Federal Home Loan Banks

by Spencer Howard

Economists are still divided about what caused the Great Depression, and what turned a relatively mild downturn into a decade long nightmare.  One contributing problem was that the United States had too many small banks (branch banking was illegal at that time), and many banks made risky loans during the late 1920s.  Only one third or so belonged to the Federal Reserve System.  As economic conditions deteriorated in 1930 and 1931, hundreds of banks closed their doors as the nation’s citizens hoarded their money and defaulted on loan payments.  Many small-town banks, struggling to meet the demands of customers withdrawing their deposits, were forced to call in (that is, ask for early payment of) loans and mortgages in order to have enough cash on hand.  Those that couldn’t raise enough cash failed, and in many cases their depositors were left with nothing.  Even banks that were more secure became reluctant to make new loans or renew existing mortgages.  Millions of homeowners, holding high interest mortgages, were faced with reduced wages, lost jobs, or other hardships that resulted in foreclosure of their homes.

In November 1931, President Hoover proposed that Congress authorize a system of mortgage discount banks similar to the Federal Reserve System, which would provide a stable, low cost source of funds for mortgage lenders, thereby enabling millions of Americans to afford to keep or purchase their own home.  In July 1932, Congress finally passed a bill that authorized the creation of Federal Home Loan Banks, but placed stringent restrictions on the loans that could be financed.  When the Federal Home Loan Banks began operating, less than 0.01% of loans were approved.  Through 1932 and into 1933, Hoover unsuccessfully lobbied Congress to loosen the purse strings of the FHLB.  Congress eventually expanded the lending authority of the FHLB with the Home Owners’ Loan Act of 1933 and the National Housing Act of 1934.

“All this seems dull economics,” Hoover later wrote, “but the poignant American drama revolving around the loss of the old homestead had a million repetitions straight from life, not because of the designing villain but because of a fault in our financial system.  Had we been able to get a general mortgage discount institution established at the time I proposed, it would have saved thousands of homes, farms, and holdings of productive city real estate from foreclosure, and prevented many bank failures.  And, above all, it would have promoted home ownership, and employment on home construction”

In January 1932, as Congress stalled on Home Loan Banks, Hoover asked for authority to expand the role of the existing Federal Land Banks to help farmers facing foreclosure.  Congress delayed action until just before Hoover left office, then passed the Farm Credit Act, which enabled President Roosevelt to establish the Farm Credit Administration and expand the system of farm mortgage credit.

Both the Federal Home Loan Banks and the Farm Credit Administration proved to be vital and effective financial institutions, and are both still with us today.