The little-known banks loaning billions to failing banks like First Republic : The Indicator from Planet Money Unsung hero of the financial system or enabler of failing banks? Today on the show, how the Federal Home Loan Bank system, originally designed to support homeownership and affordable housing, ended up loaning billions to failing banks like First Republic.

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The banking system that loaned billions to SVB and First Republic

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And I'm Wailin Wong. On a chilly morning last November, a group of state and local government officials gathered on an empty lot in Mesquite, Nev. They were there to break ground on a new affordable housing development.

WOODS: The functionaries all got lined up with hard hats and shovels, all ready for a photo. And one of the special guests was a woman named Nia Girma.

NIA GIRMA: I thought that I was really coming in and getting to work. I didn't realize that you just put a little dirt on your shovel and pose. (Laughter) They were - they said, Nia, you can stop digging.

WOODS: Stop digging, Nia. You can't dig your way out of a hole.

WONG: Yeah, she's like a one-woman construction crew.

WOODS: Yeah.

WONG: Nia's actual title is affordable housing advocate in the Nevada housing division. And in her job in state government, she's seen how hard it can be to find the money for these kinds of projects. But one important source of funding is an institution called the Federal Home Loan Bank.

GIRMA: They've done something really remarkable, which is targeting some funds for affordable housing specifically for Nevada.

WOODS: The Federal Home Loan Bank System funds affordable housing projects. It also loans money to banks that might be running into trouble with liquidity. Four major banks in the U.S. have collapsed this year. All of them, including First Republic, borrowed money from Federal Home Loan Banks before their demise.

WONG: Today on the show - as jitters hit even more regional banks, we talk to an economic policy expert about this 90-year-old piece of financial architecture - what it does, how it has an uncanny knack for showing up in periods of banking turmoil and why he thinks it might be due for an overhaul.

WOODS: If you're not working in the banking or housing industries, you might not ever have heard of the Federal Home Loan Bank System. That's because these banks don't offer services for regular people, like savings and checking accounts.

WONG: Instead, they provide funding to other banks in the form of loans. Last year, Federal Home Loan Banks lent out over $800 billion. That money goes towards helping banks that might be struggling with declining deposits or liquidity issues.

WOODS: And the Federal Home Loan Bank System has been playing this role since 1932. It was the middle of the Great Depression, and the government wanted to support financial institutions that were providing home mortgages.

WONG: So the government set up a dozen regional banks that would support mortgage lenders in their areas. Aaron Klein is a senior fellow in economic studies at the Brookings Institution. He says this structure of regional hubs was modeled after the Federal Reserve.

AARON KLEIN: There were 12 Federal Home Loan Banks, just like there are 12 Federal Reserve regional banks, and they were set up as a cooperative structure owned by their membership.

WOODS: At first, that membership was limited to financial institutions that provided mortgages. But in 1989, the system was opened up to commercial banks and credit unions. And that meant all kinds of banks could tap into what Aaron says is a very special, under-the-radar system.

KLEIN: The home loan bank system has one of the great business models of society, which is uniquely given by the federal government. Nobody else has this model.

WONG: So here's what the Federal Home Loan Banks do. They raise money by selling bonds, which Aaron says are considered very safe investments, like U.S. Treasuries. Then they lend money to their members, often at lower rates than what their member banks can get elsewhere.

WOODS: Now, a bank that wants one of these loans has to provide collateral - you know, something that the Federal Home Loan Bank can sell if the borrower can't pay back the loan. And a common form of collateral is a mortgage.

WONG: This system of loans is very similar to the way that banks borrow money from the Federal Reserve. But let's say a bank that's taken out one of these loans gets into trouble and fails. This is where things get interesting for the Federal Home Loan Banks.

KLEIN: The home loan bank gets to go in first - above the taxpayer, above the Federal Reserve - through a legal mechanism called a super lien and be made whole.

WOODS: A super lien - you know those passes that you can buy at amusement parks to skip the line and get on the ride before everybody else? Well, that's what this super lien is. Federal Home Loan Banks get to jump at the front of the queue to get paid back.

WONG: That's a good deal for the Federal Home Loan Banks. But Aaron says this super lien has created a bit of a problem. It's made the Federal Home Loan Banks more willing to lend money to banks that could be considered risky borrowers - say, if their collateral isn't very good.

WOODS: And this dynamic became important in the 2008 financial crisis with financial institutions like Washington Mutual and Countrywide Financial.

KLEIN: They had these kind of crummy, subprime mortgages on their books, and the market started to get a little skeptical of them in 2007. Hey, wait, the home loan banks will take them.

WONG: In other words, the Federal Home Loan Banks will accept these crummy, subprime mortgages as collateral because even if the financial institutions fail, the super lien means that the Federal Home Loan Banks will still get paid before everyone else.

KLEIN: So you see a huge explosion in home loan bank lending to Countrywide, Washington Mutual, Bank of America - these entities that were deep in subprime mortgages.

WOODS: The Federal Home Loan Banks sometimes get called the lender of second-to-last resort. They're like the last stop before going to the actual lender of last resort, the Fed. Now, why don't they just go straight to the Fed? Well, that particular lending program has a lot of stigma attached to it. So if you're going there, it can send a signal to investors and depositors that something's quite wrong.

WONG: But lenders of last resort can be a lifeline for the financial system. Ryan Donovan, the head of the trade association for Federal Home Loan Banks, he's described the banks as shock absorbers in times of crisis.


RYAN DONOVAN: ...That they're providing critical access to liquidity for community banks, credit unions.

WONG: He was speaking at an event last year to discuss the future of the system.


DONOVAN: They were the unsung heroes of the global financial crisis.

WOODS: But Aaron Klein at Brookings thinks that the Federal Home Loan Banks actually made the subprime crisis worse by lending so much money to financial institutions that were already doomed.

WONG: Fast forward to this year's turbulence in the financial system, and some of the same red flags have reappeared. Silicon Valley Bank, which failed in March, had $15 billion in outstanding loans from the Federal Home Loan Bank of San Francisco at the end of 2022. A year earlier, it didn't have any outstanding loans from the bank.

WOODS: The other major banks that have collapsed this year - Signature, First Republic and Silvergate - also borrowed billions of dollars from the Federal Home Loan Bank. In the case of First Republic, it had over $25 billion in outstanding loans at the end of March.

WONG: Aaron compares the situation with SVB and other banks to those classic Looney Tunes cartoons where the Road Runner chases the Coyote to the edge of a cliff.


KLEIN: The banks are like the Coyote in the Road Runner cartoons who's run off the cliff.

WONG: Right. And they're like in midair, and they're still - the little legs are still cycling.

KLEIN: That's right. And then, like, somebody taps them on the shoulder, right? In Silicon Valley Banks, it was, you know, some VC started sending emails, hey, pull your money, right? But you say what allows the bank to run so far off the cliff? And the answer is the home loan bank funding.

WOODS: Aaron believes the Federal Home Loan Banks need reform, and he's not alone in scrutinizing the system. The government agency that regulates these banks is doing a comprehensive review that included a monthslong listening tour. Officials crisscrossed the country talking not just to bankers, but also community groups and nonprofits about whether the bank's model is working for all of them.

WONG: Because the thing about Federal Home Loan Banks is they don't just lend money to other banks. They're required to contribute 10% of their earnings to affordable housing programs in their regions. And they also funnel money through their members, usually community banks, to support local initiatives like food pantries and job training programs.

KLEIN: Here we have this fantastic system bequeathed to us kind of by accident, from a historical anachronism when the world was a very different place. And if you refocused it and reused it, you could do a lot of good. And it does a lot of good.

WOODS: Like in Nevada, where Nia Girma works as the state's affordable housing advocate. Her regional Federal Home Loan Bank provides grants to first-time homebuyers.

WONG: And that development that Nia helped break ground on - that was also backed by a Federal Home Loan Bank. When the project is completed next year, it will have 96 affordable units plus a playground and a dog park.

WOODS: At the groundbreaking ceremony, attendees got to write something on a commemorative stone for the foundation of the building.

GIRMA: I wrote that housing is a human right, and then I snuck and put another stone in and said, home means Nevada.


WONG: This episode was produced by Brittany Cronin with engineering from James Willetts. It was fact-checked by Sierra Juarez. Viet Le is our senior producer. Kate Concannon edits the show. And THE INDICATOR is production of NPR.

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