What’s going on with US banks?
Over the last month, loans outstanding in the Federal Reserve bank bailout program increased by $17.24 billion. It was the second month we’ve seen borrowing from the Bank Term Funding Program (BTFP) surge. And the pace of borrowing is increasing.
Between December 13 and December 20, the balance in the BTFP grew by $7.57 billion.
As of Dec. 20, the balance in the BTFP stood at just under $133.34 billion. It’s the largest balance since the program was created in March.
The increase in banks tapping into the BTF started in November. As you can see from the chart, borrowing had leveled off in August before the sudden spike in November. Keep in mind that banks were still tapping into the bailout even as the total balance in the program plateaued. Some banks were paying off loans as others borrowed.
This surge in bank bailout borrowing would seem to indicate more banks are struggling in this high interest rate environment, and the financial crisis that kicked off in March continues to boil under the surface.
But thanks to the Fed bailout, the crisis remains “out of sight, out of mind.”
After the collapse of Silicon Valley Bank and Signature Bank, the Fed created the BTFP, allowing banks to easily access capital “to help assure banks can meet the needs of all their depositors.”
The BTFP offers loans of up to one year in length to banks, savings associations, credit unions, and other eligible depository institutions pledging US Treasuries, agency debt and mortgage-backed securities, and other qualifying assets as collateral. Banks can borrow against their assets “at par” (face value).
According to a Federal Reserve statement, “the BTFP will be an additional source of liquidity against high-quality securities, eliminating an institution’s need to quickly sell those securities in times of stress.”
The ability to borrow against the face value of their bond portfolios is a sweetheart deal for banks given the big drop in bond prices over the last year-plus.
Fed interest rate increases to fight price inflation decimated the bond market. (Bond prices and interest rates are inversely correlated. As bond prices fall, bond yields increase.) With interest rates rising so quickly, banks could not adjust their bond holdings. As a result, many banks have become undercapitalized on paper.
According to the FDCI, unrealized losses on securities climbed to $683.9 billion in Q3. That represented a 22.5% jump from the second quarter. Rising mortgage rates reducing the value of mortgage-backed securities drove the increase.
The BTFP gives banks a way out, or at least the opportunity to kick the can down the road for a year. Instead of selling bonds that have dropped in value at a big loss, banks can go to the Fed and borrow money at the bonds’ face value.
PAPERING OVER THE PROBLEM
The creation of the BTFP allowed the Federal Reserve to paper over the banking crisis its interest rate hikes created. But what happens when the loans come due?
In the first week of the BTFP, banks borrowed $11.9 billion from the program, along with more than $300 billion from the already-established Fed Discount Window.
The Discount Window requires banks to post collateral at face value and loans come with a relatively high interest rate and must post collateral at fair market value. While Discount Window borrowing surged in the weeks after the collapse of SVC and Signature Bank, the balances were quickly paid back down, and Discount Window borrowing returned to normal levels.
One would expect borrowing from a bailout program to slow down considerably once the crisis passed. But banks never stopped tapping into the BTFP. And borrowing suddenly accelerated in November.
Notably, the sudden spike in bailout borrowing happened even as the bond market rallied and bonds regained some of their value as the Fed eased off the rate hike accelerator. This ostensibly provided some relief on banks’ balance sheets.
Granted, the $133 billion outstanding appears insignificant compared to the $22.8 trillion in commercial bank assets held by the 4,100 commercial banks in the US. The fact that some troubled banks are still tapping into a bailout program nine months after the crisis doesn’t necessarily mean the banking system is on the verge of collapse. But while the bailouts might not be a fire, it’s at least smoke. There are still problems in the banking system bubbling under the surface.
This is a predictable consequence of the Fed raising interest rates to battle price inflation.
Artificially low-interest rates and easy money are the mother’s milk of this bubble economy. With everybody from corporations, consumers, and the federal government buried in debt, this economy and the financial system simply can’t function long-term in a high-interest rate environment. The banking crisis earlier this year was the first thing to break as a result of rising interest rates. Other things will follow. We’ve already seen some tremors in the commercial real estate market.
While you might be tempted to blame the Fed’s recent rate hikes for these issues, the real problem started years ago.
After the Great Recession, Federal Reserve policy intentionally incentivized borrowing to “stimulate” the economy. It cut rates to zero and launched three rounds of quantitative easing. After an unsuccessful attempt to normalize rates and shrink its balance sheet in 2018, the Fed doubled down on easy money policies during the pandemic. This monetary inflation inevitably led to price inflation. That forced the Fed to raise interest rates. The central bank appears to have cooled price inflation (for now), but it also broke the financial system.
In effect, the Fed managed to paper over the financial crisis with this bailout program. It slapped a bandaid on it. But it has not addressed the underlying issue – the impact of rising interest rates on an economy and financial system addicted to easy money.
And it’s only a matter of time before something else breaks.
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