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E C O N O M I C R E V I E W Third Quarter 2006
The federal government has played an active role in residential mortgage finance
since the Great Depression.1 Prior to that time, mortgages typically had short
terms (often less than five years), carried variable rates, and required final “balloon”
payments that were generally refinanced. In the early 1930s residential real estate
values (and financial asset values generally) fell dramatically. Coupled with limited
refinancing opportunities, this decline generated a wave of mortgage defaults and
foreclosures, further depressing the housing market. The federal government
responded to this crisis by creating several financial institutions to promote the use
of long-term, fixed-rate, fully amortizing residential mortgages. The first of these new
institutions was the Federal Home Loan Bank System (FHLB System), which was
created in 1932 as a collection of cooperatively owned wholesale banks.
Historically, the twelve Federal Home Loan Banks (FHLBs or Banks) primarily
acted as a reliable provider of long-term funding to specialized mortgage lenders.
Specifically, the Banks made (over)collateralized loans, known as “advances,” to thrift
institutions and a few insurance companies. While the advance business has endured,
the FHLB System has evolved since the resolution of the 1980s thrift crisis.
The Financial Institutions Recovery and Reform Act of 1989 (FIRREA) included
two provisions that precipitated lasting changes for the FHLBs. First, the law opened
FHLB membership to all depository institutions with more than 10 percent of their
portfolios in residential mortgage-related assets. This change allowed many com-
mercial banks and credit unions to join the FHLB System for the first time.
Membership increased from 3,200 to more than 8,000 between 1989 and 2005
despite the declining number of federally insured thrifts, which were legally required
to be FHLB members until 1999. The transition from mandatory to voluntary FHLB
membership also arguably forced the Banks to