FHFA's DeMarco on the FHLB's - Ugly

Bruce Krasting's picture

The FHFA’s acting director Edward DeMarco has proven to be a refreshing
change from his predecessor James Lockhart. Mr. DeMarco has consistently
delivered the straight story ever since he assumed responsibility.
Yesterday was no exception.

He spoke at the Directors of the FHLB conference. He delivered this message:

FHFA is looking for the FHLBanks to prepare for
eventually moving derivatives activity to central clearing. This is a
prudential matter, and one we anticipate the FHLBanks doing with or
without legislation mandating it.

The time to be evaluating options in this
area is now.

I could imaging the groans of the Directors when this message was
delivered. What an elegant way of saying, “Mark you books down now
boys, we can’t extend and pretend any longer

It is impossible to determine what the size of the losses the FHLB’s are
looking at. Here is a look at the trillion-dollar balance sheet:

There may be some losses
in the retained mortgage portfolio but I am assuming this is small beer.
The $631b of “advances” is probably okay as well. These are short-term
loans to Community Banks. These are the banks that show up on the list
every Friday from the FDIC. If there is an issue here there is going to
be a big problem.

The real concern is in the $284b of “investments”. This is all private
label MBS. If the assets are marked to market the losses will be
significant. 30-50% is possible. That would put the loss in the range of
$80-$120 billion.

DeMarco's words on the “investments”:

“As we all know, when the credit characteristics of those
investments changed, leading to losses on the FHLBanks’ holdings of
private label mortgage-backed securities, the “normal” operations of
some of the Banks were disrupted.”

That is a polite way of saying that they took a bath. Fannie and Freddie
will cost us at least $400 billion. Add in another $100b for the FHLBs.