For 65 years, the Federal Home Loan Bank System has provided liquidity to the housing finance market. But today some critics are questioning whether the system's 12 banks have outlived their purpose.

Viable institutions are hard to build; when they work, the trick is to harness their capacity for the future. In the case of the Federal Home Loan banks, the capacity to serve is unique in this government: a decentralized, wholesale lender of first resort, cooperative in structure, flexible in product delivery, unequaled in its ability to partner nationally, regionally, and locally to meet credit needs in housing and community revitalization.

These characteristics are almost essential in a climate of scarce budget resources and desperately large and complicated credit and revitalization needs in both urban and rural areas. And with ever-larger institutions and a global economy, the bank system can make it possible for smaller financial institutions to maintain control over dwindling resources and invest in their communities' destinies.

An unsentimental journey to the 21st century therefore leads me to three conclusions about the system's role now and in the future.

First, the Home Loan banks provide competition in housing finance, by funding residential mortgages through member institutions.

Yes, the secondary markets have developed and altered mortgage finance in irreversible, efficient ways. But with their enormous concentrations of credit risk-$1.4 trillion in residential mortgages held or guaranteed by Fannie Mae and Freddie Mac-they can also spring a leak, a leak taxpayers will be unaware of until the government is called upon to build an ark. The Home Loan banks comprise a triple-A-rated system that offers healthy competition to the secondary market giants.

By finding more appropriate ways of allocating market risks among the players in mortgage finance-which is what the Chicago bank's pilot most obviously represents-the system can provide mortgage lenders with a new choice, and that can lead to lower costs to homebuyers.

Second, the system may be the last, best hope for maintaining the viability of small institutions. Consolidation continues apace. And some say that the deposit drought facing these institutions could become a crisis. Without local institutions, smaller local borrowers will have little choice, and local communities may die.

The House Banking Committee and Sen. Chuck Hagel, recognizing the problem that small institutions have in accessing the capital markets, have proposed to make it easier for them to become Home Loan bank members and borrowers. For institutions with assets of under $500 million, pending legislation would:

Waive the requirement that residential mortgages make up at least 10% of assets.

Expand eligible collateral to allow secured loans for small business, agriculture, rural development or low-income community development.

Expand authorization of long-term advances for these purposes.

And the Federal Housing Finance Board has recognized the problem of small institutions in a recent proposed rulemaking that would enable banks to reclassify some rural and urban mortgage loans on "combination properties" as mortgages, and to use them to qualify for system membership.

Third, the Home Loan banks target underserved markets. The system can offer both smaller and larger institutions a way to funnel housing and community investment funds to populations and projects that might otherwise go unfunded.

I have said over and over again that with the status of government- sponsored enterprise comes a borrowing advantage that is intended to serve a public purpose. That advantage can be used to fund nonconforming home mortgage loans and loans for multifamily dwellings that cannot be sold into the secondary market. Remember that Fannie Mae and Freddie Mac do not originate loans. Remember that they take only what "fits" the standard profile.

And value added will come from a new role in economic development, where federal Home Loan banks can provide both the technical and funding assistance needed to put together the difficult-to-do community investment deals that might otherwise not be do-able at all.

In this arena, too, the Chicago pilot may offer a model of how to make it profitable to "portfolio" economic development loans by allocating risk in a more appropriate way. The Home Loan Bank System made homeownership affordable in the 20th century; it can do the same for community development in the 21st.

Much controversy has been attached to the four pilots programs approved to date by the Finance Board. In fact, they are modest proposals to chart the territories I have just discussed: new ways of allocating risk, new ways of providing liquidity, and new ways of funding otherwise underserved populations.

The pilots in New York, Chicago, Atlanta, and Seattle will prove the potential that is there for the system to serve housing finance and community investment in innovative and essential ways.

And as the Finance Board continues to promote changes in the balance sheets of the Home Loan banks to reflect more mission-related activity, I have no doubt that additional pilots will be developed that demonstrate profitable, safe ways for members and Home Loan banks to partner in meeting targeted credit needs.

The government-assisted creation of long-term, fixed-rate, amortizing mortgages brought homeownership within reach of millions of hardworking average Americans.

Today it is small businesses rural and urban, small multifamily projects, and local economic development investments that can't "pay their way." Some surely lack the cash flow to borrow and repay, but many just need the financial structure reengineering magic that remade homeownership opportunities. The Federal Home Loan banks and their members are uniquely appropriate tools for this reengineering project.

So let us not discount the value of an evolving institution, on an inexorable path to renewal.

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