The Federal Housing Finance Board is moving ahead with a proposed rule that would make permanent a somewhat controversial pilot program giving many smaller thrift institutions and community banks a new avenue to fund fixed rate loans.

Instead of just two options holding fixed rate loans in their portfolios or selling them into the secondary market - members of the Federal Home Loan Bank System would have a third alternative under the Mortgage Finance Program. They could sell them to their regional federal home loan bank.

Using the cooperative nature of the FHLB system, the MPF program is looked upon by its proponents as a way for local lenders to regain their share of the mortgage market.

Mortgage companies currently originate the lion's share of the $900-plus billion mortgage pie. But only 15 years ago, the thrift industry was still king of the hill.

In fact, it wasn't until 1985 that mortgage companies originated a greater volume of home loans than savings and loans $110 billion vs. $109.3 billion. But when the $7.5 billion worth of loan written by savings banks is included, thrifts even then were still the largest source of home financing.

From 1986 to 1989, S&Ls, now known as community banks, held their own with mortgage companies. But from 1990 on, they have been clobbered. And nowadays, institutions which do not take desposits or have continuing relationship with customers are the number one source of housing finance.

Under the MPF program, participating lenders would continue to service the loans they make, so they would continue to have a one-on-one relationship with their customers. But the FHLB would manage the liquidity, interest rate and prepayment risk associated with loans, in effect, taking the originating lender off the hook if the economy tanks or borrowers don't pan out.

That's essentially what FHLB members do now when they sell their loans to Fannie Mae and Freddie Mac, which are government chartered institutions which buy mortgages from local lenders and package them into securities for sale to investors worldwide.

But rather than paying a fee to the secondary market securitizer, as they currently do, MPF participants would receive a fee for their credit expertise.

The nuances of the program are not as important as the benefits, though. And one could be better up-front pricing, which translates to slightly lower loan rates to consumers perhaps as much as 0.25 percent.

A quarter percent is not a lot, to be certain. But by giving small, community-based lenders another source of liquidity, it also means that they would be able to remain in the game. Furthermore, mortgage companies and other housing finance entities would have to be more competitive, which will serve to keep loan costs low.

"MPF provided (us) an avenue to be more competitive in our local market against the larger banks," says Dan Behrend of Community National Bank in Oregon, Wisc., one of the lenders which took part in the pilot program.

Better yet, the transactions must be in keeping with the FHLB system's mission to promote affordable housing in particular and housing finance in general. It would also foster financing for economic development, which is something most mortgage companies don't do.

The mortgage business doesn't particularly like the MPF program, largely because non-depositories are not members of the FLHB system and, therefore, cannot participate. But the Mortgage Bankers Association has testified that if its members were allowed to play in the same sandbox, they'd turn the other cheek.

Fannie Mae and Freddie Mac don't like the program, either, arguing, in effect, that it represents unfair competition.

Nevertheless, it has proven popular with community lenders since it was first introduced in January 1997. As of Jan. 1, $1.8 million mortgages had been funded under the experimental program and commitments had been issued for an additional $6.6 billion worth of funding.

And now, says FHFB Chairman Bruce Morrison, it's time to step up to the next level. "MPF is a success," says Morrision, a former Connecticut congressman, "and should move beyond the pilot stage."

The proposed rule is expected to be published in the Federal Register next month. There will be a 30-day public comment period.