It makes sense for the FHLBs to expand their reach to firms such as mortgage REITs, with the proper controls, said Clifford Rossi, a former Citigroup Inc. risk manager who is now executive in residence at the University of Maryland’s Robert H. Smith School of Business in College Park.

“Anytime you’re increasing access to a low-cost, liquid source of financing, that’s a potentially a good thing, because it can be passed on to borrowers in the form of lower rates,” Rossi said. “The policy question is whether opening up the door to institutions that may not be regulated like banks might pose some sort of counterparty risk in the future.”

While the traditional membership base of the home loan banks has been contracting, interest from insurance companies has been expanding, Watt said in his speech last month. Borrowing by insurers in 2013 increased to 14 percent of the banks’ loans, known as advances, up from 1 percent in 2000. The number of insurance members is now 290, he said. The FHLBs have about 7,500 total members.

Marriage of Convenience

“If you don’t have primary members seeking advances and need to pay dividends you need new customers,” said Petrou of Federal Financial Analytics. “So this is a marriage of extreme convenience.”

While FHLBs provide a new source of funding, their advances are limited, providing only a small amount of the REITs’ necessary borrowings, according to Merrill Ross, an analyst with Baltimore-based Wunderlich Securities Inc.

Two Harbors can only get $1 billion from the FHLB of Des Moines. “It’s a much bigger company than that,” Ross said, with borrowings in excess of $12 billion.

As the FHFA considers how to address REITs gaining access to the lending network, the financing may alleviate a concern of other regulators. The International Monetary Fund and Financial Stability Oversight Council have said the investors’ reliance on short-term funding could dry up in a crisis, forcing asset sales that ripple across the financial system.

Last Resort

The banks’ regular bond sales allow them to offer advances with a range of maturities and terms. During the last credit seizure their steady financing of firms prompted New York Fed researchers to call the system the “Lender of Next-to-Last Resort” in a 2008 paper, ahead of the central bank itself. Member borrowing reached a year-end peak of $901 billion that year, from $642 billion at the start of 2007, as other providers of credit to banks and insurers retreated.