Financial Update (Fourth Quarter 2006)
FHLBs' Risk Taking
Risk taking among housing government-sponsored enterprises (GSE) such as Fannie Mae and Freddie Mac has been well
|The fact that each FHLB guarantees the debt obligations of its sister institutions, coupled with a lack of equity market discipline, may heighten FHLB risk-taking incentives.|
Founded in 1932, the 12 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 FHLB System to expand in both size and scope. The FHLB System now has more than $1 trillion in total assets, including a substantial investment in mortgages and mortgage-backed securities.
Examining risk-taking behaviors among GSEs
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. In a recent Atlanta Fed Economic Review article, authors Mark J. Flannery and W. Scott Frame identify some differences in risk-taking incentives between the cooperatively owned FHLB system and investor-owned Fannie Mae and Freddie Mac.
FHLBs' structure may encourage risk taking
Cooperative ownership itself does not reduce FHLB risk-taking incentives because, unlike many mutual depository institutions, which are owned by their depositors, the FHLB system does not bundle its equity and debt claims, the authors write. Also, the fact that each FHLB guarantees the debt obligations of its sister institutions, coupled with a lack of equity market discipline, may heighten FHLB risk-taking incentives.
However, the FHLBs cannot avail themselves of equity-based managerial compensation, which creates high-powered risk-taking incentives in investor-owned firms. Overall, the authors conclude, it is unclear whether the FHLBs' risk-taking incentives are necessarily weaker than Fannie Mae's and Freddie Mac's.