Testimony 

Before the Committee on Banking, 

Housing, and Urban Affairs, U.S. Senate

United States Government Accountability Office

GAO

For Release on Delivery 

Expected at 10:00 a.m. EDT 

Wednesday, April 13, 2005 FEDERAL HOME LOAN 

BANK SYSTEM 

An Overview of Changes 

and Current Issues 

Affecting the System 

Statement of Thomas J. McCool, Managing Director 

Financial Markets and Community Investment 

GAO-05-489T 
What GAO Found

United States Government Accountability Office

Why GAO Did This Study

Highlights

Accountability Integrity Reliability

www.gao.gov/cgi-bin/getrpt?GAO-05-489T.

To view the full product, including the scope 

and methodology, click on the link above. 

For more information, contact Thomas J. 

McCool at (202) 512-8678 or 

mccoolt@gao.gov. 

Highlights of GAO-05-489T, a testimony to 

the Committee on Banking, Housing, and 

Urban Affairs, U.S. Senate 

April 13, 2005

FEDERAL HOME LOAN BANK SYSTEM

An Overview of Changes and Current 

Issues Affecting the System 

Established in 1932 to facilitate the extension of mortgage credit, the 

FHLBank System has undergone significant statutory changes in the last 15 

years. Between the 1930s and the 1980s, the System consisted primarily of 

thrift members that accepted advances from the FHLBanks. However, 

during the 1980s, hundreds of FHLBank member thrifts failed forcing 

Congress to fundamentally reform the System through the Financial 

Institutions Recovery, Reform, and Enforcement Act of 1989 (FIRREA). For 

example, FIRREA permitted commercial banks to join the System. Although 

FIRREA is credited with strengthening the thrift industry and the System, 

concerns were raised during the 1990s about the System’s capital structure. 

In particular, commercial bank members could remove stock from their 

FHLBank on 6-months notice, which raised concerns about the System’s 

financial stability. Among other provisions, the Gramm-Leach-Bilely Act 

(GLBA) of 1999 created a more permanent and risk-based capital structure 

for the System. 

Due to these statutes and FHFB rulemaking, the FHLBank System has 

evolved substantially since 1990. For example, commercial banks now 

account for more than 70 percent of all System members. The composition 

of FHLBank System assets has also fluctuated considerably over the years. 

For example, FHFB authorized the FHLBanks to purchase mortgages 

directly from their members in the 1990s. The System’s mortgage assets 

grew to about $113 billion at yearend 2003 representing about 14 percent of 

total assets. However, the rapid growth in System mortgage assets leveled 

off in 2004 as two FHLBanks experienced problems managing the interestrate risks associated with holding mortgages on their books. As provided by 

GLBA, System capital is now more permanent as members generally must 

invest capital for a period of 5 years and the FHLBanks are subject to new 

leverage and risk-based capital requirements. 

The FHLBank System faces important challenges and questions going 

forward. For example, FHFB has called the FHLBanks’ risk-management 

practices into question, particularly those related to mortgage purchase 

programs. Further, proposals to permit the FHLBanks to issue mortgagebacked securities (securitization) could help ensure the growth of the 

mortgage purchase business and improve risk management, however these 

proposals raise questions regarding the FHLBanks’ capacity to manage the 

related risks. Additionally, there is limited empirical information available 

regarding the extent to which the System is fulfilling its housing and 

community mission. Finally, questions have been raised regarding the 

potential negative affects that large financial institutions may have on the 

traditional cooperative structure of the FHLBank System and its programs 

designed to benefit targeted groups. 

The FHLBank System (FHLBank 

System or System) is a governmentsponsored enterprise (GSE) that 

consists of 12 Federal Home Loan 

Banks (FHLBanks) and is 

cooperatively owned by member 

financial institutions, typically 

commercial banks and thrifts. The 

primary mission of the FHLBank 

System is to promote housing and 

community development generally 

by making loans, also known as 

advances, to member financial 

institutions. To minimize the 

potential for significant financial 

problems, the Federal Housing 

Finance Board (FHFB) regulates 

the FHLBank System’s safety and 

soundness. Over time, a number of 

developments have affected the 

System’s safety and soundness and 

have created pressures on its 

traditional cooperative structure. 

To assist the committee in 

understanding the important issues 

surrounding the FHLBank System 

and its regulation, this testimony 

provides information on the 

development of the System; two 

legislative changes and FHFB 

rulemaking that led to changes in 

membership, asset composition, 

and capital structure; and 

important challenges and questions 

the FHLBank System currently 

faces. 
Page 1 GAO-05-489T 

Dear Mr. Chairman and Members of the Committee: 

I appreciate the opportunity to participate in today’s hearing to provide an 

overview on the Federal Home Loan Bank System’s (FHLBank System or 

System) operations, its federal oversight, and challenges that it faces. As 

you know, the FHLBank System is a government-sponsored enterprise 

(GSE) that consists of 12 Federal Home Loan Banks (FHLBanks) and is 

cooperatively owned by member financial institutions, typically 

commercial banks and thrifts (or savings and loans). The primary mission 

of the FHLBank System is to promote housing and community 

development generally by making loans, also known as advances, to 

member financial institutions. These institutions are required to secure 

FHLBank advances with high-quality collateral (such as single-family 

mortgages) and may use the advances to fund mortgages. To raise the 

funds necessary to carry out its activities, the FHLBank System issues debt 

in the capital markets at favorable rates compared to commercial 

borrowers due to its GSE status. According to the Federal Housing 

Finance Board (FHFB), as of December 31, 2004, the System had $855 

billion in outstanding debt obligations.1

Because the FHLBank System is a GSE, the potential exists that the 

federal government would be called on to provide financial assistance to 

the System if it was unable to meet its financial obligations. To minimize 

the potential that the FHLBank System would experience significant 

financial problems, Congress established the FHFB as the System’s safety 

and soundness regulator in 1989. FHFB is also responsible for helping to 

ensure that the FHLBanks fulfill their housing and community 

development mission. 

In recent years, the FHLBank System has undergone important changes 

and questions have been raised regarding the adequacy of FHLBanks’ riskmanagement practices and the functioning of the System’s cooperative 

structure. For example, since 1997, the FHLBank System has moved 

beyond the traditional advance business by establishing programs to 

purchase mortgages directly from member financial institutions, an 

activity similar to the mortgage purchase business of the two other 

housing GSEs: Fannie Mae and Freddie Mac. Although such mortgage 

 1

As of the date of this testimony, the FHLBanks 2004 annual combined financial report was 

not yet available. For this testimony, we used FHLBank System’s Office of Finance data 

from 1990 through 2003 and obtained the best available data for 2004 from FHFB. 
Page 2 GAO-05-489T 

purchase programs have the potential to increase profitability and better 

serve member institutions, they also expose FHLBanks to interest-rate and 

credit risk.2

 FHFB recently identified interest-rate risk management 

deficiencies at two FHLBanks and required them to take corrective 

measures. The traditional cooperative structure of the FHLBank System 

has also been challenged by sometimes sharp differences in business 

strategies among the 12 FHLBanks. In particular, FHLBanks have 

disagreed over proposals to permit securitization of mortgage assets.3

While securitization may permit FHLBanks to expand their purchase of 

mortgage assets, some FHLBanks also regard it as changing the business 

of the System and increasing potential risks. 

To assist the committee in understanding the important issues 

surrounding the FHLBank System and its regulation, my testimony today 

is divided into three parts. First, I will provide an overview on the 

development of the FHLBank System and its supervision with a focus on 

how two statutes: the Financial Institutions Recovery, Reform, and 

Enforcement Act of 1989 (FIRREA) and the Gramm-Leach-Bliley Act of 

1999 (GLBA) made substantial changes to the System’s original structure 

and capital requirements. Second, I will provide more detailed information 

as to how FIRREA and GLBA, as well as FHFB rulemaking have changed 

the System’s membership, asset composition, and capital structure over 

the past 15 years. Third, I will discuss important challenges and questions 

affecting the FHLBank System. 

In summary: 

• Congress established the FHLBank System in 1932 to help rescue the 

housing finance market, which had been decimated by the Great 

Depression. Between the 1930s and the 1980s, each FHLBank made 

 2

Interest-rate risk is the risk that relative and absolute changes in interest rates may 

adversely affect an institution’s financial condition. Credit risk is the risk of 

nonperformance by counterparties to derivative agreements and other obligations or the 

risk that an FHLBank member would default on an advance. No FHLBank has reportedly 

ever suffered a credit loss on an advance due, in part, to the System’s collateral 

requirements. Also, FHLBanks have a priority lien status on the assets of members who 

experience financial problems and are placed into receivership. 

3

Securitization is the process of aggregating similar instruments, such as loans or 

mortgages, into pools and selling investors securities that are backed by cash flows from 

these loan pools. Proposals have been made to permit FHLBanks to securitize mortgages 

that they purchase and issue mortgage-backed securities to investors. Fannie Mae and 

Freddie Mac are large issuers of mortgage-backed securities. 
Page 3 GAO-05-489T 

advances to thrifts in its district that were required to be members of the 

System, and these activities were credited with helping to develop a 

unified housing finance market. However, in response to the thrift crisis of 

the 1980s, Congress enacted FIRREA which, among other provisions, 

opened FHLBank System membership to commercial banks and other 

insured depository institutions on a voluntary basis and permitted such 

members to withdraw capital from the System with 6-months notice 

(whereas thrifts were still required to become members and as mandatory 

members could not withdraw their minimum required amount of capital). 

In 1999, due to concerns that voluntary members’ ability to withdraw 

capital increased risks to the System, GLBA made System membership 

voluntary for all institutions but required a more permanent capital 

structure with leverage and risk-based capital requirements. 

• Due to FIRREA, GLBA, and FHFB rulemaking, the FHLBank System has 

evolved substantially since 1990. For example, commercial banks now 

account for more than 70 percent of all the System members, whereas 

thrifts accounted for nearly 100 percent of all members in 1990. The 

composition of FHLBank System assets have also fluctuated considerably 

over the years, although advances remain the largest asset. In the early to 

mid 1990s, advances declined from about 70 percent of the System’s assets 

to about 50 percent as the FHLBanks increased investments in mortgagebacked and other types of securities (investments increased from about 27 

percent of the System assets in 1990 to 43 percent in 1996). System 

investment assets increased as FHLBanks sought higher returns than 

those available from the traditional advance business. Between 1997 and 

2003, FHLBank System mortgage holdings increased as a percentage of 

assets, relative to advances and other investments. However, mortgage 

holdings leveled off in 2004 as a result of the financial difficulties some 

FHLBanks experienced with their mortgage purchase programs. 

Consistent with GLBA, the FHLBank System has also largely implemented 

its new capital structure. 

• The FHLBank System is currently facing several important challenges and 

questions regarding its risk-management practices, future business 

strategies, mission accomplishment, and organizational structure. As I 

described previously, FHFB has entered into written supervisory 

agreements with two FHLBanks due to risk management deficiencies in 

their mortgage purchase programs—including the Chicago bank which has 

been the engine of growth for the System’s mortgage purchases—and 

placed limits on future purchases until identified deficiencies are 

corrected. Although securitization has been proposed as a means to permit 

the FHLBank System to continue expanding its mortgage purchase 

programs over the long-term, the idea is highly controversial. Another 
Page 4 GAO-05-489T 

challenge facing the System is that there is limited empirical information 

on the extent to which FHLBank advances and other services benefit 

housing and community finance. Finally, concerns have been raised that 

large financial institutions that may have subsidiaries with memberships in 

two or more FHLBank districts could generate dangerous competition 

within the System and negatively affect its community development 

efforts. 

To prepare for this testimony, we reviewed several reports and 

testimonies that we have completed on the FHLBank System and FHFB.4

We also obtained FHLBank System financial data for 2004 from FHFB. 

Additionally, we interviewed several FHLBank presidents as well as the 

FHFB Chairman, two FHFB board members, and agency officials. We 

conducted our work in Washington, D.C., between March and April 2005 in 

accordance with generally accepted government auditing standards. 

I would like to begin my testimony by briefly describing the development 

of the FHLBank System, significant statutory changes to the System, and 

its operations. Then, I will describe FHFB’s structure and activities. 

 4

See GAO, Federal Home Loan Bank System: Reforms Needed to Promote Its Safety, 

Soundness, and Effectiveness, GAO/GGD-94-38 (Washington, D.C.: Dec. 8, 1993); Capital 

Structure of the Federal Home Loan Bank System, GAO/GGD-99-177R (Washington, D.C.: 

Aug. 31, 1999); Comparison of Financial Institution Regulators’ Enforcement and 

Prompt Corrective Action Authorities, GAO-01-322R (Washington, D.C.: Jan. 31, 2001); 

Federal Home Loan Bank System: Establishment of a New Capital Structure, GAO-01-873

(Washington, D.C.: Jul. 20, 2001); Financial Regulation: Review of Selected Operations of 

the Federal Housing Finance Board, GAO-03-364 (Washington, D.C.: Feb. 28, 2003); and 

Federal Home Loan Bank System: Key Loan Pricing Terms Can Differ Significantly, 

GAO-03-973 (Washington, D.C.: Sep. 8, 2003). 

Overview of the 

Federal Home Loan 

Bank System and Its 

Regulation 
Page 5 GAO-05-489T 

Congress passed the Federal Home Loan Bank Act (FHLBank Act) in 1932 

and established the FHLBank System to facilitate the extension of 

mortgage credit and the housing finance market, which had been severely 

affected by the Great Depression. The FHLBank Act required all federally 

chartered thrifts to become members of the FHLBank located in their 

districts (see fig. 1) and invest capital in the FHLBanks. The System acted 

as a central credit facility that made advances to thrifts which, in turn, 

were expected to make additional mortgage credit available to 

homebuyers and thereby revive the housing finance market. The act also 

established safeguards to help ensure the financial soundness of the 

FHLBanks. In particular, thrifts had to pledge high-quality assets in excess 

of the value of their advances as collateral. In addition, the act created the 

Federal Home Loan Bank Board (Bank Board) to oversee the safety and 

soundness regulation of the FHLBanks as well as the thrift industry. 

However, between 1985 and 1989, the Bank Board delegated its oversight 

responsibility of the thrift industry to each of the FHLBanks. 

The FHLBank System Was 

Established to Facilitate 

Housing Finance and Has 

Undergone Significant 

Changes in Recent 

Decades 
Page 6 GAO-05-489T 

Figure 1: Location of the 12 Federal Home Loan Banks 

The business of the FHLBank System and its members essentially 

remained unchanged from the 1930s until the 1980s. The System is 

generally credited with serving as a relatively low-cost funding source for 

thrifts during that period and helping to overcome regional shortages in 

housing credit. However, due to regional downturns, sharply rising 

interest rates, and poor management, hundreds of FHLBank member 

thrifts failed during the 1980s, causing a contraction in FHLBank System 

business. As a result, Congress appropriated billions of dollars to cover the 

costs associated with ensuring the payment of insured thrift deposits. In 

addition, the regulatory structure for the thrift industry—where FHLBanks 

supervised thrifts on behalf of the Bank Board—involved significant 

conflicts of interest. These conflicts (such as FHLBanks regulating 

Source: FHFB.

Seattle

San Francisco

District 11

Dallas

District 9

Des Moines

District 8

Topeka District 10

Atlanta

District 4

Chicago

District 7 District 6

District 5

 Indianapolis

Cincinnati

Pittsburgh

District 3

New York

District 2

Boston

District 1

District 12
Page 7 GAO-05-489T 

institutions to which they made advances) compromised the safety and 

soundness oversight of the thrift industry. In response to these issues, 

Congress enacted the FIRREA, which made substantial changes to the 

FHLBank System’s membership, regulation, and mission requirements as 

summarized below: 

• FIRREA opened FHLBank system membership to commercial banks and 

credit unions that engaged in mortgage activities. These voluntary 

members were required to invest capital in their FHLBank but could 

normally withdraw such capital on 6-months notice. However, FIRREA 

still required thrifts to be members of their FHLBank and did not allow 

them to withdraw their capital contributions. 

• FIRREA required the System to capitalize the Resolution Funding 

Corporation (REFCORP) to help pay for the deposit insurance fund losses 

resulting from thrift failures. Furthermore, the System had to pay up to 

$300 million per year of annual earnings to contribute towards interest 

payments on bonds issued by REFCORP to pay for thrift losses. 

• FIRREA abolished the Bank Board and established FHFB to regulate the 

12 FHLBanks. FIRREA also transferred the Bank Board’s previous 

supervisory and regulatory responsibilities for thrift institutions and their 

holding companies to the newly created Office of Thrift Supervision. 

• FIRREA also directed each FHLBank to establish or maintain two low- and 

moderate-income housing programs—the Community Investment Program 

(CIP) and the Affordable Housing Program (AHP). As part of CIP, each 

FHLBank makes advances to finance the purchase or rehabilitation of 

housing for eligible households and finance other projects benefiting 

residents of low- and moderate-income neighborhoods. AHP requires each 

FHLBank to subsidize the financing of eligible low- and moderate-income 

housing and FIRREA sets priorities for use of these advances among 

eligible projects. 

Although FIRREA is credited with helping to restore the financial 

condition and supervision of the thrift industry during the 1990s, the 

capital structure of the FHLBank System and the financial obligations that 

the act imposed on the System and its members subsequently raised 

concerns. In particular, the fact that voluntary members, such as 

commercial banks, had the option of removing their capital from the 

System with 6-months notice appeared to increase financial risks to the 

System. Additionally, since the FHLBanks’ earnings had been weakened by 

the declining profitability of the thrift industry, the $300 million REFCORP 

obligation posed a challenge. Consequently, FHLBanks looked for new 
Page 8 GAO-05-489T 

sources of revenue and increased investments in mortgage-backed 

securities that offered potentially higher returns, but exposed them to 

increased risks. 

After years of attempting to resolve these issues, Congress passed the 

Gramm-Leach-Bliley Act of 1999 (GLBA), which contained provisions that 

• Eliminated the requirement that thrift institutions be members of the 

FHLBank System and made membership voluntary for all members. 

Additionally, GLBA established new capital requirements for FHLBank 

members that were intended to make the System’s capital more 

permanent. I will describe the capital provisions of GLBA in more detail 

later in my testimony; 

• Revised the System’s REFCORP obligations, moving from a fixed annual 

payment of about $300 million to a specified percentage (20 percent) of 

the System’s annual earnings after AHP expenses. This change minimized 

the financial obligation on the System during periods of relatively low 

profitability but increased the total payment when profits increased; and 

• Expanded the amounts and types of collateral that FHLBanks could 

accept for advances from small members known as community financial 

institutions (CFI).5

 GLBA permitted CFIs to pledge small business and 

agricultural loans as collateral for FHLBank advances. 

Each of the 12 FHLBanks has a board of directors of at least 14 persons, 

with 8 elected by members and at least 6 appointed by FHFB. The FHFB 

appointed directors are commonly referred to as public interest directors.6

Additionally, each FHLBank board appoints a president who is responsible 

for overseeing the institution’s staff (see table 1). The president and staff 

are responsible for such activities as the FHLBank’s asset and liability 

management, AHP and other community development activities, and 

compliance with laws and regulations. 

 5

CFIs are defined as Federal Deposit Insurance Corporation insured institutions that have 

less than $500 million in total assets, adjusted for inflation. In 2004, the CFI designation 

was $548 million. GLBA also allowed FHLBank members to make greater use of other real 

estate related collateral—such as commercial real estate loans and home equity loans—as 

collateral for FHLBank advances. 

6

At least two of the public interest directors are designated as community development 

directors because of their ties to the local community. 

The Structure and 

Operations of the 

FHLBank System 
Page 9 GAO-05-489T 

Table 1: Staff at Each FHLBank as of December 31, 2003 

FHLBank Full-time Part-time Total 

Boston 154 2 156

New York 204 4 208

Pittsburgh 192 5 197

Atlanta 278 0 278

Cincinnati 144 2 146

Indianapolis 127 7 134

Chicago 295 6 301

Des Moines 154 17 171

Dallas 135 0 135

Topeka 135 2 137

San Francisco 220 4 224

Seattle 148 3 151

Source: FHLBank System Office of Finance. 

The FHLBank System raises funds in the capital markets through its Office 

of Finance (OF), which has a board of directors consisting of three 

individuals who serve 3-year terms. FHFB appoints the OF chair and 

selects two FHLBank presidents to serve as the other OF board members. 

As I discussed earlier, the FHLBank System can issue debt, generally 

referred to as consolidated obligations, at a relatively low cost due to its 

GSE status, which may allow members to fund mortgages at lower rates. 

Consolidated obligations are the “joint and several” obligations of the 

FHLBanks. That is, if an FHLBank defaults on its repayment obligations, 

all the other FHLBanks may have to cover its obligations. Although the 

federal government does not explicitly guarantee that it would provide 

financial assistance to the FHLBank System in a financial emergency, 

investors perceive an implied guarantee because of the ties between the 

government and the System. For example, each FHLBank has a federal 

charter and consolidated obligations are exempt from federal, state, and 

local taxes. Moreover, the federal government did provide financial 

assistance to other GSEs, such as Fannie Mae and the Farm Credit System, 

when they experienced financial difficulties during the 1980s. 

In addition to providing advances to its members, the FHLBank System 

provides member institutions other benefits and services. For example, 

FHLBanks generally pay dividends to their member financial institutions. 

Other services FHLBanks may offer members include providing discounts 

on advances for large transactions, funding the AHP and CIP programs to 
Page 10 GAO-05-489T 

help members finance affordable housing and community development 

activities, and offering mortgage purchase programs as discussed next. 

Although reportedly no FHLBank has ever suffered a credit loss on an 

advance, the business activities of the FHLBanks have become 

increasingly complex and potentially risky in recent years largely due to 

the implementation of the mortgage purchase programs. All of the 

FHLBanks are authorized to purchase mortgages from members through 

programs such as the Mortgage Partnership Finance (MPF) program and 

the Mortgage Purchase Program (MPP).7

 Through these mortgage 

purchase programs, FHLBanks purchase conventional or governmentguaranteed mortgages directly from their members. The FHLBanks hold 

the mortgages on their books and bear the interest-rate risks associated 

with them.8

 To manage the interest-rate risks, FHLBanks must employ 

sophisticated risk-management techniques including the use of financial 

derivatives. Although such strategies are appropriate for risk management, 

they require specialized expertise, sophisticated information systems, and 

an understanding and application of sometimes complex accounting rules. 

As I discuss later, some FHLBanks recently have encountered financial 

problems in managing the interest rate risks associated with their 

mortgage portfolios. 

FHFB is responsible for regulating the FHLBank System’s safety and 

soundness as well as its mission achievement. The agency has a fivemember board, with the President of the United States appointing four 

board members, subject to Senate approval. Each appointee serves a 7-

year term. The fifth board member is the Secretary of the Department of 

Housing and Urban Development, or the secretary’s designee. The 

President also designates one of the four appointed board members as the 

chair, subject to Senate approval. FHFB is located in Washington, D.C. and 

 7

In 1997, the FHLBank of Chicago received approval from FHFB to begin operating a pilot 

program for MPF. In 1998, FHFB granted all 12 FHLBanks the authority to establish similar 

mortgage purchase programs. Today, 9 FHLBanks offer MPF in conjunction with the 

Chicago FHLBank, and the remaining 3 (Cincinnati, Indianapolis, and Seattle) offer their 

own individual MPPs. However, the Seattle FHLBank recently announced its intention to 

exit from its MPP. 

8

Interest-rate risk management has always been necessary to deal with advances and 

holdings of investments in mortgage backed securities, but the increasing purchases of 

mortgages from members through MPF and MPP has increased the FHLBanks’ need to 

manage the interest-rate risk associated with holding mortgage assets. 

FHFB Regulates FHLBank 

System Safety and 

Soundness and Mission 

Achievement 
Page 11 GAO-05-489T 

has a staff of about 124 individuals, including 17 examiners in eight cities 

where FHLBanks are located. 

FHFB supervises the FHLBanks by conducting annual on-site 

examinations and off-site monitoring to ensure that the Banks satisfy 

capitalization requirements and maintain their ability to raise funds in the 

capital markets. On-site examinations are focused on particular risk areas 

(interest-rate risk, credit risk, and operational risk) and compliance with 

mission requirements such as the AHP program.9

 Examiners set the scope 

for the examinations based on potential issues identified at previous 

examinations, as well as through quarterly monitoring. Off-site monitoring 

involves FHFB headquarters staff reviewing financial data on the 

FHLBanks on a continual basis. FHFB also conducts systemwide reviews 

of significant FHLBank operational, governance, and other practices and 

uses advisory bulletins and regulatory interpretations to convey guidance 

that addresses supervisory issues with systemwide implications. 

Under the FHLBank Act, FHFB is authorized to promulgate and enforce 

such regulations and orders that it deems necessary to carry out its 

responsibilities. The following summarizes several of FHFB’s key 

authorities: 

• FHFB has the authority to issue cease-and-desist orders and other 

enforcement actions to address unsafe FHLBank practices. FHFB also has 

the authority to remove FHLBank officials and prohibit actions by 

FHLBank officers and directors. 

• FHFB does not have specific statutory authority to establish a prompt 

corrective action (PCA) mechanism as do other federal banking regulators 

such as the Office of the Comptroller of the Currency and the Federal 

Deposit Insurance Corporation. Under such PCA authorities, bank 

regulators are required to take specific supervisory actions when bank 

capital levels fall below specified levels and may take other actions when 

specified unsafe and unsound actions occur. Although FHFB does not 

have PCA authority, FHFB officials believe they have all the necessary 

authorities to carry out their responsibilities; and 

• FHFB has the statutory authority to liquidate or reorganize a critically 

undercapitalized FHLBank “whenever [FHFB] finds that the efficient and 

 9

Operational risk is the risk of potential loss due to human error, systems malfunctions, 

man-made or natural disasters, fraud, or circumvention or failure of internal controls. 
Page 12 GAO-05-489T 

economical accomplishment of the purposes of the [FHLB Act] will be 

aided by such action.”10

Until 1989, the FHLBank System consisted of the 12 FHLBanks, OF, and 

thrifts, which were required to join. However, FIRREA and GLBA made 

substantial changes to this traditional structure. In this section, I will 

describe in more detail how FHLBank System membership, asset 

composition, and capital structure have changed over the past 15 years 

after the implementation of these statutes and FHFB regulations. 

Between 1990 and 2004, FHLBank System membership nearly tripled from 

2,855 to 8,131 institutions (see fig. 2). As shown in the figure, the vast 

majority of membership increase can be attributed to commercial banks; 

whereas in the same period, thrift membership declined markedly. In 1990, 

thrifts accounted for 98 percent of all the System members but only 16 

percent in 2004. In contrast, commercial banks accounted for 2 percent of 

all members in 1990 and 73 percent in 2004.11 A variety of factors may 

account for the surge in commercial bank membership. First, FHLBanks 

actively recruited commercial banks as members after FIRREA. 

Commercial banks may also have been attracted by the fact that FHLBank 

advances represent a stable and relatively low-cost source of funding. 

Additionally, in an attempt to offset declining membership resulting from 

the failure of many thrifts, FHLBanks modified their services and products 

to attract new members. For example FHLBanks made changes in advance 

pricing and terms in response to market pressures. 

 1012 U.S.C. §1446. 

11As of 1999 before GLBA made membership voluntary for all members, commercial banks 

accounted for 72 percent of all System members. 

FHLBank System 

Membership, Asset 

Composition, and 

Capital Structure 

Have Undergone 

Significant Changes in 

the Past 15 Years 

Commercial Banks 

Currently Account for the 

Majority of System 

Members and Advances 
Page 13 GAO-05-489T 

Figure 2: Composition of FHLBank System Membership, 1990 and 2004, by Member 

Institution Type 

Not only do commercial banks represent a large percentage of FHLBank 

System members, they also hold a large percentage of System capital and 

advances.12 As shown in figure 3, commercial banks now account for 

almost half of the System’s capital and advances. However, member thrifts 

still account for 43 percent of all system capital and 50 percent of all 

advances. Although thrifts account for a relatively small percentage of 

FHLBank members, they have remained significant customers of the 

FHLBank System due to their focus on mortgage financing. 

 12FHLBank members are required to invest capital in their FHLBank as a condition for 

membership. Members are generally also required to place additional capital in their 

FHLBank on the basis of the size of their advance business or mortgage purchases. 

98%

2% 1%

73%

16% 10%

1990 (2,855 member institutions) 2004 (8,131 member institutions)

Source: GAO analysis of Federal Housing Finance Board data.

Thrifts

Commercial banks

Credit unions

Insurance companies
Page 14 GAO-05-489T 

Figure 3: System Capital and Advances, by Member Institution Type, as of 

December 31, 2004 

FHLBank System assets, which consist of advances, investments, and 

mortgages, increased from $165 billion in 1990 to $934 billion in 2004. As 

shown in figure 4, the mix of the three asset types has fluctuated in this 

time period although advances remained the largest category of assets. 

However, I note that the System did not hold mortgage assets until 1997. 

In 1990, advances represented about 70 percent of all the System’s assets, 

but declined to about 50 percent between 1991 and 1996. In contrast, 

FHLBank System investments—such as holdings of mortgage-backed 

securities (MBS) issued by Fannie Mae and Freddie Mac—increased from 

27 percent of all assets in 1990 to 43 percent in 1996. During that period, as 

I have discussed, the number of thrifts declined, resulting in a loss of 

System advance customers and concerns were raised that REFCORP 

obligations imposed significant financial burdens on the FHLBanks. 

Investments in MBS were viewed within the System as more profitable 

Mix of System Asset Types 

Has Fluctuated 

Significantly from 1990 

through 2004 

48%

4% 4%

43%

2%

50% 46%

2%

Capital Advances

Source: GAO analysis of Federal Housing Finance Board data.

Thrifts

Commercial banks

Credit unions

Insurance companies
Page 15 GAO-05-489T 

than traditional advances and a potential means to comply with the 

REFCORP obligations. Through rulemaking, FHFB facilitated the 

FHLBanks’ ability to invest in MBS. In 1991, FHFB increased the 

percentage of MBS that the FHLBanks could hold as a percentage of their 

capital from 50 percent to 200 percent and, in 1993, FHFB raised the MBS 

to capital ratio to 300 percent. I note that investments as a percentage of 

all the System’s assets began to decline in 1995 while advances began to 

increase perhaps due, in part, to the increase in commercial bank 

members joining the System and taking advances. 

Figure 4: Mix of System Assets between 1990 and 2004, by Advances, Mortgages, and Investments 

Note: Data from 1990 to 2003 is from Office of Finance annual reports. According to the Office of 

Finance, the FHLBank of Chicago restated its 2003 financial results, which resulted in changes to 

certain FHLBank System financial information. As of the date of this testimony, the restated report 

was not available, so we used the originally reported data for 2003. Since the Office of Finance 2004 

annual report was not available at the time of this testimony, we used yearend 2004 data from FHFB. 

However, FHFB and the Office of Finance calculate investments differently. Therefore, we obtained 

2004 data on investments from highlights of the upcoming Office of Finance 2004 annual report. 

Source: GAO analysis of Federal Housing Finance Board and Office of Finance data.

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

0

10

20

30

40

50

60

70

80

Percentage

Mortgages

Investments

Advances

Year
Page 16 GAO-05-489T 

As I have discussed, FHFB also authorized the FHLBanks to begin 

purchasing mortgage assets through mortgage purchase programs in 1997. 

By 2003, such mortgage assets grew to almost 14 percent of all the 

System’s assets (about $113 billion in total System mortgage assets at yearend 2003). The growth in mortgages generally occurred relative to 

investments which declined from 40 percent of all assets in 1997 to 23 

percent in 2003. However, in 2004, the System’s mortgage assets leveled 

off, partly because of difficulties identified at some FHLBanks in managing 

such assets. I discuss this issue in the next section. 

As I discussed earlier, prior to 1999 voluntary FHLBank members, such as 

commercial banks, could withdraw their capital on 6-months notice, which 

raised questions about the stability of the FHLBanks’ capital structure. To 

address this concern, GLBA established that FHLBank membership was 

voluntary but required that financial institutions that choose to become 

members invest more permanent stock in their FHLBank. Under the new 

capital structure, FHLBanks can issue class A stock, which can be 

redeemed with 6-months notice, and class B stock, which can be 

redeemed with 5-years notice, or both. To help ensure that capital does 

not dissipate due to redemption in times of stress, GLBA does not allow an 

FHLBank to redeem or repurchase capital if following the redemption the 

FHLBank would fail to satisfy any minimum capital requirement. 

Under GLBA, the FHLBanks are also subject to both a leverage 

requirement (minimum capital-to-assets ratio) and a risk-based capital 

calculation. Under the leverage requirements, each FHLBank must comply 

with two minimum capital ratios. First, permanent capital (equal to 

amounts paid in for class B stock plus retained earnings) plus class A 

stock is to be at least 4 percent of assets. Second, class A stock plus 1.5 

times permanent capital is to be at least 5 percent of assets. The risk-based 

capital standards account for credit risk, interest-rate risk, and operations 

risk. For credit risk, a FHFB regulation specifies capital requirements 

according to the mix of activities (advances, mortgages, etc.) in which the 

individual FHLBank is engaging. For interest-rate risk, each of the 

FHLBanks must have a FHFB-approved interest-rate risk model that 

provides an estimate of the market value of the FHLBank’s portfolio 

during periods of market stress. The capital requirement for operations 

risk is generally 30 percent of the total capital charge for credit and 

interest-rate risk. 

GLBA required each FHLBank to submit a capital plan to FHFB for review 

and approval. FHFB approved all 12 FHLBank capital plans by 2002 and 11 

FHLBank System Has 

Implemented a New 

Capital Structure 
Page 17 GAO-05-489T 

of the 12 FHLBanks have implemented their capital plans. According to 

FHFB, 10 of the 12 capital plans rely entirely on class B stock and two of 

the capital plans include class A stock. As part of the capital plan 

implementation process, FHFB has required the FHLBanks to submit 

plans for modeling interest-rate risk and related procedures for managing 

these risks. 

Finally, I would like to discuss some important challenges and questions 

affecting the FHLBank System. They include risk-management practices, 

the securitization of mortgage assets, the extent to which the FHLBank 

System is meeting its mission requirements, and the alleged impacts that 

large financial institutions are having on the System’s traditional 

cooperative structure and AHP program. 

Over the past year, FHFB identified risk-management deficiencies at two 

FHLBanks—Chicago and Seattle—primarily related to their management 

of the interest-rate risks associated with mortgage purchases. FHFB 

identified weaknesses at these FHLBanks in such areas as corporate 

governance, financial recordkeeping, audit, and financial performance. 

Additionally, FHFB entered into written enforcement agreements with 

both FHLBanks that require improvements in accounting practices and 

internal controls. The Chicago and Seattle FHLBanks were both required 

to submit 3-year business and capital plans to FHFB and hire outside 

management consultants to review the banks’ management and their 

board’s oversight of the banks. The Chicago FHLBank has submitted its 

plan to FHFB, which accepted it. The Seattle FHLBank received an 

extension and submitted its plan to FHFB on April 5, 2005. 

The financial problems identified at the Chicago and Seattle FHLBanks 

have had significant effects on their operations and business practices. For 

example, FHFB required the Chicago FHLBank to restate its financial 

results for 2003 and placed limits on the growth of the institution’s 

mortgage purchases until its risk-management practices improve. 

Previously, the Chicago FHLBank had been the primary engine of growth 

for the mortgage purchase programs within the FHLBank System. The 

Seattle FHLBank has decided to exit from the MPP program and thereby 

stop purchasing mortgages from its members. 

FHFB officials told us they continue to monitor risk management practices 

within the FHLBank System, particularly the management of interest-rate 

risks. FHFB officials said that their examinations continue to identify 

FHLBank System 

Faces Important 

Challenges and 

Questions 

FHFB Has Questioned 

FHLBanks’ RiskManagement Practices 
Page 18 GAO-05-489T 

deficiencies in these areas and that they are working with the FHLBanks 

to correct them. 

In recent years, proposals have been made to permit the FHLBanks to 

securitize mortgage assets to provide for the continued growth of the 

mortgage purchase programs. Without securitization, which would permit 

FHLBanks to remove mortgage assets from their balance sheets, the 

System’s ability to increase its mortgage purchases may be constrained by 

capital requirements. That is, since the FHLBanks must comply with 

capital requirements for assets such as mortgages held on their balance 

sheets, they would not be able to expand these programs without 

obtaining additional capital from their members, which may prove 

difficult. According to FHFB’s chair, the agency should defer to Congress 

on the question of whether FHLBanks should be permitted to securitize 

their mortgage assets. 

Securitization offers potential benefits to the FHLBank System but it raises 

questions as well. One potential benefit of securitization is that it would 

provide the FHLBanks with an additional tool to manage the interest-rate 

risks associated with mortgage purchases. Authorizing the FHLBanks to 

securitize mortgage assets has also been advocated as a means to increase 

competition in the secondary mortgage market, which could benefit 

lenders and homebuyers. However, questions exist on whether the 

FHLBanks would be able to develop the necessary infrastructure, 

including hiring staff with specialized expertise, to effectively manage 

securitization programs. Some FHLBank System members have also 

commented that securitization would further alter the System’s traditional 

focus on providing advances to member institutions, and therefore, be 

undesirable. 

Although anecdotal information exists on the benefits of the FHLBank 

System, limited quantitative analysis exists on the extent to which the 

FHLBanks’ activities benefit homebuyers, mortgage finance, and 

community development. We recognize that conducting such research is 

challenging. First, isolating the FHLBanks’ effects on mortgage markets is 

a complex and technical undertaking. Second, with the addition of 

mortgage purchase programs, the financial activities of the FHLBanks 

have become more sophisticated, thus complicating any analyses of 

benefits and costs. Nevertheless, assessing the outcomes of the FHLBank 

System’s activities is important for Congress and others to determine 

Proposals to Use 

Securitization to Expand 

FHLBanks’ Mortgage 

Purchase Programs Are 

Controversial 

Limited Information Exists 

on the Extent to Which the 

FHLBank System Is 

Meeting Its Mission 
Page 19 GAO-05-489T 

whether the risks associated with the System are offset by the potential 

benefits. 

I would now like to highlight information and data limitations that hamper 

any assessment of mission achievement: 

• We are not aware of any studies on the extent to which FHLBank 

advances, mortgage purchase, and other activities directly benefit 

homebuyers through lower mortgage costs. In contrast, several studies 

have estimated the potential savings to homebuyers associated with the 

mortgage purchase activities of Fannie Mae and Freddie Mac. Some of 

these studies estimate a substantial savings to homebuyers while others 

conclude that the savings are small and that Fannie Mae and Freddie Mac 

as well as their shareholders are the primary beneficiaries. Although the 

studies’ findings may differ, they provide an empirical basis for discussing 

the costs and benefits of Fannie Mae and Freddie Mac’s activities. 

• Similarly, there is minimal empirical evidence on the extent to which the 

FHLBank System’s advance business encourages lenders to expand their 

mortgage business. We have identified one existing study on this subject: a 

2002 report by the Federal Reserve Bank of Cleveland.13 The study found 

that there is a significant positive relationship between an FHLBank 

member’s use of advances and its mortgage finance activity. However, we 

believe the report has certain methodological limitations and should be 

interpreted with caution. For example, the report does not demonstrate 

that members increased their mortgage assets as a result of joining the 

System, it only shows that System members have relatively high mortgage 

assets compared to non-System members (We are also aware that the 

FHLBank Council recently released two reports on this subject but we 

have not had time to analyze them in preparation for this testimony). 

• There is limited information as to why the placement of small business and 

agricultural collateral by small community financial institutions (CFI) to 

secure FHLBank advances has been minimal. GLBA expanded the types of 

collateral (including small business and agricultural collateral) that CFIs 

could pledge to secure FHLBank advances in the view that doing so would 

allow the System to better meet the needs of small institutions. However, 

FHFB data indicates that such collateral represents less than 1 percent of 

all collateral pledged to secure System advances. On the one hand, it may 

 13James B. Thompson, “Commercial Banks’ Borrowing from the Federal Home Loan 

Banks,” Federal Reserve Bank of Cleveland, July 2002. 
Page 20 GAO-05-489T 

be the case that very few institutions are willing to pledge such collateral 

to secure advances. However, the potential also exists that FHLBanks 

have established such strict underwriting standards—for example by 

applying significant haircuts to the collateral—that CFIs have been 

discouraged from pledging it.14 We understand that FHFB is planning a 

conference later this year to gather additional information on the use of 

CFI collateral. 

In recent years, questions have been raised about the potential impacts of 

holding companies who may have mortgage subsidiaries that are members 

of two or more FHLBank districts on the FHLBank System structure, 

which traditionally involved each financial institution belonging to one 

FHLBank. In a 2003 report, we noted that there are about 100 holding 

companies that had subsidiaries who were members of two or more 

FHLBank districts.15 Some observers have expressed concerns that such 

large financial institutions could pressure the FHLBanks to compete with 

one another on advance pricing terms—such as interest rates and 

collateral requirements—and that this competition could impair the 

overall safety and soundness of the FHLBanks. Our report noted 

significant differences in advance term pricing among the 12 FHLBanks 

and that the opportunity existed for holding companies to obtain advances 

from the FHLBank that offered the most favorable advance terms. Some 

FHLBank officials also said that holding companies seek to play one 

FHLBank off another creating competition within the System. However, 

we also found that FHFB had not identified any material safety and 

soundness issues related to FHLBanks’ advance-term pricing. I would 

reiterate a statement in our 2003 report that FHFB has a continued 

responsibility to monitor the FHLBanks to help ensure that any 

competition within the System does not result in unsafe and unsound 

practices. 

Concerns have also been raised that the activities of large financial 

institutions such as holding companies are having negative affects on the 

AHP program in certain FHLBank districts. Under FIRREA, FHLBanks 

 14Haircuts refer to the discounts that FHLBanks apply to collateral that is used to secure 

advances. For example, if the FHLBank has a 40 percent haircut for single-family mortgage 

loans, an FHLBank member could borrow up to 60 percent of the value of the single-family 

mortgages loans that it pledged as collateral. 

15See GAO, “Federal Home Loan Bank System: Key Loan Pricing Terms Can Differ 

Significantly,” GAO-03-973 (Washington, D.C.: Sep. 8, 2003). 

Questions Have Been 

Raised About the Impact 

of Large Holding 

Companies on the 

FHLBank System 
Page 21 GAO-05-489T 

must contribute 10 percent of their previous year’s earnings to subsidize 

housing finance for targeted groups. In some cases, financial institutions 

located in one FHLBank district have purchased banks or thrifts in other 

FHLBank districts. As such financial institutions grow through out-of-area 

acquisitions, they may be able to increase their business relations with 

their local FHLBank thereby increasing its profitability. For example, such 

financial institutions may take out additional advances or sell additional 

mortgages to the FHLBank. With potentially increased profits from doing 

business with a larger member, the FHLBank would have additional funds 

to devote to the AHP program. In contrast, FHLBanks whose members 

were acquired potentially lose net income and AHP funding dollars. 

According to one FHLBank president, such acquisitions have hurt AHP 

funding in his bank’s district. However, according to FHFB officials, recent 

research they conducted shows that mergers may have a short-term 

impact on AHP funding, but these effects seem to balance out over time. 

For example, financial institutions in a FHLBank district that lost 

members through acquisitions may purchase financial institutions in other 

FHLBank districts thereby recapturing AHP funds. FHFB officials also said 

that they may develop a regulation to address any concerns associated 

with mergers on AHP funding. 

Mr. Chairman, this completes my prepared statement. I would be happy to 

respond to any questions that you or other members of the committee may 

have at this time. 

For further information regarding this testimony, please contact me at 202-

512-8678 or mccoolt@gao.gov or William B. Shear, Director, at 202-512-

8678 or shearw@gao.gov, or Wesley M. Phillips, Assistant Director, at 202-

512-5660 or phillipsw@gao.gov. Individuals making contributions to this 

testimony include Rachel DeMarcus, Austin Kelly, Jill M. Naamane, Andy 

Pauline, Mitchell B. Rachlis, and Barbara Roesmann. 

Staff Contacts and 

Acknowledgments 

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