Home interest loan mortgage rate

The secondary market for mortgage loans is an important part of the U.S. housing finance system. The Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac) have traditionally dominated the secondary mortgage market for conforming loans. However, competition in this market may be increasing as a result of mortgage purchases by Federal Home Loan Banks (FHLBs). Increased competition, in turn, is likely to have implications for interest rates paid by homebuyers and for the risk profiles of the government-sponsored enterprises (GSEs) that dominate this market.

The FHLB System is made up of twelve regional wholesale banks that are cooperatively owned by their member financial institutions. (1) Like Fannie Mae and Freddie Mac, the FHLB System is a GSE created by Congress to support residential housing finance. Historically, the FHLB System has achieved this mission by making loans to its depository institution members secured by residential mortgage loans while Fannie Mae and Freddie Mac have provided credit guarantees on mortgage-backed securities or purchased mortgages for their own portfolios.

In 1997, however, the Federal Home Loan Bank of Chicago began purchasing pools of conforming mortgages under its Mortgage Partnership Finance Program. (2) Today, nine FHLBs offer this program in conjunction with the Chicago FHLB, and the remaining three offer their own Mortgage Purchase Programs. All of these programs use a risk-sharing arrangement whereby member institutions manage most of the credit risk associated with the loans while the FHLB absorbs the market risk. (3) As a result, members now have a more complete menu of alternative ways of finding a pool of conforming mortgages with the three housing GSEs. These options include

1. selling the mortgages to Fannie Mae or Freddie Mac for a one-time cash payment,

2. selling the mortgages to an FHLB in exchange for a one-time cash payment as well as a stream of credit enhancement fees,

3. swapping the mortgages for a security guaranteed by either Fannie Mae or Freddie Mac, or

4. holding the mortgages funded by an FHLB advance. (4)

Each alternative other than the first exposes a depository institution to credit risk, market risk, or both. Furthermore, the specific choice of how to fund a pool of mortgages--including whether to deal with a housing GSE at all--depends on the relative prices of these risks in the context of the GSE programs, regulatory capital requirements, and the cost of issuing liabilities.

The FHLB mortgage programs represent a small but growing part of the secondary conforming mortgage market. In 2002 the FHLBs acquired $45.7 billion in conforming mortgages from their members, about 2.4 percent of the $1.9 trillion in originations that year. However, the year-over-year change in the stock of mortgages held on the consolidated balance sheet of the FHLB System rose 119 percent between 2001 and 2002. (5) Future growth of the FHLB mortgage programs appears to hinge on these cooperatives' ability to effectively manage their required regulatory capital through either new equity offerings or by moving assets off their balance sheets.

This article describes the various mortgage programs offered by the FHLB System, analyzes the evolving competitive environment in the secondary conforming mortgage market, and identifies implications for this market. It does not delve into legal and political questions of whether the FHLB System should compete in the secondary mortgage market or whether such participation should be limited. (6) The discussion begins with a brief introduction to the FHLB System.

The FHLB System

The FHLB System was created in 1932, in the midst of the Great Depression, to increase the supply to thrift institutions of long-term funding for mortgage loans. As a GSE, the FHLB System benefits from various provisions in its federal charter that result in lower operating and funding costs, including exemptions from federal, state, and local taxes, a $4 billion line of credit with the U.S. Treasury, and an exemption from federal securities registration requirements. (7) Taken together, these benefits confer a subsidy on the FHLB System, which the U.S. Congressional Budget Office (2001) estimates to be $3 billion in 2000. (8) The Federal Housing Finance Board (Finance Board) regulates the FHLB System for both mission compliance and safety and soundness.

Over time, membership in the FHLB System has been liberalized and is now open to all depository institutions as well as certain other financial institutions. A stock purchase is required for membership, and while this stock is not tradable, it is redeemable at par after a notification period. (9) As of year-end 2002, total membership in the FHLB System stood at 8,011 institutions: 5,886 commercial banks, 1,390 thrifts, 660 credit unions, and 75 insurance companies.

The FHLBs are wholesale financial institutions, which offer credit products, investment products, payments services, and custody services. (10) As of December 31, 2002, the consolidated balance sheet for the FHLB System reported total assets of almost $764 billion. Advances to members were the largest category of assets ($490 billion), followed by investments ($206 billion) and mortgage loans ($61 billion). (11) Although mortgages are only about 8 percent of total assets, this share represents a significant increase from year-end 2001, when they were just 4 percent of total assets.

The principal funding source for the twelve FHLBs' operations are consolidated obligations issued in the form of bonds and discount notes. The FHLBs' Office of Finance issues this debt, for which all of the FHLBs are jointly and severally liable. (12) As of year-end 2002, the FHLB System had consolidated obligations outstanding of almost $674 billion; the majority of these were fixed-rate issues.

By year-end 2002, the FHLB System had equity capital totaling $36 billion, or 4.7 percent of total assets. (13) The Gramm-Leach-Bliley Financial Modernization Act of 1999 established capital requirements and a new capital structure for the FHLBs. (14) This legislation required the Finance Board (1) to promulgate new capital regulations establishing regulatory risk-based and leverage capital requirements for the FHLBs and (2) to outline the different classes of stock that an FHLB may issue and to establish the various rights and preferences associated with each class. The Finance Board published its final capital rule on January 30, 2001, and all twelve FHLBs have filed their new capital plans and had them approved by the Finance Board. (15) Each institution has up to three years from the approval date of its respective capital plan to implement its new capital structure. (16) Box 1 describes the new capital structure and minimum regulatory capital requirements for the FHLBs.

The FHLBs' new capital structure and capital requirements may have implications for the long-term prospects of their mortgage programs. Before examining these issues, however, the discussion details the structure of the mortgage programs and their variants.

GSE Secondary Conforming Mortgage Market Programs

As noted in the introduction, the FHLB System offers two broad classes of mortgage programs. The Mortgage Partnership Finance Program represents a single mortgage program offering standardized products with most functions consolidated at the Chicago FHLB. During 2002 the Mortgage Partnership Finance Program purchased $27.9 billion in mortgages, and at year-end there were $42.3 billion of these loans outstanding. The Mortgage Purchase Programs offered by the FHLBs of Cincinnati, Indianapolis, and Seattle are operated individually in the sense that differences in terms and features exist. (17) The Mortgage Purchase Programs funded $17.8 billion in residential mortgages during 2002, and $18.3 billion of these loans were outstanding as of December 31, 2002.

The Mortgage Partnership Finance Program. The Mortgage Partnership Finance (MPF) Program allows members to sell conventional or government-guaranteed mortgages to their regional FHLB. In exchange, members receive payment for the assets, plus a monthly fee to manage most of the credit risk (typically on the order of 10 basis points annually on the outstanding principal balance). (18) Under the MPF Program, the FHLBs hold the mortgages on their books, and the market risks associated with long-term fixed-rate mortgages, including the funding risk and prepayment risk, are borne by the FHLB.