In Focus: Home Loan Banks Wary Of Proposal to Limit Short-Term

No consensus emerged during a daylong hearing last week on the investment practices of the Federal Home Loan banks.

Hosted by the Federal Housing Finance Board, the hearing focused on a plan by regulators to cut by half the amount banks may stash in short-term investments, such as Treasury securities, commercial paper, and Fed funds.

These investments, which totaled $100 billion in 1997, do little to accomplish the system's mandate of providing credit for residential housing and community development, the Finance Board staff argued.

The regulators concluded that reducing such investments would not significantly affect the banks' net income, dividends, or liquidity. At the same time, they argued, the banks could make additional investments that more directly support mortgages and community development.

Officials representing most of Home Loan banks opposed the agency's plan, arguing that money market investments generate income needed to fund affordable housing and pay off bonds used to finance the first savings and loan bailout. The Home Loan banks contribute $100 million a year to their affordable housing program and $300 million a year in interest on Resolution Funding Corp. bonds.

"Holding such assets, while not an end in itself, helps us fulfill our core purpose," said Elizabeth H. Mitchell, chairwoman of the Council of Federal Home Loan Banks, a group representing 10 of the 12 banks.

Bank representatives also bristled at the idea of losing investment flexibility. Imposing a uniform formula is foolhardy, they said, given regional differences and cyclical variations in the economy.

When interest rates fell in March and April, for example, the Des Moines Federal Home Loan Bank redeemed more than $1 billion of its bonds. To finance that purchase, the bank used overnight Fed funds-a type of short- term, money market investment. It later issued new bonds at a lower interest rate.

"Money market investments are the 'swing' asset that acts as a shock- absorber" for bank balance sheets, said Brian P. Smith, director of policy and economic research at America's Community Bankers. "Any loss of system elasticity has safety-and-soundness ramifications."

Before money market investments can be radically reduced, Congress must reform the system's capital structure and its thrift bailout obligations, said Curtis Hage, the council's vice chairman. And the Finance Board must permit the banks to invest more in mortgage-backed securities, Indianapolis Home Loan Bank Chairwoman M. Margaret De Santis argued in written testimony.

In the meantime, the liquidity these investments provide is critical, Mr. Hage added.

But Finance Board Chairman Bruce A. Morrison said the banks' money market investments are excessive and represent an overzealous attempt to attract and retain members. "Return to shareholders is not the only justification required for a particular composition of the balance sheet," he said.

Mr. Morrison has some support in Congress. In a letter, House Banking Committee Chairman Jim Leach suggested that the banks are abusing their federal subsidy by focusing more on member dividends than on housing and community development.

Community development groups, hungry for capital, are also more or less in Mr. Morrison's camp. So is Art Agnos, one of the two other Finance Board members.

In fact, with only three seats filled on the five-member Finance Board, not even opposition from Mr. O'Neill, who is leaning against the limits, could stop Mr. Morrison and Mr. Agnos if they decided to act on the staff proposal.

Mr. Morrison promised that any changes in investment rules would still allow banks to respond to market conditions, and not result in "straitjackets."

For reprint and licensing requests for this article, click here.
MORE FROM AMERICAN BANKER