Agency would become part of the Treasury. That would be similar to the construct of the Office of the Comptroller of the Currency and the Office of Thrift Supervision.

"I wouldn't be at all surprised to see the FHFA become part of Treasury," DelliBovi said. "If you're sitting in Congress, you say, 'They've spent a lot of money, and it's going to take them a while to get their money back.'"

The GSE reform efforts could also give lawmakers a chance to press for consolidation within the system, especially among weaker banks like those in Boston, Chicago and Seattle. But consolidation efforts have not paid off in the past — the Chicago and Dallas Home Loan banks spent nearly a year debating whether to merge — and DelliBovi questioned whether combining banks would really solve any problems.

"They have a bellyache," he said. "I'm not sure that consolidation is the right cure for a bellyache. If you consolidated two of them — one strong, one weak — there'd be a price to pay to be the weaker one with shareholders."

He went on: "It's not going to happen because of anything other than an economic need to consolidate."

For reprint and licensing requests for this article, click here.
ABS
MORE FROM ASSET SECURITIZATION REPORT