Federal Home Loan Banks may need U.S. bailout

The mortgage crisis is seeping into one of the last dry corners of the mortgage business, the regional network of Federal Home Loan Banks, which provide U.S. banks with hundreds of billions of dollars in low-cost funding to support lending to home buyers.

The little-known network has grown in importance as banks lose access to other sources of funding because of the credit crunch. The volume of outstanding loans provided by the home-loan banks has increased by 58% since the beginning of 2007, to more than $1 trillion at the end of September.

But several of these banks hold mortgage-related investments that have plummeted in value. The losses are draining the capital foundations of the home-loan banks, forcing them either to reduce their lending -- making mortgages more expensive and harder to get -- or to raise additional capital.

The money could come from taxpayers. The Treasury Department created a program in September that for the first time allows the home-loan banks to borrow directly from the federal government. That hasn’t happened yet, but some financial experts said it was looking increasingly likely.

A report from Moody’s Investors Service last week citing “the demonstrated importance of the [home-loan banks] to the banking system through the credit crisis” concluded that the government was likely to provide the necessary support to keep loans flowing.

The 12 home-loan banks are collectives chartered by the federal government and owned by member financial firms. The government’s sponsorship allows the collectives to borrow money at low cost, which they lend to banks of all sizes, including giants such as Bank of America Corp. and small community lenders. Nearly all U.S. banks are members of at least one of the collectives.

As with other banks, federal regulators require the home-loan banks to keep a certain amount of money as a capital foundation to support their lending.

The home-loan bank in Seattle, which serves the northwestern United States, said last week that the declining value of its investments probably dropped its capital below a level required at the end of the year, though a final determination won’t be made until the bank completes its fourth-quarter bookkeeping.

The home-loan bank in Pittsburgh warned Friday that it too was in danger of dropping below a capital threshold.

And Moody’s estimated that six more banks could follow Seattle and Pittsburgh.

The most immediate effect is that the collectives are paying less to their members. Several of the collectives have suspended dividend payments. The 12 collectives had paid about $1 billion in dividends to member banks during the first nine months of the year. The payments are an important source of revenue, particularly for smaller banks.

Many banks also hold relatively large amounts of stock in the collectives. In normal times, the banks can sell that stock back to the collectives, redeeming their investments. But several of the collectives have announced moratoriums on redemptions, freezing access to the money.

And if the situation continues to deteriorate, the collectives could require members to make additional investments.

The collectives got into trouble by investing $76.2 billion in private mortgage securities, packages of mortgages not guaranteed by Fannie Mae or Freddie Mac. The market value of those securities had dropped to $62.7 billion at the end of September and has almost certainly continued to fall.

The Pittsburgh collective, for example, spent $8.8 billion on securities that declined in value to about $6.4 billion by the end of December.

The banks have not sold the securities, so they have not incurred a loss, but accounting rules require them to acknowledge some of the loss in value and set aside capital in a proportionate amount.

As a result, the Pittsburgh bank is running short on capital. At the end of September, it had $2.6 billion more than the federal minimum. The bank estimates that it exceeded the minimum by only $72 million at the end of December.

The home-loan banks contend that the accounting rules are creating a misleading impression by requiring them to prepare for losses that won’t happen because they don’t plan to sell the securities.

“The banks are very healthy. The accounting doesn’t represent the true economic picture,” said John von Seggern, chief executive of the Council of Federal Home Loan Banks, which represents the network in Washington. He said the banks want regulators to change the rules.

Proponents of the accounting rules, however, say this system is the most accurate way of measuring the value of securities. Experts on the home-loan banks also note that the institutions already have lower capital requirements than commercial banks, leaving little room for error.

The collectives are regulated by the Federal Housing Finance Agency, which said it was reviewing the capital rules.

The agency’s director, James B. Lockhart III, said he believed that the home-loan banks on the whole remained healthy. “The overall system is in good shape, and I still believe it is unlikely that anyone would need to tap the liquidity facility,” he said.

The home-loan banks have also found themselves at the center of a firestorm over their lending to some of the nation’s most troubled institutions.

Lockhart said the Federal Housing Finance Agency had ordered the collectives to work with regulators to control the flow of funding to troubled banks.