Buried in the Corker-Warner reform bill are two provisions that would give the Federal Home Loan banks an opportunity to play a major role in the new housing finance system.

Under the bill, a new federal corporation, a Federal Mortgage Insurance Corp. would among other things vet any application to issue covered securities brought forward by a Federal Home Loan bank. In addition, it would ensure that at least one issuer of FMIC-backed bonds fulfills the securitization needs for credit unions and community banks.

With their larger government-sponsored enterprise sisters wound down as required in this proposal, the fortunes of the FHLBs may be on the rise. To get to that place will require some reshaping of the current structure of the FHLB system. But there is much to be leveraged from these lesser-known GSEs.

The FHLBs are somewhat of a financial curiosity among major institutions that specialize in mortgages. The 12 FHLBs were set up during the Great Depression to ensure regional liquidity needs were met for financial institutions operating in an FHLB's jurisdiction. FHLBs are effectively owned by member financial institutions that purchase nontradable stock and as a result have access to low-cost financing via FHLB advances. The debt of these FHLBs is issued on a consolidated basis and each FHLB is jointly and severally liable for the debts of other FHLBs. While the federal government does not explicitly guarantee the debt of FHLBs, there is an implicit guarantee that, while not exercised during the crisis, poses some risk to taxpayers as another form of GSE.

No FHLB failed during the crisis, though there were some close calls. The current structure of the FHLBs has some kinks that need to be worked out ahead of any substantive increase in the scope of FHLB activities. However, great potential exists to leverage the system.

During the late 1990s, a new FHLB product, the Mortgage Partnership Finance program, appeared on the scene, poised to compete head-on with Fannie Mae and Freddie Mac. Originally it was touted as way to provide banks with a mechanism for managing those risks for which they have a comparative advantage, namely credit risk, while leveraging FHLB advantages in managing interest rate risk.

MPF products were not securitizations but rather in some ways resembled covered bonds, which have been much discussed as an important financing component for the post-Fannie and Freddie world. Lenders would sell their mortgages to a Home Loan bank and receive a fee for taking a first-loss position in the underlying collateral. The MPF and related programs became popular but declined after 2003 for a variety of reasons, not the least of which were restrictions on securitization and the struggles of two leading participants, the Chicago and Seattle FHLBs.

The FHLBs provide a ready-made platform for issuing securities with several distinct advantages based on features of the original MPF programs. First, these entities are directly linked to smaller institutions that have historically been at a competitive disadvantage to large originators with greater market power to demand preferential pricing from Fannie and Freddie. Moreover, the FHLBs have demonstrated their ability as loan aggregators for members and selling these mortgages to Fannie. Serving as the principal aggregator for smaller mortgage originators would help level a field that has been dominated by the top five originators for decades and at great cost, as evidenced by the carnage created in the industry during the crisis.

Second, FHLBs could issue bonds and sell them back to originators (a variation on the GSEs' swap-and-hold securitization strategy) or sell them to other investors and retain the loans on their balance sheets. Leveraging the interest rate risk management capabilities of the FHLBs would also maintain long-term fixed-rate mortgages as an important product in the U.S. Underlying loans at the FHLB would effectively become the "cover pool," much as in the case of covered bonds, with a couple of important risk management features added. Aggregating loans across many originators diversifies the lender and geographic risks that would otherwise be concentrated in a single-issuer covered bond. And having as many as 12 FHLBs participate would dilute the risk to the broader financial system (although admittedly joint and several liability means that any one FHLB's participation would increase the risk to the other 11).

In addition, the credit risk could be allocated across the originator, FHLB, private mortgage insurers and investors with great flexibility, taking a cue from the MPF program. To avoid becoming a repository for the dregs of mortgage origination, the new program could turn the MPF model on its head and require participating lenders to take a first-loss position; a mezzanine layer could be sold to investors. A catastrophic guarantee currently held by the FHLB in the MPF program could be retained or in turn sold under a new issuance structure. The point is that the FHLBs have the potential to play a major role either in a securitization (with or without a federal guarantee) or in a covered-bond-ike structure.

Some might argue the FHLBs enabled large mortgage originators to go on a binge with their cheap advances available to members. The flip side of that story is that the FHLBs also provided a countercyclical role during the crisis by providing much-needed liquidity when the market seized up.

The FHLBs' cooperative structure, joint and several liability, implicit federal guarantee, number and composition are issues that need to be addressed if their role is to be expanded. Notwithstanding these structural issues, conceptually the FHLB model holds great promise at breaking the GSE-large originator stranglehold in the industry while offering tremendous flexibility for credit risk transfers.

Clifford Rossi is the Executive-in-Residence and Tyser Teaching Fellow at the Robert H. Smith School of Business at the University of Maryland.