Strategists at JPMorgan Chase predict that the Federal Reserve’s emergency lending program to bolster stressed banks could inject as much as $2 trillion into the U.S. banking system, with some analysts raising concerns that the program could fuel inflation or boost moral hazard.
Following the abrupt failures of Silicon Valley Bank (SVB) and Signature Bank, the Federal Reserve rolled out an emergency funding mechanism called the Bank Term Funding Program to ensure banks ample have access to cash to meet depositor demand.
“The usage of the Fed’s Bank Term Funding Program is likely to be big,” JPMorgan strategists wrote in a client note Wednesday.
The strategists said that the maximum usage for the emergency lending facility is close to $2 trillion. They said it would be able to provide the U.S. banking system with enough funds to reduce reserve scarcity and reverse the central bank’s recent tightening of financial conditions.
While the U.S. banking system has reserves of around $3 trillion, a large part of that is held by the biggest banks, and it will be the smaller banks that are more likely to tap the Fed’s lending mechanism.
SVB, a midsized bank, collapsed when depositors rushed to withdraw their savings as word spread that the bank had booked huge losses on its bond portfolios, which had eroded in value due to rising interest rates. The bank took a $1.8 billion loss on a forced $21 billion bond liquidation and then announced it was looking to raise $2.25 billion in capital to fill the gap, with the announcement spooking depositors, who rushed for the exits.
A mechanism like the one the Fed rolled out since the collapse of SVB would have allowed it to borrow against the face value of its bond holdings to meet its funding needs rather than sell its Treasury holdings at market rates at a deep loss.
‘New Form of Quantititave Easing’?
FDIC chair Martin Gruenberg warned recently that U.S. banks are sitting on unrealized losses on their bond holdings of around $620 billion.
“Unrealized losses on securities have meaningfully reduced the reported equity capital of the banking industry,” he said, explaining that unrealized losses weaken the ability of banks to meet unexpected liquidity needs because they generate less cash when sold and because their sale often reduces the amount of regulatory capital.
Gruenberg added, however, that banks in the country are “generally in a strong financial condition and have not been forced to realize losses by selling depreciated securities.”
The Fed’s new funding facility gives banks an additional security blanket because it allows them to borrow from the Fed for a one-year period using their securities as collateral at par value, not at market rates.
“Basically, this is a facility that provides collateralized liquidity for banks that can’t obtain it elsewhere,” ING analysts said in a note, adding that it’s a “means of making liquidity available on good terms, at least until the current period of elevated systemic pressure passes.”
But some experts have warned that the Fed’s emergency backstop could be inflationary.
“The SVB rescue package is essentially a new form of quantitative easing,” Nigel Green, CEO of wealth advisory DeVere Group, told Forbes.
Quantitative easing (QE) is the term given to the Fed’s bond-buying program launched during the financial crisis of 2008–09 in order to stabilize the financial system. QE dramatically increased the amount of money in circulation, putting upward pressure on prices.
“If the bank crisis is limited to just a few banks, then the actions taken on Sunday by the Fed and Treasury will prove inflationary,” said Tom Esssaye, an analyst at Sevens Report.
Joseph Wang, chief investment officer at Monetary Macro, sees the Fed’s funding facility as part of a bailout that will increase the likelihood of risky behavior.
“I think there is a moral hazard aspect to this,” Wang told Marketplace in an interview.
Moral hazard is the idea that when people are protected from the negative consequences of their risky actions, such as through bailouts or other safety nets, they will be incentivized to take those actions again.
“This is basically the biggest bailout to the banking sector” since the financial crisis of 2008–09, Wang said in the interview.
“In central banking, one of the basic tenets is you lend to solvent banks with good collateral at above-market rates because the role of a central bank, as we understand, is to be a lender of last resort.”
“But that [new] bank facility, it breaks all those tenets.”
The Fed said in a statement (pdf) that it will report the use of the emergency program on its weekly H.4.1 statistical release.
From The Epoch Times