Unified regulation of banks and thrifts, for which I argued in the first part of this article on May 12, should lead to a phasing out of the Federal Home Loan Bank System.

The system is billed as an essential adjunct to the nation's housing finance system, but that is false advertising.

With total loans to members of $79.9 billion at the end of 1992 -- about six weeks' origination volume in today's refinancing-driven mortgage market -- any impact that may be left is a far cry from yesteryear's.

Others Would Step In

Pumping up housing during a slump by increasing the Home Loan banks' lending to thrifts hasn't been tried in 20 years, and hasn't worked in 40. As a housing and home finance reporter in the 1980s, I never heard of a market-rate home loan funded and priced off an advance from the system.

While the Home Loan banks' willingness to accept unsecuritized home loans as collateral is a big convenience, there are probably plenty of enterprising correspondent lenders out there, including some thrifts, which have such programs or could develop them.

Since at least the late 1970s, S&Ls have used the Home Loan banks primarily as a source of liquidity, rather than to fund mortgages.

The main lending policy difference between the Federal Reserve and the Home Loan banks is that the latter are major lenders to healthy thrifts, while the Fed only rarely lends to healthy banks.

Lending to healthy thrifts in the '80s cost the taxpayers billions. of dollars in the '90s, because many S&Ls that later failed used Home Loan bank advances to grow faster and maintain liquidity more easily. In fact, when the advances were used to fund mortgages, it was often for commercial loans that later went bad.

An Indefensible Perk

Obviously, there are still S&L managers who like the federally subsidized interest rates and low markups offered by the 12 banks.

These rates are perks that thrifts must give up to put behind them the craziness that they, the government, and the taxpayers have endured for the past 14 years.

In my view, after the Great Depression when the Home Loan banks were created, central bank funding for day-to-day operations of depository institutions was always an unsafe and unsound policy.

Window Dressing

The thrift-bailout law established the Federal Housing Finance Board, a small agency in Washington to replace the Federal Home Loan Bank Board in its role as administrator of the Home Loan Bank System.

The board is headed by Daniel F. Evans Jr., an Indianapolis lawyer and adviser to former Vice President Dan Quayle, and the former chairman of the Home Loan Bank of Indianapolis.

Mr. Evans has run the Home Loan Bank System to keep it alive.

Open thrifts, and the Resolution Trust Corp. in liquidating failed institutions, have cut S&L borrowing from the Home Loan banks by more than half. But Evans has encouraged the 12 banks to reinvest these loan pay-offs, rather than pay down their own debt.

As a result, at the end of 1992 the Home Loan banks had "investments" of $79.1 billion -- a figure equal to 99% of their loans to members, and to 49% of their total assets of $162.1 billion.

Federally Subsidized |Float'

These investments, far in excess of any working capital needs, are really federally subsidized "float," because they are financed with cheap Home Loan system. debt that Wall Street views as federally guaranteed.

Eight of the 12 banks have more of these investments than loans to members. I've heard of window dressing before, but half the balance sheet is a bit much!

Despite profits of $2 billion in the past two years, the long-term outlook for the Home Loan banks is bleak. About 40% of 1991-92 profits came from prepayment penalties that the RTC paid on behalf of failed thrifts. With thrift failures way down, this item will virtually dry up.

If income from the window-dressing operation were also lost, profits would plummet. Finally, the thrift law required the system's banks to pay up to $300 million a year toward the cost of the S&L bailout, and $50 million to $75 million a year toward low-income housing.

Opening the Door

The '89 law created two new constituencies for the Home Loan banks. Commercial banks were allowed to become members, and 2,000 -- more than the thrift membership of 1,850 -- accepted the invitation.

So far, banks account for about 6% of total Home Loan bank loans. And the thrift law created a housing program that has lent about $1.5 billion to members. These two "tails that wag the dog" should not be allowed to grow into reasons to keep the Home Loan banks alive, even after their sponsoring industry is merged out of existence.

Running Off the Balance Sheet

Apart from the legal steps of abolishing the finance board and the Home Loan Bank System in conjunction with the Office of Thrift Supervision, phasing out the Home Loan banks is largely a matter of running off the asset and liability sides of their balance sheets.

Given how much short-term money is involved, a lot of the runoff could be accomplished by the board and the Home Loan banks now, before any legislation is passed.

After the banks are abolished, the Fed, through its New York desk and regional banks, can complete the task.

Fed Would Assume Some Loans

A limited amount of Home Loan bank advances to weak thrifts will not be placeable in the private market, and will have to be accepted by the Fed. Such loans will become subject to restrictions on Fed loans to troubled banks mandated in the Federal Deposit Insurance Corp. Improvement Act of 1991.

The housing finance board has done well with its housing program. It should be transferred to the Department of Housing and Urban Development, not to the Federal Reserve.

Meanwhile, former thrifts should be permitted to join the Fed. On a one-time-only basis, they should be able to elect their own representatives to the 12 regional Fed bank boards.

Mr. Simon, a journalist and lawyer, is editor of Bank Bailout Litigation News and associate editor of Bank Lawyer Liability, both published by Buraff Publications, Washington. this is the second of two commentaries.

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