As the debate on housing finance reform moves forward, more attention will be paid to the activities of the Federal Home Loan Banks, and how these institutions fit into the future structure of housing finance.
While resolving the conservatorships of Fannie Mae and Freddie Mac is central to the future of the secondary mortgage market, the FHLBanks can be a part of the larger housing reform discussion.
Ed DeMarco, current acting director of the Federal Housing Finance Agency, firmly believes such institutions provide secondary mortgage market services to their members such as buying whole loans directly from members and holding them in portfolio.
"Importantly, these programs demonstrate one approach to lender risk retention in mortgage lending and the credit performance of these loans was better than most other segments of the market the past several years," DeMarco explained.
He added, "Several FHLBanks participate in the MPF Xtra program aggregating loans from originators and passing them on to Fannie Mae for securitization."
While it’s clear that the government’s role in housing will not recede to zero, there appears to be consensus among policymakers that private capital needs to make a comeback in the market.
One way to do this is through issuers of mortgage-backed securities or other financial institutions guaranteeing the credit on such securities by maintaining appropriate levels of capital.
The FHLBanks could continue playing their traditional role under an issued-based approach and could even expand upon the limited loan aggregation role that these institutions play today, DeMarco stated.
"Over the years, there has been some discussion of the FHLBanks becoming guarantors of mortgage-backed securities. While that expanded role could be possible under this approach, given past history, and what appears to be a general desire to move away from a government sponsored enterprise-based model, that outcome seems doubtful," the current acting director said.
Another approach is for securities to be issued in such a way that market participants themselves advance the capital while absorbing the credit risk.
To a large degree, this is what the old private-label MBS market did and is considered a securities-based approach that would establish a market infrastructure for pricing and capitalizing on mortgage credit risk, DeMarco explained.
In a securities-based approach, the role of the FHLBanks could increase in many critical ways.
"To establish a liquid non-government guaranteed market there would seem to be a need to have greater homogeneity in borrower characteristics. For borrower characteristics that do not fit neatly into the secondary market, we need to find a way to get insured depository institutions back into the business of funding mortgages," DeMarco said.
For smaller institutions that do not want to hold mortgages on their balance sheet, a question about this approach is how will they have access to capital market investors?
A solution is to establish some type of cooperative to meet the needs of these institutions, which is already established in the FHLBanks.
"The aggregation function would seem to be a clear role for the FHLBanks in this type of approach. Much like they do with other functions, the FHLBanks would be providing a service to members, and one that would not require taking on the same amount of credit risk as in a guarantor role," DeMarco concluded.