FHLBs and Community Banks Part 1

One of the most popular defenses of the merits of the FHLBs is that, by their existence, community banks are able to do all the good things they do, and, that if the FHLBs are tampered with, community banks will not be able to survive. 

On some fronts this argument has merit.  Providing liquidity to community banks during market disruptions stabilizes the markets and reassures individual depositors at community banks.  The FHLBs provide real value here.  But as noted in my last post, at what cost should the funds be provided?  Access to liquidity is great – why is it given away at a non-market rate at the same time.  This does not appear to be a reasonable use of the subsidy pot of gold.

A quick look at some numbers shows the reality of the misaligned arguments. First, let’s assume the windfall provided by the FHLBs provides a little less than one half of one percent interest rate advantage (equivalent to the value recently estimated by the CBO, .40% or 40 basis points in the jargon).  If the community banks took this entire windfall and passed it on directly to their customers, recent data indicates this will lower the cost of mortgages in the community by .04% (FHLB loans only fund 10% of community bank mortgages) or about $8 a month for the homeowner of a $250,000 house.  Nice, maybe, but not transformative.

Instead, the FHLBanks point to a fairly recent study that is based on mortgage market data from 20 years ago, when the mortgage markets were entirely different, and which employs impressive mathematical gymnastics to arrive at counterintuitive or even illogical conclusions.  A good academic effort, and maybe relevant when the data was collected, but not in today’s market, yet the FHLBanks rely on it. 

This strategy by the FHLBanks to derail the important conversation that needs to be had – namely, what is the best way to deploy the windfall from the FHLBs to improve the dire housing affordability and community development challenges facing all communities? is self-serving and easily disproven. Time to move forward, the status quo is not defensible.