While federal officials move to implement programs to thaw the credit markets, they should not overlook a vital tool already serving the U.S. banking system: the Federal Home Loan banks.
Credit is the lifeblood of the economy, and the Home Loan banks facilitate a large portion of our financial system's credit needs, rapidly converting a range of loan collateral into affordable funding, so that more than 8,000 banks can extend credit in their communities.
This privately capitalized, cooperative system of 12 Home Loan banks was first to respond to the credit crisis. They executed their mission remarkably well, while nearly all other sources of short and mid-term liquidity dried up. Because of prudent management, the banks had limited exposure to subprime loans and thus were prepared to respond.
Like the FDIC, the Federal Home Loan Bank System was created in the midst of the Great Depression. The FDIC provides insurance to protect depositors, and the Home Loan banks provide the stable loan funding to ensure that member financial institutions can readily obtain cash for the loans they make to consumers. The banks provided the basis for the creation of the 30-year fixed-rate mortgage, and they have adapted and fine-tuned their valuable liquidity mission over time.
We would be wise to remember that following the savings and loan failures of the 1980s, the Home Loan banks were recast to become the lender of first resort for thrifts, commercial banks, and other lenders, serving as an important funding source for an industry on the mend.
In recent years the Home Loan banks have remained a financially strong and consistently reliable source of funding for most of America's lenders that, because of size or scale, cannot regularly access capital markets and have limited options for meeting loan demand when core deposits are unavailable or too costly.
The vast majority of Home Loan bank members are community banks. Some of our nation's largest commercial banks are members, too. All use Home Loan bank advances to meet the needs of their businesses and communities. The Home Loan banks are a successful cooperative, where large and small members are provided fair and equitable treatment and receive commensurate benefits from their capital investment.
More recently, as the Treasury Department has formulated responses to the credit crisis, the Home Loan banks have served as critical on-call sources of liquidity as borrowers have tapped into contingent funding plans. Without the banks, the recent liquidity crisis would have worsened rapidly. Because of its extraordinary responsiveness, outstanding advances have exceeded $1 trillion, making the system a liquidity source second only to the Federal Reserve. This performance was possible because the banks remained focused on their core mission and had the capital structure and strong credit and collateral requirements to meet critical demands safely and soundly.
Given these benefits, how can the Home Loan banks evolve to meet the challenges of the current crisis? As the banks' managers and policymakers consider ways to leverage the unique benefits of their government charter wisely, it would be helpful to keep two notions in mind.
First, policymakers need to recognize and support the Home Loan banks' critical mission. The banks consistently operate effectively and with purpose while remaining profitable, well-managed institutions whose cooperative structure fosters conservative, prudent operations. This business structure, created by Congress in 1932, has weathered today's difficult economic climate while other models have foundered.
Second, the Home Loan banks work because they serve small and large lenders and help to foster a diverse and dynamic banking system. The banks provide funding options for a rich mix of lenders, which compete against each other to serve consumers and the communities where they live. This flexibility will be especially critical as the Home Loan banks give members the ability to manage funding more flexibly and confidently and put those funds to work in their communities.
Policymakers must recognize that the Home Loan banks are a long-term, essential part of the financial services industry that does not require new actions or appropriations. In light of recent events, their utility and importance cannot be underestimated.
As a consistent and reliable source of funding, the Home Loan banks are — and must remain — a central part of the U.S. banking system.