Feds failed to stop banks from making billions in risky overseas loans

With little objection from federal regulators, U.S. banks that were created specifically to finance home loans for Americans took significant risks in 2010 and 2011 by providing billions of dollars in no-collateral loans to European banks as that continent’s debt crisis was worsening, a government watchdog discovered.

The report released Thursday by the Inspector General for the Federal Housing Finance Agency suggests the U.S. banking system may not have fully learned the lessons of the 2007-08 mortgage crisis and engaged in new risks over the last two years with inadequate supervision from the Obama administration.

The inspector general found that the dozen regional banks that compromise the Federal Home Loan Bank System at one point in 2011 had doled at out more than $120 billion in unsecured short-term loans – 87 percent of which went to overseas institutions such as European banks.

The unsecured loans grew unabated for months before the banks recognized the severity of their risks and began reducing their exposure. But even after substantially reducing such loans, the home bank system still started 2012 with $57 billion in no-collateral loans, much of it to foreign entities, the report found.

“Several FHL Banks violated FHFA’s regulation that sets maximum exposures for unsecured credit,” the report concluded. “Additionally, several FHLBanks extended unsecured credit to particular foreign banks despite indications of heightened risks associated with doing so.”

The report said the regional banks need to improve their risk management practices and also suggested FHFA, the federal agency charged with overseeing the bank system, should do a better job making sure “that unsecured credit risks are adequately and properly mitigated.”

FHFA is the federal agency charged with overseeing the financially troubled Freddie Mac and Fannie Mae mortgage giants, which were at the center of the 2007-08 mortgage crisis, as well as the dozen regional institutions that compromise Federal Home Loan Bank System. That system was created in the 1930s and is chiefly designed to support American financing for housing.

Heading into the election season, both parties may find fodder in the new watchdog report. President Barack Obama vowed his administration would better police financial institutions to avoid future meltdowns like the mortgage crisis, and Republicans may cite the new findings as evidence his administration has fallen short of the pledge.

The president, meanwhile, can point to the fact that FHFA has been stuck with an acting director for years because Senate Republicans blocked his nomination of a North Carolina banking regulator to head the agency.

The heart of the risk-taking cited by the inspector general involves the fact that the home loan banks are permitted to extend short-term loans to other domestic and foreign institutions.

At their peak in 2011, these loans totaled more than $120 billion – just as Europe was starting to plunge into a debt and economic crisis.  One FHL financial institution gave more than $1 billion to a European bank - despite the fact the bank’s credit rating was downgraded and it suffered a multi-billion dollar loss, the inspector general found.

In comparison, the banks loaned about $20 billion to domestic institutions during the same period.  In the spring of 2011, foreign loans accounted for 87 percent of all lending FHL Banks were making.

The report found the FHFA realized in early 2010 the risk posed by its member banks sending such large amounts overseas, but did not take action because its attention was focused on America’s own economic troubles.  The original purpose of the loans was to generate interest revenue that could be used to create low-interest loans for American mortgages.  The loans are supposed to be a quick source of credit, and more than 40 percent were made for a single overnight period.

But loaning the money to sometimes shaky foreign banks posed risks those banks could default on the loans, the report said.  At the height of the lending, 10 percent of the FHL Bank System’s assets were being sent overseas; but the loans made up almost 30 percent of the FHL Bank’s investments, showing an increased reliance on this type of income.

Lending to foreign banks is not the main purpose of the FHL Bank System, and taking such risks left open the possibility the banks would lose their money and have none to provide to U.S. citizens, the report said.  Even if no money was lost, lending so much to foreign entities could reduce the agency’s credibility in the eyes of American taxpayers, the report said.

The Inspector General found that while there are legal limits on how much each bank can lend to a single foreign entity, there is no limit on how many entities they can lend to, essentially allowing the banks to pump as much of their assets into short-term loans as they want.  The FHFA has already begun taking action to address that concern, the report said.

An increase of FHFA oversight of its bank’s loans, coupled with the deepening troubles in Europe, led to a sharp decline in the amount of loans given at the end of 2011, the Inspector General’s office found.  Still, that amount totaled about $57 billion.