"Another Quasi-Governmental Agency that's Lending Hundreds of Billions to Troubled Banks"

Daniel Gross on another GSE we haven't heard much about:

Freddie and Fannie's Healthy Cousin, by Daniel Gross: The Federal Reserve's extraordinary efforts to help investment banks have effectively put the taxpayer on the hook for enormous potential losses..., we could end up paying tens or hundreds of billions...

But the actual amount of credit extended so far through these public-rescue efforts pales in comparison with the credit that has quietly been extended to banks in the past year—another lifeline that taxpayers could end up paying dearly for. ... For the past 12 months, an obscure agency created by President Herbert Hoover during the Great Depression has come to the rescue of the banking industry. It is called the Federal Home Loan Banks.

Like Fannie Mae and Freddie Mac, the FHLB (here's ... a brief history, and an overview) is a government-sponsored enterprise. But it differs from the wounded giants in some significant ways. Instead of being owned by public shareholders, as Fannie and Freddie are, the 12 independent regional FHLBs are owned by their 8,100 members. Banks large and small, representing about 80 percent of the nation's financial institutions, own shares in the FHLB and share in the profits.

The FHLB has a simple business model.... Basically, it funnels cash from Wall Street to banks on Main Street. Member banks present mortgages they've issued—high-quality ones, not junky subprime ones—as collateral to the FHLB and borrow money so they can have more cash to lend. To finance its activity, the FHLB sells debt to big investors in the capital markets. As with Fannie and Freddie, the FHLB benefits from a unique status. ... While the FHLB takes pains to note that "Federal Home Loan Bank debt is not guaranteed by, nor is it the obligation of, the U.S. government," there's an assumption afoot in the marketplace that were the FHLB to encounter serious trouble, the government would step in. In return for this special treatment, the FHLB provides some vital public services. Twenty percent of its net earnings are used to help cover interest on debt issued by the Resolution Funding Corp., which paid for the Savings & Loan bailout. The FHLB also channels one-tenth of its profits to affordable-housing loans and grants.

During the mortgage boom, FHLB quietly did its job and avoided many of Fannie and Freddie's excesses. ... Subprime holdings were minimal. And since commercial banks were able to raise capital from Wall Street to make any kinds of loans they wanted, they didn't have all that much need for the FHLB's services. As the chart ... shows, the number of loans extended to member banks rose modestly in the boom years, up 7 percent in 2005 and only 3 percent in 2006. ...

But last year the mortgage house of cards began to collapse. And as Wall Street's securitization machine, which had enabled banks to raise cash with alacrity, broke down, banks staged their own run on the FHLB. .... Since ... the broken-down Wall Street mortgage securitization machine was sold for scrap, FHLB loans to member banks ...[rose] to $914 billion at the end of this June. In the past 12 months, FHLB loans to its members have risen by 43 percent, representing an additional $274 billion in real credit provided by the system to its member banks. That sum dwarfs the actual amount of credit extended to investment banks by the Fed—or by the government to Fannie and Freddie.

Does the increase in FHLB's balance sheet mean taxpayers may be on the hook for another trillion dollars in mortgage debt? It's unlikely. FHLB has a much better track record than Fannie and Freddie. Because it maintains high standards, it has never suffered a credit loss on a loan extended to a member. It doesn't spend hundreds of millions of dollars each year on executive compensation or lobbying, as Fannie and Freddie did. And it didn't lower standards ... as a way of increasing market share.... Seventy-six years after it was created by a president whose administration was hostile to government intervention in markets, the FHLB stands as an enduring and (so far) effective example of socialism among capitalists.

Why does the FHLB exist at all?:

The Housing Giants in Plain View, by William R. Emmons, Mark D. Vaughan and Timothy J. Yeager , FRB St. Louis, July 2004: ...The Federal Home Loan Bank System was the first housing GSE. The FHLBanks were established by Congress in 1932 to advance funds against mortgage collateral. At the time, the country was in the midst of an unprecedented wave of depositor runs. Depository institutions faced the risk that loans would have to be liquidated at fire-sale prices to pay off anxious depositors. The FHLBanks enabled their members, primarily savings and loan associations and savings banks, to obtain cash quickly should depositors come calling. This access to ready cash reduced the liquidity risk of mortgage lending, thereby freeing FHLB members to originate more home loans.

The FHLBanks also allowed the thrifts to offer better terms on mortgage loans. At the time, there was no secondary market for mortgages; so, thrift institutions were forced to hold loans until maturity. Consequently, they made only very short-term loans—three to five years at most. Moreover, these loans were nonamortizing “balloons”—upon maturity, the borrower either repaid the loan in full or paid a fee to renew the loan. Few families had the incomes necessary to get funding under these terms; so, few families owned their own homes. The FHLBanks stepped in and provided a source of long-term stable funding, thereby allowing member institutions to separate the credit risk and the liquidity risk of mortgage lending. ...

Many of the conditions that were present when the FHLB was created have now eased or been eliminated (e.g. by the FDIC which resolves the depositor run problem, at least for small depositors, financial innovation, etc.). So why does the FHLB still exist?:

Although advances against mortgage collateral remain the focus of FHLBank activities, the justification for this focus has widened beyond support for home ownership. Now, the system sees its mission as including support for community banking. Community banks are relatively small institutions that specialize in making loans to and taking deposits from small towns or city suburbs. Community bankers find FHLB membership and services attractive... FHLB advances are dependable and convenient... Indeed, the FHLBanks offer a wide variety of maturities, from overnight to over 20 years.

The FHLB web site adds:

In a time when cash deposits in community banks are dwindling, the funds provided by the Federal Home Loan Banks guarantee a stable source of funds for mortgages and community lending. Without the Federal Home Loan Banks, most depository institutions would not have access to medium- and long-term sources of funding.

By supporting community-based financial institutions, the Federal Home Loan Bank System helps to strengthen communities.

What are the costs of the FHLB? Going back to the St. Louis Fed article:

Many economists believe that the implicit subsidization of the housing GSEs distorts the allocation of scarce funds in the capital markets. Left alone, these markets would allocate funds to the business and household borrowers capable of putting them to the best use. Cheaper funding for the housing GSEs means more new homes, more larger homes and higher rates of home ownership. On the other hand, this distortion might lead to fewer funds being available for business investment, possibly resulting in slower economic growth. ...

Three problems are clearly associated with housing GSEs...: moral-hazard problems related to risk-taking, incomplete pass-through of subsidies intended for mortgage borrowers, and risk-shifting to the Federal Deposit Insurance Corp.

Moral Hazard

When a firm can take risks, enjoy the full benefits and avoid the full costs, economists say a moral hazard is present. The hazard is that the firm will respond to these incentives by increasing risk to imprudent levels. Moral hazard is a problem for the housing GSEs. Because the capital markets view their debt as virtually free of default risk, Freddie, Fannie and the FHLBanks can enjoy all the upside of risk-taking and little of the downside. ... The burden of the extra risk does not, of course, go away just because the housing GSEs do not bear it. Indeed, taxpayers ultimately would bear the extra risk if the federal government were to stand behind a failing GSE.

Taxpayer exposure to risk-taking by housing GSEs is not limited to potential losses from default. Risk-taking by housing GSEs could undermine the stability of the financial system because so many banks depend on them for liquidity. Commercial banks hold more than one-half of their securities portfolios—a key source of emergency liquidity—in the form of mortgage-backed securities and GSE debt. Moreover, the portion of commercial bank loans backed by real estate is at an all-time high. Banks are comfortable holding mortgage-related securities because these securities can be sold quickly with minimal transaction costs, and banks are comfortable holding real-estate-backed loans because these loans can be pledged against advances from the FHLBanks or sold to Freddie or Fannie. A severe shock to one or more of the housing GSEs could lead to a market lockup, in which investors become reluctant to hold GSEs’ direct or indirect obligations. This could, in turn, lead to a temporary suspension of mortgage purchasing, mortgage securitizing or mortgage “advancing,” thereby forcing the Federal Reserve to intervene to re-liquefy the mortgage markets.

Incomplete Pass-Through of Subsidies

Who actually benefits from the subsidy—homeowners or the employees and shareholders of GSEs? As noted, the implicit guarantee against default lowers housing-GSE funding costs. Lower funding costs can be used to reduce mortgage rates for homeowners or to raise employee salaries or dividends for housing-GSE shareholders. Estimates vary about the division of the subsidy; one recent study estimated that the subsidy to Freddie and Fannie lowered mortgage interest rates by about 7 basis points (0.07 percent), yielding a savings to homeowners of about $44 billion. At the same time, the gain to Freddie’s and Fannie’s shareholders was estimated at $72 billion. ...

Shifting Risk to the FDIC

Of the three housing GSEs, the FHLBanks are the least likely to increase their own risk. The shareholders of the 12 regional FHLBanks are also the customers. Therefore, the cost of excessive risk-taking by an FHLBank would fall on the same parties that enjoy the benefits. Still, the FHLB System may create moral hazard through another channel by implicitly encouraging its members to ramp up risk.

Advances from the FHLBanks may encourage risk-taking at member institutions because the FHLBanks have little incentive to demand higher interest rates when the credit risk of a borrowing bank increases. Advances are heavily collateralized—the market value of mortgage collateral typically covers 125 to 170 percent of the advance. This protection explains why the FHLB System has never lost a penny on an advance. Because advances carry no credit risk, the individual Home Loan banks can set terms that are largely independent of the failure risk of the borrower. Put another way, borrowing from the FHLB enables a bank to avoid any market-imposed penalty for failure risk. Moreover, the FDIC, which covers losses to insured depositors in the event of a bank failure, cannot make up the difference by hiking deposit-insurance premiums. Many observers believe that the current cap—27 cents a year per $100 of deposits—is too low to deter risk-taking. In short, greater risk-taking by FHLB members implies a higher failure rate over time. A higher failure rate, in turn, implies greater losses to the deposit-insurance fund. Taxpayers ultimately stand behind this fund.

Unless someone can identify the substantial government failure that this program solves, show that the FHLB provides liquidity insurance banks cannot get from the discount window or through other means, or make the case that the private sector, even with all of the recent financial innovation, would not make the necessary array of financial services available to smaller communities without the implicit government guarantee standing behind the FHLB, and further make the case that financial services, like telephone service or electricity, are essential services that all communities should have, then we should follow the recommendations we've heard for Fannie and Freddie and slowly eliminate the implicit government support of this institution.

Comments

says...

"we should follow the recommendations we've heard for Fannie and Freddie and slowly eliminate the implicit government support of this institution"

I was not aware there is any serious effort to reign in the GSEs. Just a bunch of nonsense chatter as the incompetent (corrupt?) government institutions who fiddled while guys like Angelo Mozila (Countrywide and Indybank) scammed the moral hazard system, hand over hundreds of billions of tax payer money at below market rates.

Reduction in moral hazard or a moral hazard steroid injection ? The greatest moral hazard is the laissez-faire (Let Do) regulatory agenda that is still operative.

[Ryan]

Herbert Hoover was against government interventions? That is some news to me.

[OhNoNotAgain]

"Herbert Hoover was against government interventions? That is some news to me."

He sure as hell was. It was like Bush all over again - ideology over action. He sat on this hands while the whole country imploded around him, refusing to intervene because he insisted that private charities and corporations could handle things just fine. The private charities were like pissing into 50mph winds, and many corporations used this unique opportunity to speed up assembly lines and exploit the shit out of the existing workers instead of hiring on more of the workers that desperately needed a job.

[kthomas]

More looting. Great.

[Bruce Wilder]

"Unless someone can identify the substantial government failure that this program solves . . ."

Huh? We're searching for "government failures" now?

[Cynthia]

OhNoNotagain,

There's no doubt that Pres. Hoover had a very sink-or-swim attitude towards the masses. But by creating FHLB's, he was making sure that a select few would never sink whether they could swim or not!

[Farrar]

Mark, you must certainly have had your tongue in cheek when you wrote this one -
"Unless someone can identify the substantial government failure that this program solves,
[I suppose you meant market failure]
show that the FHLB provides liquidity insurance banks cannot get from the discount window
[When the FHLB system was established the Fed was not to my knowledge rediscounting real estate paper. The Fed is doing so now on an exceptional basis, but will they continue to do so?]
or through other means, or make the case that the private sector, even with all of the recent financial innovation, would not make the necessary array of financial services available to smaller communities without the implicit government guarantee standing behind the FHLB,
[Are you implying that the private financial sector is now making essential services available throughout the country? If so, why do we keep hearing that credit is so tight?]
and further make the case that financial services, like telephone service or electricity, are essential services that all communities should have,"
[Now I know it was subtle sarcaasm. What a relief.]

But this does emphasize that the whole RE financing infrastructure needs to be overhauled (nationalized, in my opinion) from top to bottom. I suppose we must wait til the dust settles.

[Farrar]

Mark, you must certainly have had your tongue in cheek when you wrote this one -
"Unless someone can identify the substantial government failure that this program solves,
[I suppose you meant market failure]
show that the FHLB provides liquidity insurance banks cannot get from the discount window
[When the FHLB system was established the Fed was not to my knowledge rediscounting real estate paper. The Fed is doing so now on an exceptional basis, but will they continue to do so?]
or through other means, or make the case that the private sector, even with all of the recent financial innovation, would not make the necessary array of financial services available to smaller communities without the implicit government guarantee standing behind the FHLB,
[Are you implying that the private financial sector is now making essential services available throughout the country? If so, why do we keep hearing that credit is so tight?]
and further make the case that financial services, like telephone service or electricity, are essential services that all communities should have,"
[Now I know it was subtle sarcaasm. What a relief.]

But this does emphasize that the whole RE financing infrastructure needs to be overhauled (nationalized, in my opinion) from top to bottom. I suppose we must wait til the dust settles.

[S]

high time someon brings this to light. GS advised coutnrwiode in the throes last year to draw down $60B in loans from FHLB. WM ihas also drawn $60B or so. So if this is the hgih quality collateral what is the stuff that is going to the fed? Also, this indeed could be a good way for the govt to inject funds into the banks via stealth recap..Paulson included backing the FHLB debt in his bailout request and don;t know if it got included in the bill? Would be interesting to know?

[Bruce Wilder]

The full-scale propaganda assault on the web of institutions supporting home ownership sickens me.

This endless chant of "moral hazard, moral hazard" is one-eyed man's economics -- completely devoid of perspective and proportion.

Risk attenuation is one of the prime desiderata for economic organization. The economic analysis of incentives does not suggest that the optimum infliction of incentives is to put a gun to anyone's head, and then cock the trigger.

A few moment's thought should allow anyone to recognize that home ownership is fraught with peril for a middle-class wage earner. It is a classic case of putting all of one's eggs in one basket. And, yet, rent is, easily, among the largest household expenses, and the ability to channel some of that stream of expenditures into the gradual accumulation of a modest nestegg gives many people a perfectly reasonable strategy for managing their finances, provided that the considerable risks can be attenuated and insured.

The full panoply of Progressive Era and New Deal institutions, when they worked properly, provided that risk attenuation and insurance, which allowed people to get an affordable, fixed-rate, 30 year mortgage, and to feel reasonably sure that they could hold onto their home, or sell it. The central idea, here, is to make it possible for an ordinary person to make reasonable, prudent decisions with a long time-horizon.

That web of institutions has been under assault for 35 years, and has been substantially eroded in that time period. The purpose of that assault is quite clear to me: it is the upward redistribution of wealth and income.

I see a lot of propaganda, which is focusing populist anger on these institutions, in an attempt to enlist the mob and its frustrations and resentments, in what will prove to be self-destruction.

Chanting "moral hazard" in reference to Fannie Mae or the FHLB's seems utterly scurrilous to me. These institutions have been corrupted, and having been corrupted, have failed to some degree, as rusted iron will fail to bear a load. Are we so ignorant of economics, though, that we must try the experiment, to see what crushing load they did bear for more than 50 years?

[SGC]

"Does the increase in FHLB's balance sheet mean taxpayers may be on the hook for another trillion dollars in mortgage debt? It's unlikely. "

A few points about the FHLB worth noting: The FHLB is cooperatively owned by 8,000+ banks. That means that if it gets into trouble it can issue a capital call on the banking system. Leaving the FHLB system requires 5 years notice. The Chicago FHLB is troubled right now and it recently refused to return the "redeemable" capital investment of a few banks that withdrew from the system.

The FHLB has priority in bankruptcy collection before the FDIC.

It's not clear to me that a market system would ever provide 30 year fixed rate mortgages. 30 years of interest rate risk is just too much for a profit seeking financial institution to handle. If you're going to argue that the banks can hedge the risk, I would respond that the problem is that someone needs to buy that risk. I think that the market price of 30 year interest rate risk in the absence of government support would be too high for a viable 30 year fixed rate mortgage product.

So the real question is: Do we want to go the European route with adjustable rate mortgages and individuals bearing the interest rate risk (and lower rates of home ownership) or do we believe there is value to 30 year fixed rate mortgages that merits government support?

[Bruce Wilder]

SGC makes the calm, reasonable case. But, the calm reasonable case is bullshit! Imagining what "a market system" would produce buries a great deal in imagination. Some institutional structure will frame any "market system" and a great variety can be imagined; every one will evolve and deteriorate over time.

A substantial political movement exists in the U.S., which has been, and continues to press for "a market system" that features financial predation.

That's the truth. It sounds shrill. It sounds paranoid. Tough. That is the truth. Whatever path of reasoning about the history and evolution of the present crisis, that does not involve substantial moral outrage, is, either not being realistic, or is part of the problem.

[Bruce Wilder]

SGC: "Do we want to go the European route with adjustable rate mortgages and individuals bearing the interest rate risk (and lower rates of home ownership) or do we believe there is value to 30 year fixed rate mortgages that merits government support?"

A fine, reasonable frame. I admire the idealism, that frames the question in this way.

But, it is completely unreasonable to survey the current state of things, or the political contest, and imagine that this is the question at issue.

Some powerful group wants banking and finance organized around predation -- 33% credit card interest rates, payday lenders, housing bubbles, and all the rest. The present crisis, by wiping out fully half of middle class home equity has advanced that cause. And, now many of the sponsors and apologists for predation, with serious mien, propose to further dismantle the barriers to predation.

[bob]

BTW, James Galbraith's "Predator State" is out. Buy it, read it, love it, implement it.

[SGC]

BW: I'm an optimist at heart. I can't agree with: "The present crisis, by wiping out fully half of middle class home equity has advanced that cause." I think the consequence of wiping out home equity will be serious constraints on financial institutions -- whether or not the GSEs survive in their current form. Congress is bending over backward not to fan the flames of the crisis, but Congress is not happy.

Of course, I could be wrong ...

[Cynthia]

So banks have hopped into bed with FHLB's not only to ride the mortgage gravy train, but also to take a joy ride with moral hazard. I suppose this is what it means for a bank to be worthy of a XXX credit rating.**

**mixed metaphor alert!

[Bruce Wilder]

SGC: "I can't agree . . ."

I get it. And, I've been there. But, nevertheless, wiping out a substantial part of middle-class wealth does advance someone's cause, and that cause has been on the march for more than a generation.

Pretending that we common folk share a common cause with the leadership offered up by the convervative movement is a pretty fantasy. But, it is just a fantasy. Hank Paulson is no steward of the commonwealth.

[Andy]

Per my recent article - http://www.savingtoinvest.com/2008/07/why-you-should-be-angry-with-2008.html - , all the bill will achieve is that in the short term it will slow the current housing market crisis and credit crunch, but only delay the inevitable downward spiral. Unfortunately the American and global economy is heading into a recession, not out of one. So the housing bill, like the stimulus checks, will only have a temporary affect. The government again is trying to spend us out of an economic crisis, which is unlikely to work and only add to our national debt and the continued devaluation of the US dollar. Paulson (Treasury chief) is going to drive us broke, because the American economy is not like Goldman Sachs.

[Bruce Wilder]

Andy: "Paulson (Treasury chief) is going to drive us broke, because the American economy is not like Goldman Sachs."

And, maybe, Paulson wants us broke.

[macburger]

The St Louis Fed article:
Many economists believe that the implicit subsidization of the housing GSEs distorts the allocation of scarce funds in the capital markets. Left alone, these markets would allocate funds to the business and household borrowers capable of putting them to the best use

Former Fed president Poole: NY tims oped 07/27
Fannie Mae and Freddie Mac are not essential to the mortgage market; if they were put out of business in an orderly fashion over 5 to 10 years, the market would pick up the business they abandon. Fannie and Freddie exist to provide guarantees for mortgage-backed securities trading in the market. The business is simply insurance....

“In fact, there has already been a test case for how the mortgage market would function without Fannie and Freddie. After an accounting scandal in 2005, regulators severely constrained their activities. The nation’s total residential mortgage debt outstanding rose by $1.176 trillion in that year, even though Fannie’s and Freddie’s stakes rose by only $169 billion, just 14.4 percent of the total. In essence, the market barely noticed that the two agencies’ private competitors were providing 85 percent of the increase in mortgage debt in 2005.”

Now for reality:

The private competitors of Fannie and Freddie, during 2004-2006, i.e. when Fannie/Freddie were crimped - ran a huge racket. There was a collapse in mortgage underwriting standards. They gave mortgages to lots of truly unqualified borrowers.

This shady environment, along with the exponential growth of structured financial products, SIVs and other off-balance sheet gimmicks that was enabled by the openly corrupt misrepresentation of risk by banks, IBs and the large financial services firms who peddled these toxic junk to naive investors, has brought us into the current financial doomsday scenario.

GSE's indeed If anything, the shift away from the GSE’s to the private markets led to the bubble in the real estate markets. The GSE's just got caught up in that bubble bursting.

If the time when Fannie and Freddie barely got to do business is the reality of the private markets, let us have more of it. Then maybe there will be real outrage.

[Mary]

This discussion is dated. H.R. 3221 ENR, that is as enrolled and passed by both chambers, establishes the Federal Housing Finance Agency. It is a new GSE ("independent agency") to which regulatory and supervisory authorities vested in OFHEO and in the FHFB over FANNIE MAE, FREDDIE MAC, THE FEDERAL HOME LOAN BANKS, AND THE OFFICE OF FINANCE now are given. (Title I)

Title II Sec.2201 in particular enumerates regulatory "reforms" of FHLB management, services, and member exemptions from capital reqs and certain reporting provisions of the Securities Exchange Act of 1934. Why? So far as I see this federal Housing Finance Agency intends to function like an investment bank, specializing in MBS product "innovations" brokered by FHLBs. Commercial and residential stocks, registered and unregistered issues.

The function of FHLBs in 2004 or even Jan 2008 is beside the point.

[OhNoNotAgain]

"There's no doubt that Pres. Hoover had a very sink-or-swim attitude towards the masses. But by creating FHLB's, he was making sure that a select few would never sink whether they could swim or not!"

Indeed, and the situation today is eerily similar. What's especially eerie is this description of the cause of the Depression from Marriner Eccles, the Chairman of the Federal Reserver during FDR's administration, on Wikipedia:

http://en.wikipedia.org/wiki/Great_Depression

"As mass production has to be accompanied by mass consumption, mass consumption, in turn, implies a distribution of wealth -- not of existing wealth, but of wealth as it is currently produced -- to provide men with buying power equal to the amount of goods and services offered by the nation's economic machinery. [Emphasis in original.] Instead of achieving that kind of distribution, a giant suction pump had by 1929-30 drawn into a few hands an increasing portion of currently produced wealth. This served them as capital accumulations. But by taking purchasing power out of the hands of mass consumers, the savers denied to themselves the kind of effective demand for their products that would justify a reinvestment of their capital accumulations in new plants. In consequence, as in a poker game where the chips were concentrated in fewer and fewer hands, the other fellows could stay in the game only by borrowing. When their credit ran out, the game stopped.

That is what happened to us in the twenties. We sustained high levels of employment in that period with the aid of an exceptional expansion of debt outside of the banking system. This debt was provided by the large growth of business savings as well as savings by individuals, particularly in the upper-income groups where taxes were relatively low. Private debt outside of the banking system increased about fifty per cent. This debt, which was at high interest rates, largely took the form of mortgage debt on housing, office, and hotel structures, consumer installment debt, brokers' loans, and foreign debt. The stimulation to spending by debt-creation of this sort was short-lived and could not be counted on to sustain high levels of employment for long periods of time. Had there been a better distribution of the current income from the national product -- in other words, had there been less savings by business and the higher-income groups and more income in the lower groups -- we should have had far greater stability in our economy. Had the six billion dollars, for instance, that were loaned by corporations and wealthy individuals for stock-market speculation been distributed to the public as lower prices or higher wages and with less profits to the corporations and the well-to-do, it would have prevented or greatly moderated the economic collapse that began at the end of 1929.

The time came when there were no more poker chips to be loaned on credit. Debtors thereupon were forced to curtail their consumption in an effort to create a margin that could be applied to the reduction of outstanding debts. This naturally reduced the demand for goods of all kinds and brought on what seemed to be overproduction, but was in reality underconsumption when judged in terms of the real world instead of the money world. This, in turn, brought about a fall in prices and employment.

Unemployment further decreased the consumption of goods, which further increased unemployment, thus closing the circle in a continuing decline of prices. Earnings began to disappear, requiring economies of all kinds in the wages, salaries, and time of those employed. And thus again the vicious circle of deflation was closed until one third of the entire working population was unemployed, with our national income reduced by fifty per cent, and with the aggregate debt burden greater than ever before, not in dollars, but measured by current values and income that represented the ability to pay. Fixed charges, such as taxes, railroad and other utility rates, insurance and interest charges, clung close to the 1929 level and required such a portion of the national income to meet them that the amount left for consumption of goods was not sufficient to support the population.

This then, was my reading of what brought on the depression."

Doesn't that read exactly like our situation today (apart from the high interest rates) ?

It seems that until we completely and utterly discredit Republican economic ideology, it is simply going to keep coming back like some zombie to cause massive pain to everyone in this country.

[prostratedragon]

The function of FHLBs in 2004 or even Jan 2008 is beside the point.

Posted by: Mary

Well, how about their balance sheets, i.e. existing obligations?

Anyway, before we put the vast FHLB œuvre to torch here's a recent overview (2006) of the internal structure and risk-taking activities of the FHLB system. When I first read it about a year ago, I must say it scared me almost as badly as the Credit Suisse reset graph, mostly because of the opportunity it seemed to describe for large lenders to fly under the radar and suck up huge amounts of extra funds from the national pool.

[Mark Cassell]

Thanks. I disagree strongly with the article’s tone and argument. The FHLBanks were not meant to promote economic efficiency. They, like many entities were created to pursue a public purpose – in this case homeownership. I would argue, in fact, that it was Fannie and Freddie’s efforts at greater and greater profits that led them astray. As for moral hazard – maybe. Gross can infer it but I’d like to see the evidence. So far the FDIC hasn’t suffered as a result of the FHLBank’s advance behavior. And, I would actually make a counter argument, namely that it is through it collateral policies that the FHLBanks have a huge positive impact on all housing finance markets. By giving greater weight to certain forms of collateral like 1-4 family homes purchased with conventional mortgages, the FHLBank System creates a huge positive influence on the housing market; an influence that can’t be easily picked up because it’s so broad and indirect. There may be a moral hazard and the FHLBank System (through its advance lending) may be creating a market for subprimes or it may be enabling banks to be more risky. But I’d like to see the evidence before jumping to the assumption. The influence of large commercial banks like Countrywide, Wells Fargo, and WashMu, make this scenario more likely by I still haven’t scene the evidence. For another view of the FHLBank System's mission see:

Hoffmann, Susan and Mark Cassell. “What Are the Federal Home Loan Banks up To? Emerging Views of Purpose Among Institutional Leadership,” Public Administration Review 62 (July/August 2002): 461–470.

Hoffmann, Susan M. and Mark K. Cassell. "Understanding Mission Expansion in FHLBs: A Return to Behavioral Choice Theory. Public Administration Review 65 (Nov/Dec 2005): 677-689.