On Sunday morning, March 12, Treasury Secretary Janet Yellen told CBS there would be no bailouts. Later in the day the Fed declared quantitative easing to infinity and beyond.
What’s going on?
Quite simply, the Fed is willing to overpay for debt (again). They call it the Bank Term Funding Program (BTFP), and as far as one can tell, its dollar value is limitless. The term sheet reads:
Program: To provide liquidity to U.S. depository institutions, each Federal Reserve Bank would make advances to eligible borrowers, taking as collateral certain types of securities.
And who is eligible?
Any U.S. federally insured depository institution (including a bank, savings association, or credit union) or US branch or agency of a foreign bank…
Basically everyone (i.e., not you or main street, just financial institutions) can take part in this legal counterfeiting operation.
So what’s being traded for newly created Federal Reserve notes?
Eligible collateral includes any collateral eligible for purchase by the Federal Reserve Banks in open market operations … provided that such collateral was owned by the borrower as of March 12, 2023.
Meaning: Practically any bank can exchange US Treasury (or even mortgage-backed securities, should they have held any on their books) with the Federal Reserve.
This program will be offered for one year at no charge to banks, and of course with no recourse!
The Fed explains:
Recourse: Advances made under the Program are made with recourse beyond the pledged collateral to the eligible borrower.
Now here’s the rub:
Collateral Valuation: The collateral valuation will be par value. Margin will be 100% of par value.
Therefore, if Wells Fargo or Bank of America owns US debt that is trading at fifty cents on the dollar, they can trade it with the Fed which will pay one dollar. In theory, it’s only an unrealized and temporary loss for the Fed because once the debt comes due, it will be paid in full. So the Fed won’t suffer a loss, nor will the bank.
The Fed will purposely pay an amount above market value on debt held by banks. The banks will receive this newly created money and get rid of their unrealized losses. Afterward, the banks will have to do something with this new money, such as buy more debt. We can only guess, but whatever the banks do with the money, it will most certainly be highly lucrative for them, push asset prices up, and further erode whatever is left of the middle class. It will also offer a new way for banks to make even riskier bets that will land them in more trouble in the future.
It is theft, a moral hazard, anti-capitalistic, and even antagonistic to those forced to pay taxes and work for a living. But still more questions remain, specifically: How large is this program? Are we talking a few billions or trillions of dollars? At one extreme, this program serves as a confidence booster more than anything; it’s public messaging. Very few banks will accept the generous offer. But it will provide public assurance that the Fed will insure deposits, keep banks from panic selling bonds at a loss, and quell any ideas of a bank run.
If this is the case, then the Fed has bought a little more time until the next panic sets in.
At the other extreme, every bank in America lines up to receive free money from America’s central bank. The Fed will eventually expand its balance sheet by trillions of dollars more, and they’ll tell us that it would have been worse if it weren’t for the Fed.
As for the Fed’s commitment to reducing the balance sheet, we’ll know the answer to this soon enough! Few things are certain at the moment, but it sure is a good day to be a banker.
