Though the government put out one fire over a controversial Chicago Federal Home Loan Bank pilot program, it failed to stamp out the major criticism.

Under the program, which is expected to start in June, member banks and thrifts would originate and service one- to four-family home mortgages and hold reserves against credit losses. The Chicago Home Loan Bank would fund and hold the mortgages, and manage the interest rate risk.

To quell complaints that the Federal Housing Finance Board approved the plan without public input, the agency held a hearing last week. Chairman Bruce Morrison agreed to let the public comment on any new pilot programs the finance board considers.

But the agency couldn't snuff out what has by far been the most strident objection: That the Chicago pilot program is a first step toward direct lending by a government-sponsored entity.

The majority of those invited to the hearing support the program. But several industry representatives argued that banks and thrifts participating in the pilot would not be originating the loans, which would always be on the Home Loan bank's books.

They worried that if the program is allowed to go beyond the pilot stage, the Home Loan bank would use its access to government subsidized funds to offer lower rates than competing private portfolio lenders.

"The FHLB of Chicago will become a competitor of not only every financial institution that is a member of the Chicago FHLB, but every institution that is a member of every other FHLB as well," said Dirk S. Adams, senior vice president of Golden West Financial Corp.

The loans made under the pilot program are closed in the name of the Chicago Home Loan Bank and member institutions merely act as agents, said Gordon C. Smith Jr., president and chief executive of Liberty Federal Savings Bank, Enid, Ohio.

"Because of the nature of the portfolio lending function, the competitive effect of the program should not be dismissed," said Mr. Smith, who testified on behalf of America's Community Bankers. "This form of lending is core business for ACB members."

The finance board tried to quiet this criticism by allowing member institutions to close loans in their own name. But Robert Davis, the thrift trade group's director of government relations, said this alternative would require member banks and thrifts to set aside more capital, and would therefore never be used.

"That's a meaningless option," Mr. Davis said.

Alex J. Pollock, president of the Chicago Home Loan Bank, referred to the direct lending as "an emotional device which deters clear understanding."

"Those who have used this emotional term, 'direct lending,' must, if they are serious in their views, believe that under this program we could somehow bypass member institutions and deal directly with consumers," Mr. Pollock said. "This is impossible ... the member performs all the lending functions."

The program will come under the scrutiny of Rep. Richard Baker, R-La., who is expected to hold hearings on the pilot this year.

"When you have a hearing before three finance board directors who approved the pilot and when you have only a handful out of 25 people testifying who disagree with the plan, you don't exactly have an impartial airing of the issues," a congressional aide said.

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.