For Release on Delivery 9:00 AM PST March 21, 1997 FHFB 97-03

Thank you, Dale, for that very kind introduction. And thanks to Ken Guenther for inviting me to be with you.

I am truly delighted to be here. This is my first appearance at the IBAA annual convention, and I must say that it's not easy to make my debut on the same program with the Chairman of the Federal Reserve Board and the Comptroller of the Currency, nor to be following FDIC Chair Ricki Helfer at the podium.

On the other hand, I do feel I have a kind of "home court" advantage with IBAA, no matter the level of competition for your attention. For one thing, I'm not your primary regulator! More seriously, the Federal Home Loan Bank System exists to strengthen your capacity as community lenders, particularly in housing and community development finance. It is a key tool in leveling the playing field between your businesses and the large institutions that can go directly to the capital markets for liquidity. And you, in turn, are today the key mechanism for delivering credit where it is truly needed. And so I believe there is a natural connection and alliance between the IBAA and the FHLBank System, even though you are the newcomers to the System.

Today I want to talk to you about the two ways in which the System can be of assistance to community bankers. First, I want to talk about how the Federal Home Loan Bank System provides oxygen to the community banking business through its traditional pipeline, the advance product. Second, I want to discuss several specific pilot programs being undertaken to modernize the tools the System supplies you with -- to make these tools more relevant and you more competitive. The ultimate goal, of course -- the System "mission" -- is to make you better able to offer broader credit opportunity to the people of your community, particularly in housing finance and targeted community investment.

Background

Let me give you a bit of historical perspective first.

The Federal Home Loan Bank System has been a consistent and reliable source of liquidity to thrift institutions for 65 years. Now when most of the lenders were QTL housing lenders in the traditional sense -- when most of the balance sheet was housing -- it was easy to say what the System was for: funding from the Federal Home Loan Bank System supported housing finance. The mission was clear. There was no need for debate.

But the world has changed since 1932 -- and since l989. First of all, the way housing is financed has changed. The dramatic growth of securitization has produced effective, competing sources of liquidity, particularly for standardized mortgage loans. Second, depository institutions have changed -- and membership in the System has expanded beyond thrifts to commercial banks and other lenders -- such that no financial institution has a single-minded housing orientation.

It may come as a surprise to some of you that commercial banks now make up over two-thirds of System membership, and you hold about 40 percent of elected board directorships. Charter merger is going to add another wrinkle to what used to be the direct connection between the Home Loan Bank System and housing lending.

These developments have brought the System to a crossroads. There are many critics who say that the System is now obsolete, that with the direct link to housing finance severed, we're searching for a mission. There are others who wonder why anything has to change at all. The Finance Board sees a third alternative: strengthened and modernized support of community institutions directed toward housing and community development finance. The mission is the same as ever, but the means need to be updated.

The Traditional Advance

How does the FHLBank System support commercial bank members?

Fundamentally, through the traditional product, the advance, which is available as a supplement to deposits and as the "first resort" source of liquidity. This liquidity does its work even when members don't borrow, because the access to advances allows lower balance sheet liquidity and higher loan to deposit ratios. We are the central bank for small banks. That fundamental function, that relationship between us does not have to change.
In fact, late last year Chairman Leach suggested that it be expanded: that the FHLBanks have the ability to serve as an alternative funding source for community banks in a financial world where savers are as likely to turn to mutual funds as to bank accounts. And bank regulators are beginning to learn what thrift examiners have long accepted: access to FHLBank advances is a safe and sound substitute for balance sheet liquidity.

The good news this year, according to American Banker, is that many of you are reporting double digit loan portfolio growth. The bad news is that deposit growth is not keeping pace. "Deposit drought" is certainly possible, and the FHLBank System definitely offers a proven, prudent, wholesale funding mechanism to help all community banks meet community credit needs. I agree with Chairman Leach that expanding the scope of the System's traditional advances programs to respond to this kind of situation, should it occur, would build on the "meat and potatoes" business of the System. IBAA has noted the liquidity pressures of small community banks in rural America in particular, and I commend you for that. And the Finance Board is currently at work on modifications in membership and collateral rules to facilitate participation in the System by rural banks.

Why should this liquidity support continue to be given?

Because by tying smaller members to the capital markets, the Bank System makes members more competitive and better able to help their communities. I don't need to remind you, the independent bankers, that the community bank is more than just rhetoric.

Increasingly, we have a two-tiered banking system in this country today: we have very large, mass market, interstate and international institutions; and we have community banks. I can't easily draw the line between the two based on asset size or any other objective criteria. Nor can I say with any certainty what the next several years will bring in terms of consolidation.

But I can say that community bankers are the ones who know their customers, and who are battling to keep them. Community bankers are the small fish in what is now a global pond where they can be swallowed whole. And I will state my strong opinion that we ought not to let this happen -- that we need to keep both tiers of the banking system strong and healthy on behalf of the consumer population.

There is a set of values at stake here. I know that most of you get tired of hearing about the Jimmy Stewart movie, "It's a Wonderful Life." But I'll risk mentioning that Washington Post columnist E.J. Dionne Jr. offered new insights on that movie, reminding his readers why the character played by Jimmy Stewart is so beloved: because [quote] "he's put his bank's money to work for others, letting them share capitalism's bounty." He's given his neighbors their own stake in "the quiet warmth of a real community." That commitment to community is a value that has helped shape our country. It is a value that is realized by the cooperative structure of the FHLBank System and the public/private partnership that exists between the Banks, you, the member institutions, and your borrowers.

During a period of severe government spending constraints, public/private partnerships have become almost the buzzword for what can be done in the housing and community development arena. Government spending on affordable housing isn't even keeping pace with the deterioration of the existing affordable housing stock. HUD rent subsidies, which cover the gap between what the working poor make and the rents they have to pay, are decreasing. Federal housing tax credit and block grant programs at best maintain the status quo, but don't make a dent in the housing shortage. And so periodicals from the Atlantic Monthly to the New York Times Sunday Magazine praise these local partnerships -- partnerships that Home Loan Banks, members and borrowers have been forming since 1932. We were the first generation of partnerships -- and we can be the next successful wave!

Pilot Programs

We should build on what works, and there is no question that the advance is an important tool. At the same time, there is no question that the Federal Home Loan Bank System must modernize the tools it offers you to meet community credit needs and to compete with larger institutions.

Since becoming Chairman of the Finance Board, I have been encouraging institutions to "knock on the door" of their Federal Home Loan Banks and let them know what kinds of new and innovative projects and products would help them better meet borrower and balance sheet needs. And I've made it clear that the Finance Board would encourage creativity, that we would not be a regulatory stumbling block.
That challenge has been met so far by three new pilot projects within the System. These are all modest in amount and pose little risk. But if they work, they could be replicated nationwide. We are not doing the Washington "thing" of deciding what works by voting on it. The only way to find out what works is to test it, and that is what we're doing. And so we created a set of rules in our financial management policy so that the Finance Board could consider pilot programs of new investment activities that are mission-related.

I'll describe each of them briefly:

-- First, the Finance Board approved a pilot which permits the Federal Home Loan Bank of New York to purchase participation interests from members and eligible non-member mortgagees in mortgage assets to meet financing needs of underserved communities. The importance of this project is that it reduces the member's loans-to-one borrower level by the amount of the Bank's participation, thereby permitting members to originate housing and community and economic development projects they otherwise might be unable to fund, due to their size in relation to the size of the project. The FHLBank will also offer shares of its participation interest in such loans to other members. This experiment is on a small scale of $250 million.

Well, of course, we have been accused of allowing "competition" with financial institutions from the FHLBanks. On the contrary, this project has at its very core the promotion of the cooperative nature of the System -- members acting with other members to accomplish together what could not be accomplished individually and to enhance, together, their ability to compete with larger players. Would any in this crowd, I would ask -- and you may challenge me during our question and answer session -- say this is bad?

-- Second, we approved a pilot program in which the Federal Home Loan Bank of Atlanta will purchase participation interests in affordable multi-family housing loans originated by the Community Investment Corporation of North Carolina (or CICNC). CICNC is an affordable housing consortium of small banks -- most of which are FHLBank members -- whose sole purpose is to facilitate the availability of long-term permanent financing for the development of low- and moderate-income multifamily housing throughout the state.

This pilot is appealing from two perspectives: first, it facilitates multifamily housing, where the secondary markets are underdeveloped; and second, it offers a model for increasing the lending capacity of "loaned up" affordable housing consortia that can be replicated nationwide.

I might add that both the New York and Atlanta pilots will also help members better manage their asset risks by helping to liquefy housing and community development loans.

-- Third -- and this has been our most controversial action -- we approved a pilot that offers a potential new alternative to holding loans in portfolio or selling them in the secondary market -- something smaller members have asked for. Under the Mortgage Partnership Finance Program (or MPF), the FHLBank of Chicago members will market and originate one-to-four family home mortgage loans and be responsible for all functions involving the customer relationship. The FHLBank of Chicago will fund and retain in portfolio the home mortgage loans originated, serviced and credit-enhanced by members.

This project is an optimum allocation of risk between the FHLBank and its members and provides a more competitive capital arrangement than currently available to portfolio lenders. It should allow members to realize more profit in home mortgage finance. It introduces competition into the market which may lower costs to homebuyers. And each participant does what it does best -- again taking advantage of what can only be done under a cooperative System.

Once again, we heard from our critics. I'll answer their charges in turn. First, that MPF is "direct lending." Technically, it is, but the FHLBank is not ever involved in the retail relationship and no mortgage loan could be issued without a member institution acting as the intermediary. Second, we heard yet again that MPF would compete with member institutions. On the contrary, it supports members -- particularly smaller members -- by giving them an alternative in the home finance arena which is currently dominated by the secondary market and large institutions. Yes, the market as a whole will be more competitive -- and who can argue against that? -- but not because the FHLBank is the competition, but rather because the increased competitive ability of some members might disadvantage others. When any FHLBank offers a new product, there will always be winners and losers!

And finally, MPF does not introduce a new "subsidy" into mortgage finance. Rather the FHLBank of Chicago has recrafted an advance -- the loan product the FHLBank System has offered successfully for 65 years -- into a more targeted and more sophisticated instrument, better tailored to the needs of members in today's marketplace. In that sense, the agency cost advantage has not changed. MPF modernizes the means of achieving the System's traditional housing finance mission. It is conceptually quite elegant, though technically somewhat complicated.

Just a little over a week ago, we held hearings on the three pilots, and the input was welcome and enlightening. Obviously, the Finance Board has not yet had time to digest suggestions made by many panels of witnesses -- nor, in fact, to assess what seems to be an overwhelming amount of support out there -- and we will carefully analyze all comments and testimony we received. But I must say that, first of all, to those who may have disagreed with our procedure, it's no secret that whenever one dislikes a program one complains about process. But as to policy, as to the substantive merits, I hold to my view that each of these pilots gives you new a way to compete with larger players while giving us, the regulator, the assurance that more FHLBank investments are related to the System's mission.

I encourage IBAA members to become as actively involved as possible in this process of developing new products and projects that meet community credit gaps. I can report to you that when the Finance Board held a conference of FHLBank board directors last year, there was very little difference of opinion between commercial bank and thrift directors on the basic issues facing the System -- with the exception of the obvious objection to mandatory membership and an inequitable capital structure.

And the reason for agreement is because smaller members -- whether banks or thrifts -- so obviously see the value-added of the FHLBank System. Advances grew by almost $30 billion in 1996. The challenge now is to grow additional advances and investments that carry out the public policy mission of housing and community development finance.

Technical Assistance

In addition to advances and pilots, I think the Federal Home Loan Bank System can be more helpful to you as members by providing technical assistance in the origination of assets, and helping you identify new, profitable lending opportunities.

The System should be able to help members plan asset growth through increased advance funding -- and some FHLBanks are already helping in this way. But a less familiar challenge to the Home Loan Banks is developing the capacity to assist members with origination of assets they do not now handle because they think the deal is too complex, troublesome or risky. By providing assistance in the initial evaluation for funding, I think FHLBanks can offer a valuable service. They can help convert community-based deals that are difficult to do -- but have been identified by members and customers as important to do -- into profitable lending opportunities.

Conclusion

And isn't this what the System is all about and what you are in the best position to deliver: more community-based housing and development finance that weds FHLBank expertise to members' local knowledge -- and that is profitable.

Last year we went through a lengthy legislative process without action on FHLBank Act revisions. Clearly, System issues will be prominent in the 105th Congress and, just as certainly, we will work diligently with interested members of Congress as we have in the past.

But let me submit that all we really need by way of legislation are technical fixes -- changes in the REFCORP formula, in capital structure, and correction of other imbalances. Let me submit that within the current legislative boundaries we can and are making enormous progress. Last year at this time, the Finance Board -- in fact a Bank System almost under siege -- needed an answer to a central policy question: if the System is essentially a provider of liquidity for its members, liquidity for what?

This year I think we can affirm that the System is modernizing itself to provide the right answer to that question with new, profitable, mission-related products that allow you and community-based thrifts as well to meet otherwise unmet community credit needs. I think that you -- the independent bankers -- will be better able to survive and compete with that essential support.

Thank you.

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