Federal Home Loan Bank Act

What Is the Federal Home Loan Bank Act?

The Federal Home Loan Bank Act is a piece of legislation passed in 1932. It was designed to encourage homeownership by providing a source of low-cost funds for member banks to be used for mortgages.

The first in a series of bills that sought to make homeownership an achievable goal for more Americans, it established the Federal Home Loan Bank Board (FHLBB) and Federal Home Loan Banks.

Origins of the Federal Home Loan Bank Act

The Federal Home Loan Bank Act was signed by then-President Herbert Hoover on July 22, 1932. It intended “to establish a series of discount banks for home mortgages, performing a function for homeowners somewhat similar to that performed in the commercial field by the Federal Reserve Banks through their discount facilities,” he announced on signing the bill into law. “The purpose of the system is both to meet the present emergency and to build up homeownership on more favorable terms than exist today.”

At the time of the act’s passage, the United States was in the Great Depression—the “present emergency” to which Hoover referred—and the financial system was in especially dire straits. In the wake of the stock market crash of 1929, thousands of panicked Americans emptied their savings and checking accounts, causing a series of bank runs that caused many financial institutions to collapse. Others were left short of lending capital.

At the same time, many mortgage holders who had lost their jobs or had their savings wiped out in the crash were defaulting on their home loans. These defaults further reduced the money that banks and savings and loan associations had available to lend.

Federal Home Loan Bank Act Provisions

Architects of the Federal Home Loan Bank Act intended it to inject money into the banking system and make mortgage loans available to consumers, thereby stimulating the housing and real estate markets.

Specifically, the act established the Federal Home Loan Bank (FHLB) System. Modeled on the Federal Reserve System, it established a regulatory agency, the Federal Home Loan Bank Board (FHLBB), to create and oversee a network of member Federal Home Loan Banks (FHLBs or FHLBanks).

Institutions Created by the Federal Home Loan Bank Act

The act created both the Federal Home Loan Bank Board and Federal Home Loan Banks.

The Federal Home Loan Bank Board chartered and supervised federal savings and loan banks and organizations.

The Federal Home Loan Banks were (and still are) independent, regional wholesale banks (similar to the 12 regional Federal Reserve Banks) scattered around the country. Although federally chartered, they were privately owned institutions—government-sponsored enterprises (GSEs).

Authorized to create eight to 12 FHLBs, the FHLBB eventually established a dozen of these independent, regional wholesale banks, giving them a total of $125 million in funding. The FHLBs were authorized to make those funds available to retail banking institutions, such as savings banks, cooperative banks, insurance companies, building and loan associations, and community development organizations. The act authorized any eligible institution to become a member of an FHLBank.

Impact of the Federal Home Loan Bank Act

The federal regulatory framework founded by the Federal Home Loan Bank Act successfully strengthened the housing and housing lender industry, as well as the loan industry, and facilitated homeownership. By subsidizing lenders, the act played a key part in increasing the number of Americans who were able to afford residences, making homeownership a key feature of the American dream.

The Federal Home Loan Bank System established by the act is still in effect today. By virtue of their GSE status, the FHLBanks are able to borrow in the capital markets at favorable rates (they no longer receive any direct federal funding). The FHLBanks then pass along that funding advantage to their members—and ultimately to consumers—by providing advances (as their secured loans are called) and other financial services at rates that the member financial institutions generally could not obtain elsewhere. That, in turn, enables these banks to make financing more available to borrowers.

In short, the FHLBs act as “banks to banks.” FHLBs also provide secondary market outlets for members interested in selling mortgage loans, as well as specialized grants and loans aimed at increasing affordable housing and economic development.

Subsequent Alterations to the Federal Home Loan Bank Act

In 1989, the Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA) was passed in response to the savings and loan crisis of the 1980s. During the crisis, nearly one-third of the savings and loan institutions in the United States failed. FIRREA eliminated the Federal Home Loan Bank Board and the Federal Savings and Loan Insurance Corp. (FSLIC) and created the Office of Thrift Supervision (OTS) and the Resolution Trust Corp. (RTC) to provide greater stability and responsibility among lenders.

The Housing and Economic Reform Act of 2008 established the Federal Housing Finance Agency (FHFA) and charged it with regulating the FHLB system.

While the Federal Home Loan Banks remain in place, their member banks have changed. At first, savings and loan associations dominated the ranks of member financial institutions. Their numbers began to dwindle in the 1980s and ’90s, after the savings and loan crisis. In the 21st century, commercial banks—which were allowed to join the system in 1989—and insurance companies have come to comprise most of the FHLB membership.

Pros and Cons of the Federal Home Loan Bank Act

Proponents of the Federal Home Loan Bank Act argue that homeownership was essential to the economic recovery of the country during the Great Depression—and, given the crisis in the banking industry, that a strong federal stimulus was necessary. They also contend that the system it created adds stability to the housing and lending market and continues to result in stronger local communities and higher overall quality of living.

However, critics claim that this long tradition of federal subsidies for mortgage loans distorted the housing market. This distortion, they fear, would culminate in overly lax lending standards and unnaturally high housing prices. Doubters say that funding through the act leads to a residential real estate cycle with wide swings between crash and boom.

There are also concerns that the growth of the Federal Home Loan Banks and increased reliance on FHLB funding, along with the interconnectedness of the financial system, could mean that any distress among FHLBs could be transmitted to other firms and markets.

The Bottom Line

The Federal Home Loan Bank Act set up a way to encourage homeownership by providing banks with low-cost funds to be used for mortgages. That activity continues to this day—along with other subsidized efforts, like grants and loans, aimed at increasing affordable housing and economic development.

It also established an important precedent, paving the way for the government to establish other agencies—along with the concept of federal oversight of and intervention in the U.S. economy and consumer financial affairs. This concept became a key tenet of the New Deal in the administration of President Franklin D. Roosevelt, Hoover’s successor.

For example, in the year following the Federal Home Loan Bank Act’s passage, Roosevelt signed into law the Banking Act of 1933 (also known as the Glass-Steagall Act). In an effort to restore faith in the banking system, it established the Federal Deposit Insurance Corp. (FDIC), which insured individual bank deposits in case of an institution’s failure.