As predicted, the Fed outdid itself last week as it announced its plan to bailout Silicon Valley Bank (SVB). Not only a bailout, but a radical (and probably illegal) proposal to insure 100% of all deposits at all banks.
"What do you mean 'bailout' Eric? The President assured us this was no bailout, and that taxpayers would not pay a dime!" Right, so get this — that was a lie.
Read on to understand all the nitty gritty details and to see the (potential) future horror of banking and inflation in America.
Table Of Contents
1) The Bailout
6) Conclusion
The Bailout
On Sunday March 12th, the Federal Reserve announced its new "Banking Term Funding Program" (BTFP). This new program is designed to put a halt to all banking concerns, not only in the US, but also for many foreign banks as well.
In a press release revealing the program to the public, the Fed described how the BTFP, along with changes in the FDIC, would accomplish its audacious mission of banking stability. It has a dual-pronged approach:
1) The BTFP will provide additional liquidity to banks, in order to secure the public from future banking crises
2) The FDIC will insure 100% of all deposits in order to protect the public (and incidentally banks) from banking failures
I'll discuss each prong so you can better understand how the Fed proposes to save SVB without saving it.
"Additional Liquidity": A Romance Story of Unsecured Loans, Inflationary Monetary Policy, and A Magical Central Bank
The first objective of the BTFP is to provide extra liquidity to banks during this time of "crisis" (and forevermore).
How does it propose to do this? It's quite simple, the Fed is going to "loan" banks the money.
Are these typical loans, with interest rates representing the risk of the loan? Do these loans have strict terms, fees, or penalties? Are they secured with collateral?
The answer to all, is no.
According to the press release, BTFP loans are one year renewable loans with no fees or penalties (in other words, the Fed is just giving the banks money). Here is the radical kicker: they are unsecured loans.
For those unfamiliar with the term, an unsecured loan is one where the creditor has no collateral for loan (no claim on additional assets from the debtor).
In plain English, it is a very risky loan. Why? Because if the debtor defaults, then the creditor is at a loss.
In the case of the BTFP loans, these loans are made against a bank's position in Mortgage-Backed Securities (MBS) and US Treasuries.
You mean the same treasuries and MBS that lost hundreds of billions of dollars in value last year? Those are the ones!
(If you have no idea what I am referring to, please take a look at my article on the SVB collapse).
To make this simple, let's imagine your bank purchased $100,000 of treasuries last year. Interest rates then doubled, and now the treasuries are worth $50,000.
The Fed is proposing to make a loan against your bank's $50,000 in treasuries, but at par value.
So, the Fed will loan your bank $100,000 using its treasuries (that are only worth $50,000) as collateral.
That means that $50,000 of the loan is unsecured. What happens if the bank then defaults on this loan? Well, then we are right back to where we started — a bank failure!
To avoid this, the Fed has guarantied the other half of the loan through — dah da da dah — the Treasury department!
The Treasury (aka the taxpayer) picks up the tab for the additional $50K.
So, yes, I regret to inform you that President Biden was less-than-truthful when describing how he planned to pay for the BTFP loans.
What's more, this first "prong" of the program creates several problems for the Federal Reserve.
First, it handcuffs the Fed's ability to raise interest rates. If the Fed raises rates, then it guarantees future defaults on these loans.
Remember that the value of bond portfolios at banks are inversely correlated to interest rates.
So, if rates go up, bond values go down, and a greater portion of BTFP loans will be borne by tax payers, as banks will be unable to pay off loans.
If the Fed cannot raise rates, then it's primary tool for fighting inflation is gone. This means inflation is likely to continue.
Second, there is the question of how the Fed will fund these loans.
Couldn't the Fed just use the money on its balance sheet for these loans? No.
The Fed currently has nearly $9T in treasuries and MBS, which make up the whole of its balance sheet (sounds oddly familiar).
The Fed cannot sell these securities in order to make the loans, because that would decrease the value of the bond portfolios at commercial banks even further.
As I already mentioned, that would increase the likelihood that banks default on these loans, increasing the likelihood that tax payers bail them out — again.
So what option does the Fed have left? Print new money! And wouldn't you know it, this also has an inflationary effect.
So, even if a bank does not default on these loans, the tax payer is still on the hook for the SVB bailout via the inflation tax.
These loans could create trillions of dollars in new money if widely adopted by banks, since banks currently have trillions of dollars stationed in treasuries and MBS
None of this has even touched on the truly disturbing aspect of these loans.
The Truly Disturbing Aspect Of These Loans
In all of this hubbub surrounding SVB, has anyone bothered to ask "If the Fed can just 'insure' a bank's investments, why couldn't it insure mine?"
In this era of farcical finance, the question seems entirely appropriate.
Which of us would seriously contend that the Fed could save us from losses in the stock market?
Can the Fed insure my stock portfolio against a loss? How about insuring the shares of all Fortune 500 companies from losses? Afterall, the financial performance of these companies has an impact on our daily lives that far out-stripes that of SVB.
Why not the shares of all companies in the US? The world?
If the Fed can save banks from investment losses, why not everyone?
When blown up to scale, the intense stupidity of this program becomes obvious to most people.
The reality is, the Fed cannot save banks from investment losses.
It can, for a time, take your money and use it to cover a bank's losses. And make no mistake, that is what is happening here.
But at the end of the day, the Fed has no more ability to simply "erase" financial problems for banks than it does to erase them for you. Evidently, two and two do not make five.
The most mesmerizing part of the Fed's act is that it has created a dangerous precedent for absolutely stupefying monetary policy in the future.
Insuring Deposits: Too Big To Fail Coming To A Bank Near You
The second prong of the Federal Reserve's banking stability plan is to insure 100% of SVB's and Silvergate's depositors (and presumably every other sizable bank that will fail in the future).
The Fed has set an outrageous precedent with this move, which Secretary Yellen and President Biden have glowingly endorsed.
Here's the problem: where do they get the money?
The FDIC has about $130B in reserves to pay out for deposit insurance. If it insures 100 percent of deposits in America — that's $22T it must now insure.
Paying just the depositors at SVB and Silvergate alone is already more money than the FDIC has available.
So where is the extra funding coming from?
You guessed it, the taxpayer (the US Treasury).
In addition to funding from the Treasury, the Fed has made it clear the the FDIC will also have access to BTFP loans from prong #1 above.
The main backbone of prong two, then, is the Federal Reserve's willingness to abandon any notion of a "soft landing" and simply print hundreds of billions or trillions of dollars until the problem goes away.
I would also note that the FDIC is a compulsory insurance program that charges a fee off of your deposits to get its funding. The FDIC does not fund itself from fees on the executive bonuses of bulge bracket banks.
So even if the FDIC had enough money to bailout SVB, it would still be at the expense of the taxpayer. In fact, it is.
All this to say nothing of the moral hazard created when the FDIC tells a bank it can risk all of its money and still be covered.
A Note About Bad Arguments From Conservatives
I've heard many conservative pundits address this issue, and a number of popular arguments have been repeatedly touted.
I would like to address one such argument, which goes something like this:
"This is a bail out of a bank where only rich people bank. Rich liberal democrats like Oprah, Prince Harry, tech bros, etc. The government shouldn't bailout rich people. The FDIC has enough money to insure the poor depositors at SVB, this bailout is just for the donors of the democrat party."
This is a bad argument. Conservatives should stop using this argument.
A principled conservative would suggest that the government's role in bailing out any bank for any reason, with any depositors, is dubious at best.
Whether they are Republican or Democrat, rich or poor, matters about as much as whether they prefer cheddar over swiss.
What matters is whether the government has any role to play in bailing out banks in the first place.
If the answer is yes, and if conservatives ceded that point decades ago, then it becomes inevitable that the government will abuse that power for its political purposes.
Conservatives should argue against the bailout based on its merits, the risks it poses, its costs, its constitutionality, etc.
Conservatives should likewise use this opportunity to make arguments against the role of government in banking in the first place.
If that is already granted, then we will convince no one that the government is doing something wrong when it exercises that role in the favor of its special interests.
Conclusion
So what hope is there for what remains of our monetary system?
Interestingly enough, both of these "prongs" to the Fed's plan seem to be illegal.
First, the Fed is not allowed to have any unsecured loans. It is currently trying to get around this requirement by having the taxpayer secure the loans.
Secondly, the FDIC's limits on depositor insurance are set by congress. The Federal Reserve has absolutely no power to declare that the limits do not apply in this case.
So is it possible some motivated group brings a suit against the Fed and takes it to the Supreme Court. Yeah, it's possible.
Is it likely? I don't think so. But we must hold on to the hope that we have.
Well this sucks. Hopefully the program ends after this one year, although that's probably wishful thinking. Great read, thanks!