Established in 1932, each FHLBank is a government-sponsored enterprise (GSE) that is cooperatively owned by its members (see fig. 1 for the location of the 12 FHLBanks). The 12 FHLBanks, along with the Office of Finance (which issues debt on behalf of the FHLBanks), comprise the FHLBank System. The members of each FHLBank must buy stock in the FHLBank as a prerequisite for obtaining advances and other FHLBank services. FHLBank System assets consist of advances and investments, such as money market funds and mortgage-backed securities (see table 1). In addition, FHLBank assets consist of acquired mortgages that the FHLBanks purchase from their members under the Mortgage Partnership Finance (MPF) program or Mortgage Purchase Program (MPP). The FHLBank-purchased mortgages consist of both conventional mortgages and federally insured and guaranteed mortgages. The FHLBank System raises funds in the capital markets partially on the strength of its ties to the federal government. Due to these ties, investors perceive an implied guarantee by the federal government on the System debt based on the belief that the government would come to the rescue of the FHLBank System rather than allow it to default on its obligations in the event of severe financial difficulties. The primary source of funds for the FHLBank System is the issuance of debt securities known as consolidated obligations, through its Office of Finance, which stood at $710 billion as of June 30, 2003. Consolidated obligations are the “joint and several” obligations of the FHLBanks and all of the banks may be required to cover such obligations of another bank that defaults on its repayment obligations. Under the joint and several structure, the potential for moral hazard exists. That is, FHLBanks may have incentives to take financial risks knowing that their losses would be covered by other FHLBanks or, ultimately, the federal government. Federal statutes and regulations as well as FHFB’s oversight efforts—which are discussed in this report—are designed to help ensure that the FHLBanks conduct their business in a safe and sound manner. The FHLBank Act provides that an eligible institution may become a member only of the FHLBank district in which its principal place of business is located, or an adjoining district for convenience purposes and if approved by FHFB. However, bank or thrift holding companies may own subsidiaries in two or more FHLBank districts and each eligible subsidiary may become a member of its district FHLBank. To become a FHLBank member, each subsidiary must be a separately chartered institution, such as a national bank or state-chartered bank or thrift. According to FHFB, approximately 100 bank or thrift holding companies currently operate in two or more FHLBank districts by having established separately chartered subsidiaries in those districts. In 2000 and 2001, continuing a long standing trend, several holding companies with subsidiaries that operated in two or more FHLBank districts merged with or purchased financial institutions that were also members of FHLBank districts. These holding companies sought to consolidate the merged or purchased institutions under one existing charter and did not want to maintain separately chartered institutions. For example, Washington Mutual (WAMU)—a thrift holding company with subsidiaries in the Seattle, San Francisco, and Topeka FHLBank districts— purchased Bank United, a member of the Dallas FHLBank district, and Dime Savings, a member of the New York FHLBank district. WAMU chose not to maintain separate charters for Bank United and Dime Savings for business purposes and instead decided to merge the institutions into its existing subsidiaries. However, under FHFB regulations Dime Savings and Bank United could no longer remain members of the FHLBank System and could no longer obtain new advances or other services from the FHLBank of Dallas and the FHLBank of New York. Therefore, WAMU was required to pay back Bank United and Dime Savings’ outstanding balances under their original terms. In 2000, the FHLBank of Dallas submitted to the FHFB an application (which the FHFB subsequently treated as a petition) to grant approval to WAMU’s thrift subsidiary’s application for membership in the FHLBank of Dallas while maintaining its membership in the FHLBank of San Francisco (the petition has been referred to as advocating multidistrict membership). The Dallas FHLBank filed the petition under the “demanded by convenience” standard. After the initial petition, FHFB received similar requests from three other FHLBanks, requests to intervene, and comment letters both in favor and against. Given the controversy associated with these petitions and their potential effects on the System (including the potential for increased competition among the FHLBanks), FHFB did not act on them and, in October 2001, requested comments from the public on the petitions. In 2002, FHFB obtained a legal opinion from a law firm stating that it had the legal authority, under certain conditions, to approve multidistrict membership under its broad safety and soundness regulatory authority and requested that the 12 FHLBanks answer questions related to multidistrict membership, which the FHLBanks did by February 2003. During 2003, FHFB staff, at the direction of the agency’s chairman, analyzed the benefits and costs associated with multidistrict membership. The FHLBank Act, as amended by GLBA, and FHFB regulations establish the general pricing and other terms that each FHLBank can offer on its advances. Statutory and regulatory provisions establish requirements for FHLBank pricing on advances, allow for price differentiation at the FHLBanks, require that advances must be fully secured, and establish eligible types of collateral. FHFB regulations establish more specific requirements to help ensure that the FHLBanks conduct their advance business in a safe and sound manner. According to FHFB regulations issued pursuant to the FHLBank Act, FHLBank advances may not be priced below the marginal cost to the FHLBank of raising matching term and maturity funds in the marketplace, including embedded options, plus the administrative and operating costs associated with making advances. FHLBanks are allowed to differentiate in advance prices based on the FHLBank’s assessment of the credit and other risk of lending to any particular member, or other reasonable criteria. Per FHFB’s guidance, such differentiation could include providing discounts to members based on the volume of the advance. Each FHLBank is to include in its member products policy standards and criteria for differential pricing and is to apply its standards and criteria consistently and without discrimination to all members. The FHLBank Act, as amended by GLBA, requires that FHLBanks fully secure their advances with eligible collateral. The eligible collateral, as listed in table 2, ranges from whole single family mortgages to small business and agricultural loans. GLBA, which amended the FHLBank Act, expanded the collateral that member institutions could use to secure an advance. In particular, GLBA allowed CFIs, those FHLBank System members that are FDIC insured depository institutions that currently have $538 million or less in total assets, to pledge small business and agricultural loans as collateral. GLBA allowed CFIs to use the expanded collateral categories because some small institutions lacked a sufficient quantity of other types of assets—such as mortgage loans—necessary to secure FHLBank advances. GLBA also allowed all FHLBank members to make greater use of ORERC—such as commercial real estate loans and home equity loans—as collateral for advances. The FHLBanks may restrict the types of eligible collateral available to them as security, based upon the creditworthiness or operations of the borrower, the quality of the collateral, or other reasonable criteria. By fully securing advances with eligible collateral as required by the FHLBank Act, FHLBanks can protect their interests should one or more of their members fail. Typically, FHLBanks make advances on what is known as a blanket lien; that is, the FHLBank has the authority to take control of all the assets that are eligible as collateral on a member’s books. In cases in which an FHLBank determines that a member is experiencing financial difficulty, the FHLBank may require the member to list specific assets that are securing advances or may even require the member to deliver the collateral to the FHLBank. Should the member fail, the FHLBank can sell the pledged collateral to ensure repayment of principal and the interest on the advance. Due in part to the collateralization requirements, the FHLBank System has never experienced a loss on an advance. FHFB has issued several regulations that are designed to help ensure that the FHLBanks make advances in a safe and sound manner. For example, FHFB has established regulations pertaining to the use of ORERC and small business and agricultural loans as collateral, which are generally considered riskier than other forms of collateral, such as single-family mortgages. FHFB regulations require that FHLBanks can reliably discount the value of ORERC and small business and agricultural loans pledged as collateral. Under its regulations, FHFB also has the authority to require an FHLBank to increase its standards for all forms of eligible collateral. FHFB requires through regulation that FHLBanks take the necessary steps to ensure that collateral is secure and to establish written procedures for verifying the existence of collateral. Although the FHLBank Act and FHFB regulations establish the advance pricing framework, each FHLBank has independent authority within the framework to establish specific policies and procedures to meet its business and member requirements. Our review of key advance pricing terms—advance interest rates, collateral requirements, advance borrowing capacity, and capital stock purchase requirements—identified several significant differences among the 12 FHLBanks.