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Economic Review


Volume 91, Number 3
Third Quarter 2006


FEATURES

One Proxy at a Time: Pursuing Social Change through Shareholder Proposals

How Resilient Is the Modern Economy to Energy Price Shocks?

The Federal Home Loan Bank System: The “Other” Housing GSE

Official Dollarization and the Banking System in Ecuador and El Salvador

Staff

 

 
The Federal Home Loan Bank System: The “Other” Housing GSE
Mark J. Flannery and W. Scott Frame

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Founded in 1932, the twelve Federal Home Loan Banks (FHLBs) have historically provided long-term funding to specialized mortgage lenders. But legislative changes in the wake of the 1980s’ thrift crises spurred the FHLBs to expand in both size and scope. For example, FHLB balance sheets now also include a substantial investment in mortgages and mortgage-backed securities, and the attendant interest rate risk has created financial and accounting difficulties at some of the FHLBs.

Like Fannie Mae and Freddie Mac, the FHLB System is a government-sponsored enterprise that funds itself largely with federal agency debt obligations that investors perceive to be implicitly guaranteed by the U.S. government. This article identifies some differences in risk-taking incentives between the cooperatively owned FHLB System and investor-owned Fannie Mae and Freddie Mac.

Cooperative ownership itself does not reduce FHLB risk-taking incentives because, unlike many mutuals, the FHLB System does not bundle its equity and debt claims. Also, the joint-and-several liability provision in the FHLBs’ consolidated debt obligations and a lack of equity market discipline may heighten FHLB risk-taking incentives. However, the FHLBs cannot avail themselves of equity-based managerial compensation, which create high-powered risk-taking incentives in investor-owned firms. Thus, it is unclear whether the FHLBs’ risk-taking incentives are necessarily weaker than Fannie Mae’s and Freddie Mac’s.