Casey Research in Vermont specializes in investment advice for precious metals and energy. But its chief economist and editor of the firm's cornerstone newsletter, the Casey Report, stirred up a small tempest in financial circles this past summer when he raised questions about the soundness of the Federal Home Loan Bank system.

Bud Conrad, who comments on Federal Reserve policy and other macroeconomic issues for Casey, published a research note warning about the dangers of toxic mortgages and mortgage-backed securities on the books of the 12 Home Loan Banks. After thumbing through the second-quarter report on the banks' combined performance that was prepared by the FHLBs' oversight authority, the Federal Housing Finance Agency, Conrad saw a potential calamity on the scale of the Freddie Mac/Fannie Mae variety.

"If, in total, the FHLB ultimately suffers defaults equal to just 10 percent of the face value of their assets, a reasonable expectation, they'll be forced to write down more than $110 billion - which is better than twice the capital on their dwindling books," wrote Conrad, himself based in the Silicon Valley. "That sets the stage for another federal government takeover or receivership like Fannie and Freddie."

The Home Loan banks have certainly suffered losses in the private-market MBS portfolios - $8.6 billion in the second quarter, though only $953 million was counted as other-than-temporary impairment (OTTI) charges against the Home Loan banks' net income of $1.1 billion, thanks to rules changes by the Financial Accounting Standards Board. But current and former FHLB officials scoff at the idea that MBS toxicity at any level looms as a systemic threat to the Home Loan Bank system.

These holdings not only represent a small percentage of assets - around 5 percent, or $70 billion of the $1.4 trillion of combined assets - but are among securities the Home Loan banks will hold as long-term assets, says John von Seggern, president of the Council of Federal Home Loan Banks. "They're funded to maturity, [and] they're senior tranche," he says.

According to another former Home Loan bank executive, the only scenario under which they are offloaded is a liquidity crisis - which will not be an issue, judging by the federal net provided for Freddie and Fannie. "Can the Home Loan banks continue to borrow to carry these assets? The answer is yes. Not because of their own virtue, but because of the government guarantee," says Alex J. Pollock, a former president and CEO of the Federal Home Loan Bank of Chicago and current scholar at the American Enterprise Institute.

If the banks were to sell the MBS at a loss, even in Conrad's 10-percent meltdown scenario, the assets at most would produce a $7 billion charge, says Pollock. "You wouldn't like that, but it's not the end of the world."

The most significant chunk of Home Loan bank assets, almost 71 percent, is from $738 billion in collateralized advances to member institutions for mortgage lending. Pollock and von Seggern insist that that collateral protects the Home Loan banks in the event of defaults. "There is no way you could ever have 10 percent loss on total assets," said Pollock. "IndyMac was busted six ways over, but the Home Loan Bank of San Francisco didn't lose a single penny on IndyMac [advances]."

Conrad is not swayed. "When the bank does the business of borrowing from the Federal Home Loan Bank, it provides collateral back - which is the mortgages themselves, on the books of the Federal Home Loan Bank," he says.

Conrad admittedly goofed in his report when he attributed a $200 billion second-quarter reduction in Home Loan bank assets to bad loan write-offs (they were instead reduced advances from member banks). But he is certainly not alone in questioning the transparency of the Home Loan banks' accounting. Former FHFA Office of Finance chairman Charles Bowsher resigned in March rather than sign off on the system's combined financial statement, and the FHFA itself has recommended a new centralized financial structure of the 12 banks to overcome inconsistent, opaque and often incomprehensible financial reports.

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