The White House may want to pull the plug on Fannie Mae and Freddie Mac, but it plans on keeping the Federal Home Loan Bank System (FHLB) alive, albeit at reduced capacity.

After studying the FHLB System, the Treasury Department decided to refocus this “third housing GSE” on serving small- and medium-sized members that are mostly commercial banks and thrifts.

Under the Obama administration’s much-ballyhooed white paper on Reforming America’s Housing Finance Market large megabanks can only be a member of one of 12 FHLBs.
Not only is the proposed membership cap already rankling some large banks, so is the White House suggestion that advances be crimped to these mega borrowers. (The “limiting” of advances is spelled out specifically in the Treasury document.)

As might be expected, the FHLB-related proposals are not sitting well with the Council of Federal Home Loan Banks and the American Bankers Association (ABA).

Under current rules, member banks can borrow from a FHLB by putting up mortgage collateral for advances. As an alternative to FHLB advances, Treasury said it supports the development of a covered bond market for large banks. “We will also work with Congress to consider additional means of advance funding for mortgage credit, including the development of a covered bond market.”

Europe has a covered bond market that provides financing for pools of mortgages that banks hold on their balance sheets. But it is still unclear whether this financing vehicle will catch fire in the U.S.

Among the stumbling blocks to passing covered bond legislation is the Federal Deposit Insurance Corp., which is concerned about its rights to the underlying assets of a covered bond should a bank issuer fail.

In short, FHLB supporters are not particularly taken with the possibility of giving up a low-cost borrowing source (advances) for the prospect of a covered bond market some day.

“We support the development of a covered bond market. But it doesn’t exist yet,” said Bob Davis, executive vice president of the ABA.“Nor is it clear that the FDIC regulations will not impede the development of the covered bond market.”

Davis also noted that the Federal Home Loan Bank System doesn’t work unless its membership includes large financial service companies.

Without their membership, the Federal Home Loan Banks wouldn’t have the scale to provide the services that are important to smaller members, he argued.

“The fact that large banks have a variety of options and outlets in addition to FHLB advances doesn’t mean they shouldn’t be part of the system,” the ABA executive said.

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