The
minutes of the April 28-29 Federal Open Market Committee and Board of Governors conference call were released yesterday.
They're valuable for information/confirmation about how the Board views the financial and economic situation. A lot of the discussion focused on the
uncertainty caused by coronavirus. One thing that stuck out to me was Lorie Logan mentioning that the Federal Home Loan Banks are "the dominant lenders in the federal funds market." So much ignorance. Here's what I learned today on (1) What are the FHLBs? (2) Why are they the dominant lender in the fed funds market? and (3) Does it matter?
A good source is a three-part series written by Stefan Gissler and Borgan Narajabad at the Fed. Links here:
Part 1,
Part 2,
Part 3.
Also, good graphics and sources here
https://www.clarusft.com/usd-fed-funds-and-the-fhlbs/.
What are the FHLBs?
The Federal Home Loan Bank system is a network of banks that provide liquidity to financial institutions to support community development and housing finance. According to the FHLBs' Office of Finance
2019 Annual Report, "The Federal Home Loan Banks (FHLBanks) are government-sponsored enterprises (GSEs), federally-chartered but privately capitalized and independently managed ... The FHLBanks serve the public by providing a readily available, competitively-priced source of funds to FHLBank members through advances. These funds may be used for residential mortgages, community investments, and other services for housing and community development. In addition, the FHLBanks may provide members and housing associates with a means of enhancing liquidity by purchasing home mortgage loans through mortgage programs developed for their members."
By the end of 2019, FHLBs had assets of $1.1 trillion, of which $642 billion was advances. They're pretty highly levered, with 5% equity. FHLBs are regulated by the Federal Housing Finance Agency (FHFA), created by the Housing and Economic Recovery Act of 2008, signed by President Bush.
Why are FHLBs the dominant lenders in the fed funds market?
Explained by Gissler and Narajabad in Part 3:
"Finally, the FHLBs currently play a crucial role in the federal funds market, which represents a key source of liquidity for eligible depository institutions. FHLBs maintain a stable share of their portfolios in federal funds, mainly as their contingent liquidity buffer. As a result, their presence in the federal funds market has been stable. But the decline of the overall size of the federal funds market has increased the relative importance of the FHLBs in this market. On some days, FHLBs account for almost the entire supply of federal funds."
Does it matter?
Two answers here. One, yes I guess. To continue quoting from Gissler and Narajabad:
"Should an FHLB experience difficulty in rolling over its short-term debt, the FHLB would likely withdraw from the federal funds market, which has the potential to disrupt trading activity. Assuming most FHLBs would withdraw, the Federal Reserve Bank of New York might need to rely on contingency options for the publication of the fed funds effective rate. Such contingencies could be necessary given that the federal funds rate is used as the benchmark rate for a very large volume of financial products."
Contingency options are public -- for example, the Fed could just use a prior day's rate. But things could be messy.
Two -- Regardless of whether the FHLBs' dominance of the fed funds market matters, a broader question regards the FHLBs more generally. Here, the question is "do FHLBs matter to financial stability" and the answer is probably yes.
As G&N point out in Part 1,
"FHLBs have grown significantly over the past few years, and their total assets have surpassed pre-crisis levels. More recently, this growth coincided with two changes in government policies: The imposition of the Liquidity Coverage Ratio (LCR) in January 2015 for the largest U.S. banking organizations and the reform of U.S. money market funds in 2016."
The LCR stipulates that banks must hold enough high-quality liquid assets to cover cash outflows for 30 days: it provides preferential treatment for banks' medium-term borrowing from FHLBs. The
money market fund reform requires prime money funds to implement a floating NAV and permits them to impose a fee on redemptions if assets that can be liquidated within a week fall below 30% of the fund. This caused $1.2 trillion to shift from prime money funds -- which fund the banks -- to government MMFs, which fund the FHLBs. Significant for a
$2.7 trillion market as of 2016. $4.79 trillion
$4.79 trillion as of May 20, 2020.
Essentially, the FHLB's implicit government guarantee as a GSE and institutional structure enables it to help banks get around certain regulations.
Here's the script:
Regulators, to banks: Be careful about your funding, make it a little less short term for lower risk of a bank run.
Banks: OK, we'll take medium funding. Where will we get it?
FHLBs: Here. And for maximum maturity transformation profit we'll take short-term funding.
So we're kind of back to where we started.
Additional questions and two charts
How does this interact (maybe not at all) with the volatility in the repo market in 2019?
FHLBs' assets and liabilities from the Annual Report:
