Co-ops provide strength behind weak economy

Farewell to 2007 — not a happy year for the financial markets, Northern Rock, many banks, most governments, or for millions of borrowers. 

Farewell to 2007 — not a happy year for the financial markets, Northern Rock, many banks, most governments, or for millions of borrowers. 

The international financial crisis is shaking peoples’ lives now and resulted from unrealistic lending by the US banks to so-called sub-prime borrowers for home loans.

This has left the stability of the US mortgage market heavily dependent on financial co-operatives — the Federal Home Loan Banks. As at the end of September, the asset base of the FHLBs was an astonishing $1.228 trillion. 

This represented a more than 20 per cent increase over the same point in the previous year, as mainstream US banks — including Merrill Lynch, Deutsche Bank, JP Morgan and Barclays — participated in increased bond issues as they sought to shore-up the home loans infrastructure. 

There are 12 FHLBs operating in all the states of the US, which were established 75 years ago in the midst of the Great Depression. 

Then, like today, their job was to create financial stability in a context of turmoil. Their primary purpose is to ensure there is a flow of credit for housing and community development — the financial co-ops are the largest source of residential mortgage and community development credit in the US.

FHLBs are owned by over 8,000 financial institutions, including some giants of the industry, but also many credit unions. Only institutions making investments into the FHLBs are entitled to membership, through which they also obtain access to low-cost funds and receive dividends on their investments. 

The banks are exempt from state and local income taxes as bodies working for the public good. But, despite their name, there is no financial support from the federal government. The liability of each FHLB is guaranteed by all their counterparts.

The banks specially describe themselves as financial co-operatives, but balance their social objectives with achieving a return on capital employed. 

They combine the provision of adequate loans for low cost lending, with profitability. “The FHLBanks’ co-operative structure is ideal for serving the system’s 8,100 member lenders,” says the central financing organisation, the Office of Finance. “Each regional FHLBank manages and is responsive to its customer relationships, while the 12 FHLBanks use their combined size and strength to obtain the necessary funding at the lowest possible cost.“

In this way, FHLBs provide liquidity in the home loans market, preventing a big increase in repossessions and have created an alternative for lenders to inter-bank borrowing (reliance on which effectively destroyed Northern Rock). 

Although they operate as co-operatives with a social objective, the US financial system as a whole benefits from their activities and is involved in it — 80 per cent of US financial institutions use FHLBs.

“By providing this assured liquidity to its members, the FHLBank system allows member institutions to remain active lenders, in all economic cycles, to help their local economies grow,” explains the Office of Finance. “The mission of the Federal Home Loan Banks is to provide cost-effective funding to members for use in housing, community, and economic development; to provide regional affordable housing programmes, which create housing opportunities for low and moderate-income families; to support housing finance through advances and mortgage programmes; and to serve as a reliable source of liquidity for its membership.”

The FHLBs have specific programmes to provide affordable housing and to invest in local communities. The Affordable Housing Program has operated for 18 years, providing over $2.9 billion in grants, enabling the building, purchase or refurbishment of 575,000 housing units. As a result of legislation eight years ago, the remit of FHLBs was extended to enable them to back small enterprise loans issued by community finance institutions. This has given them a central role in the revival of small rural communities, where small firms had difficulty in raising loans.

According to the Financial Times, the existence of the FHLBs is widely regarded as being an important factor preventing the US from suffering a run on the banks similar to that which brought down Northern Rock.

Federal Home Loan Banks are not a radical alternative to the capitalist home loans: rather they are a prop that enables the system to remain firm, even when harsh economic tides are damaging its foundations. 

But the real significance is that co-operatives provide a similar role in several markets in the US — credit unions and energy co-operatives are other examples. 

Despite the rhetoric boasting about America’s remarkable capitalist success, there is a largely unspoken acceptance in the country that market failures are inevitable and the market cannot be relied upon in all circumstances. 

Consequently, the US has back stops to market failure — which are based on collective provision. It certainly makes you think.

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