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. Hey, wait, the Home Loan Banks will take them. 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. WOODS: And this dynamic became important in the 2008 financial crisis, with financial institutions like Washington Mutual and Countrywide Financial. It's made the Federal Home Loan Banks more willing to lend money to banks that could be considered risky borrowers. WONG: But Aaron says this super lien has created a bit of a problem. WOODS: Federal Home Loan Banks get to jump at the front of the queue to get paid back. KLEIN: The home loan bank gets to go in first through a legal mechanism called a super lien and be made whole. WONG: Let's say a bank that's taken out one of these loans gets into trouble and fails. WOODS: Now, a bank that wants one of these loans has to provide collateral, and a common form of collateral is a mortgage. They raise money by selling bonds, then they lend money to their members, often at lower rates than what their member banks can get elsewhere. WONG: So here's what the Federal Home Loan Banks do. Aaron Klein is a senior fellow in economic studies at the Brookings Institution.ĪARON KLEIN: The home loan bank system has one of the great business models of society. But in 1989, the system was opened up to commercial banks and credit unions. WONG: At first, membership in the system was limited to financial institutions that provided mortgages. WOODS: And the Federal Home Loan Bank System has been playing this role since 1932. That money goes towards helping banks that might be struggling with declining deposits or liquidity issues. WAILIN WONG, BYLINE: They provide funding to other banks in the form of loans. Darian Woods and Wailin Wong from our daily economics podcast, The Indicator, explain how this 90-year-old piece of financial architecture works and why it might need an update.ĭARIAN WOODS, BYLINE: If you're not working in the banking or housing industries, you might not ever have heard of the Federal Home Loan Bank System. All of them, including First Republic, borrowed money from Federal Home Loan Banks before their demise. We've seen some high-profile bank failures this year.
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