The 12 Federal Home Loan Banks (FHLBs) are joining together to boost their capital strength and hopefully stave off harsher measures the Obama administration is considering.

The Treasury Department is currently focused in gradually downsizing Fannie Mae and Freddie Mac and their investment portfolios. But secretary Timothy Geithner also is concerned about the 12 FHLBs and their large investment portfolios, which have total assets of $331 billion.

“The FHLBs were allowed to accumulate investment portfolios, which we don’t think is necessary,” Geithner told a congressional panel recently.

Several Federal Home Loan Banks invested in private-label MBS and the losses nearly crippled them. “They didn’t have the capital to back that risk,” said Geithner.

“That is something we should avoid in the future.”

Early last week the Federal Home Loan Banks unveiled their plan to rebuild retained earnings by redirecting funds currently going towards interest payments on $30 billion of Resolution Funding Corp. bonds. (The Refcorp bonds were issued in 1989-91 to cover some of the costs of the taxpayer funded S&L bailout.)

The 12 FHLBs made $727 million in payments on the Refcorp bonds in 2010 alone. But the Refcorp obligation is scheduled to end later this year.

Now, the FHLB System wants to use this “saved money” to strengthen their capital reserves, according to John von Seggern, president and chief executive of the Council of Federal Home Loan Banks.

“The System Capital Initiative calls for each Federal Home Loan Bank to reserve 20% of its earnings in a restricted retained earnings account,” von Seggern said. (This 20% reserving requirement is equal to the banks’ current Refcorp assessment.)

Each FHLB has voluntarily agreed to accumulate retained earnings equal to 1% of their consolidated debt obligations. At the end of last year, the 12 banks combined had $801 billion in consolidated obligations outstanding.

Federal Housing Finance Authority acting director Edward DeMarco first suggested the idea of rebuilding retained earnings last fall during congressional testimony.

He noted that retained earnings are a key component of capital but the FHLBs have not been able to maintain adequate levels because of the Refcorp obligation.

As of Sept. 30, the FHLBs had a 6.4% capital ratio, but only 2.2% of capital consisted of retained earnings. The remaining 97.8% in capital is stock purchased by member banks, thrifts, credit unions and life insurance companies.

Geithner was not asked about the recapitalization plan at the recent Congressional hearing.

But he noted the “problems at the FHLBs were not nearly as bad as Fannie and Freddie’s.”

However, he did raise concerns about large banks being members of several Federal Home Loan Banks.

“We also created a system where we allow large banks to be members of multiple home loan banks. That is something we are going to look at again to make sure this doesn’t create too much risk,” Geithner said.

Treasury also raised this multiple membership issue in its GSE white paper on Reforming America’s Housing Finance Market that was released in mid-February.

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