The other GSE problem

September 23, 2009

It’s hard to keep all the U.S. housing agencies straight. Fannie Mae and Freddie Mac are still basket cases relying on government support, while the Federal Housing Administration and its partner, Ginnie Mae, are setting off alarm bells with their more aggressive efforts to support overstretched homeowners.

But the Federal Home Loan Banks, a government-sponsored enterprise (GSE) that is the lesser-known cousin to Fannie and Freddie, is one to watch — particularly as small regional banks grapple with deteriorating loan portfolios and fewer financing alternatives.

The FHLB is a system of 12 regional banks that provide cheap financing — thanks to the government’s implicit backing — to its 8,100 member banks. Set up during the Depression to support the home real estate market, the FHLB’s primary mission is still firmly rooted in making sure home buyers have access to credit by giving banks the funding they need to extend loans.

Some of the FHLB’s branches, however, made the classic bad investment choice during the credit market boom: They loaded up on subprime mortgages. Unlike Fannie and Freddie, the FHLB wasn’t forced by the subsequent losses into the arms of the government, but they have put a damper on their lending, according to Ben Garber, economist at Moody’s Investors Service.

Citing the Federal Reserve’s flow of funds data, Garber notes that FHLB lending to savings institutions shriveled by $166 billion, to $190 billion for the year ending in the second quarter — a 10-year low and nearly half of what the total was at the end of the first quarter of 2008.

In the big picture, this is positive since it means the much needed deleveraging of the financial system is taking place. But for smaller, regional banks weighed down by commercial real estate loans that are growing more delinquent with each passing day, this kind of number is worrisome, especially as other stop-gap measures begin to disappear.

The Federal Deposit Insurance Corp’s guarantee program, which was set up during the height of the crisis to bolster confidence in qualifying bank debt sold to investors, is scheduled to expire in October.

Though small banks wouldn’t necessarily benefit from the program directly, since they typically borrow in amounts too tiny for capital markets, it surely eased some of the pressure that would have otherwise fallen on the FHLB.

Moreover, the FDIC is heading for broke. Among the options it is considering to bolster its dwindling insurance fund is a special assessment fee on the banking industry — another potential squeeze on institutions that can’t count on being saved by simply being too big to fail.

A rising savings rate, however, could help alleviate some of the pain, since it will give deposit-taking banks an alternative cheap source of funding, given rock-bottom interest rates that the Federal Reserve isn’t planning to raise any time soon.

It’s unlikely to fill the void left behind by the FHLB pullback and the FDIC’s exit. But then again, who said wringing out excesses would be pain-free?

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