Federal HustLe Banks: Shoddy Goods 006
Hey, Jason Toon here with another Shoddy Goods, all about the stuff people make, buy, and sell. It's incredibly rare these days to find a policy issue that consumers of all political persuasions can agree on. But here's the story of a taxpayer-funded swindle so outrageous, it unites left, right, and everybody in-between.
Let's say the government was handing out cheap loans that you could invest in whatever you want and keep all the profit. And furthermore, let's say they promised to bail you out on any other debts you defaulted on, so you'd be a very attractive risk for other lenders, giving you even more access to cheap capital.
You could probably make a pretty tidy profit. And you'd probably be loath to give that gravy train up. But hey, this is just fantasy, right? Nobody gets that sweet a deal.
Nobody, that is, except the Federal Home Loan Banks (FHLBanks) and their 6,000 member banks and insurance companies. A Great Depression-era program meant to help more Americans afford houses has turned into an all-you-can-borrow buffet for buccaneer investors. And now that these government-sponsored entities are under more scrutiny, FHLBanks are fighting being held to any higher standards.
The Beal Bank branch in Las Vegas, home of some of the biggest action in town.
You got to know when to fleece 'em
In a time of skyrocketing housing prices and tightening credit, it sounds like a promising idea: government-backed banks that provide liquidity for financial institutions to invest in housing.
Those institutions get cheap credit and the assurance of federal backing. Aspiring homeowners get access to more mortgages. And there's more investment in new rental housing. So more homes of all kinds get built and price growth cools off a little. Everybody wins, right?
Well, that system has existed in the U.S. since 1932 in the form of FHLBanks. And unfortunately, it doesn't work that way anymore. At all.
FHLBanks refers to 11 government-sponsored banks around the country that serve some 6,000 member institutions like banks and insurance companies. This includes lots of small community lenders, but also the nation's biggest financial institutions, your JP Morgan Chases and Wells Fargos.
To join, an institution does have to prove they're involved in financing a certain amount of housing. But once they're in, they're in. There's no ongoing test for membership in FHLBanks. While some larger member banks have to meet some standards for supporting housing, most are exempt, says the Consumer Federation of America.
So a lot of savvy investors have set up tiny banks on paper just to get at the FHLBanks trough. A 2023 Bloomberg investigation found that of the FHLBanks' more than 6,000 member institutions, 42% had issued no mortgages at all for the previous five years. Instead, they've used that cheap credit to invest in everything from cryptocurrency to Hollywood mansions.
In one case, Texas banker and Texas Hold 'Em champ Andy Beal tapped some $4 billion in government-backed credit to bet on various securities, even while his Beal Bank's home lending activity shrank to just 1% of the bank's assets. Another supposed community housing bank reportedly issued a mortgage to an aspiring Californian homeowner named Johnny Depp. Yes, that Johnny Depp.
It takes a pirate to know a pirate.
Oh, the FHLBanks themselves are doing alright, too. The CEO of the FHLB of New York made $2.3 million in 2022 while paying a sweet dividend of 9.5% to their members, some of the biggest banks in the world.
FHLBanks members are required to contribute 10% of their profits to an affordable housing fund. Some have voluntarily contributed 15%. But from 1989 to 2011, FHL Banks contributed an average of 30% of profits - profits that were made by investing our money, remember.
This year those contributions will amount to about $1 billion. Maybe it's just me, but that seems like a paltry return on the public's $7 billion annual investment in FHLBanks.
Wait, how is this legal?
Well, let's start with the fact that most Americans have no idea that FHLBanks exist. And that's how FHLBanks likes it. You won't see them sponsoring any college bowl games or TikTok influencers. The Federal Home Loan Banks Wikipedia page is only 1,000 words long, shorter than the entries for Moe Szyslak or corn dogs. So public pressure to fix them has been almost nonexistent.
This hustle is also a relatively recent development. Things really started going wrong around 2012. In the wake of the global financial crisis, investors on the fringes of the mortgage market were looking for new, lower-scrutiny sources of cheap credit. A wave of phony insurance companies was the first ploy; those have been barred from FHLBanks since 2021. But those changed the perception of what you could get away with as a member institution. And regulation is still catching up to the problem.
Now that FHLBanks is getting more attention, though, voices left and right are calling for change. In fact, I couldn't find a single commentator speaking up for the current FHLBanks system, other than the banks themselves.
Some want to reform FHLBanks to serve its intended role. Just this month, liberal think tank the Urban Institute issued a report acknowledging that "The FHLBs are an indispensable source of support for the housing finance system." But they recommended cracking down to ensure "that those eligible for membership cannot wind down their support for housing finance once admitted."
The Brookings Institution also calls for a renewed focus on the original mission, including limits on permitted investments, executive pay structure, and use of lobbyists. "By restoring their original purpose while mapping onto the modern financial system," say authors Aaron Klein, Kathryn Judge, and Alan Cui, FHLBanks "can promote access to affordable housing while reducing financial stability risk and taxpayer exposure.'
The laissez-faire Cato Institute goes further, arguing that the entire FHLBanks system be abolished: "To reduce the risks both to taxpayers and the broader financial system, the FHLBs should be privatized, if not eliminated."
Mark Calabria is the Republican former head of the Federal Housing Finance Agency (FHFA) under the Trump administration and former chief economist for Vice President Mike Pence. Calabria said to Bloomberg, “Is the membership broader than it needs to be, and does it facilitate lots of activity with little social benefit? It does, and that’s a problem.”
"Does anyone NOT agree with that?"
As momentum for reform builds across the political spectrum, FHLBanks and their members won't give up their special arrangement without a fight. Late in 2023, the FHFA, which regulates FHLBanks, announced their intention to issue new rules ensuring that FHLBanks members fulfilled the housing mission - remember, the whole reason they get taxpayer backing at all.
This month, FHLBanks members fired back with letters of comment that denied that FHFA had any right at all to tell them what to do with their money (again, really our money). They say that's Congress's job. "Congress is the one that draws the box," said the president of the Council of Federal Home Loan Banks.
Mark Calabria and Catherine Cortez-Masto don't agree on anything - except FHLBanks.
They might want to be careful what they wish for. When FHLBanks came up during a January hearing of the Senate Banking Committee, it… didn't go well. Sen. Catherine Cortez Masto (D-Nev.) grilled the CEOs of the eight largest banks in the US (all big borrowers from FHLBanks) on whether FHLBanks should be required to raise their housing fund contributions to 20%, and be held to stricter housing finance requirements. Silence.
“Does anyone NOT agree with that?” Cortez Masto asked. Again, no response. "Good, all right, good start!"
For now, that gravy train still has some ways to run. Action seems unlikely between now and the November elections, and the future beyond that is anybody's guess. At the very least, though, more and more people are getting wise to the hustle. Like me. And now, you. As the Senator said, good start.
Huh, I did not expect Johnny Depp to show up here (though now I’m hungry for corn dogs). Had you heard of this FHLBanks stuff before? Got any thoughts? Join in on this week’s Shoddy Goods chat in our forum!
- Dave (and the rest of Meh)
Meanwhile, if you’re new to Shoddy Goods, enjoy our past issues: