by
Minneapolis
CNN
—
Last week, the Fed’s biggest concern was a stubbornly high rate of inflation and how much it could push monetary policy to tighten.
In recent days, a new bogeyman has emerged in the form of a trio of bank failures and the chilling specter of a financial crisis.
To prevent the latter, the Fed offered a solution that seemed to contradict its hawkish flight path: looser wallets.
On Sunday, the central bank announced the creation of the Bank Financing Program, which will provide one-year loans to banks, credit unions and other financial institutions that offer collateral such as U.S. Treasuries, agency debt and mortgage-backed securities.
These investments are usually safe, but have collapsed in value during the Fed’s aggressive rate hike campaign. Banks had about $620 billion in unrealized losses at the end of last year, according to the FDIC. So the Fed’s new facility would allow banks to swap them for a loan of up to a year’s worth of the original value of the assets they put up as collateral.
The Fed is operating on a bit of a “push and pull” in offering this liquidity option at a time when it is seeking to cool the economy, but the potential benefits of taking action outweighed the risks, economists say. The program is designed to be used in an emergency to prevent the next SBV from failing – not to start a new era of free spending.
“The BTFP is a form of monetary easing, but only to prevent what could otherwise be a liquidity crisis in the banking system and a severe tightening of monetary policy,” said Mark Zandi, chief economist at Moody’s Analytics. “I don’t think the BTFP will ultimately lead to a significant increase in bank lending and thus economic growth and inflation.”
By offering emergency funding, the Fed is fulfilling its role, first and foremost, as a lender of last resort, said Claudia Sahm, a former Fed economist and founder of Sahm Consulting.
“Long ago monetary policy was something they did [the Fed adopted its dual mandate in 1977], the Fed’s primary role was to calm financial markets, to step in when there was a possibility of bank runs, to keep money flowing,” he said. “Unfortunately, they’ve had some experience with this in the last 10 to 15 years, with the financial crisis, with the onset of the pandemic.”
While the Fed’s mandate specifies “maximum stability of employment and prices,” the key factor is financial stability, said Joe Brusuelas, chief economist for RSM US.
That means the Fed can still fight inflation even as it bolsters the banking sector.
“The outlook around hiking rates at the same time is clearly not good, but these things are not mutually exclusive as the central bank deals with a modest financial panic and prevents further banking disasters in the first place,” he said.
While the Fed’s new program is a great move to ensure banking stability, the Fed is in the business of lending every day, Brusuelas noted.
“The Fed buys and sells government securities every day to keep the range of its policy rate — the federal funds rate — between 4.5 percent and 4.75 percent,” he said. “They do this every day and it is normal for the central bank to inject and withdraw liquidity from the market to achieve its policy objectives.”
The start of the new program may cause a “very small delay” in returning the inflation target to 2 percent, and the Fed may pause temporarily, but the central bank is expected to continue raising interest rates, he said.
The Fed did this to ensure confidence in the banking system and provide a mechanism to deal with the $620 billion in unrealized losses, according to Brusuelas.
It appears that the action taken by the Fed, the Treasury Department and the FDIC this weekend has effectively eliminated the risk of SVB’s collapse turning from a disaster to a systemic issue, said Alex Pelle, US economist for Mizuho Americas.
“What previously took months and quarters has taken policymakers days and hours,” he said in a note Monday afternoon. “As a result, the economy is unlikely to experience the traditional credit crunch that we have seen over the past several business cycles in the post-Volcker era.”
The length and breadth of the Fed’s rate hike campaign over the past year caused some concern among economists, including Sahm, that the rapid increases would create weakness in financial markets.
“If you have china and you do something stupid and leave a bull in the china, you’re breaking things,” he said. “SVB were a bull going to the bullseye and they made some extremely bad decisions. … But the Fed helped create this environment that was going to be susceptible to something like SVB emerging.”
The Fed’s rate hikes contributed to Silicon Valley Bank’s collapse in two ways: Higher borrowing costs hurt the industry’s profits and ability to raise capital, forcing tech companies to pull their bank deposits to finance their operations. And interest rate hikes have undermined the value of Treasury bonds that banks rely on as a source of capital, Brusuelas said.
However, the risk of concentration (in cryptocurrencies and technology) combined with lax balance sheet management were the direct causes of the collapse of SVB, Signature and Silvergate, he added.
“It seems to me that blaming the Fed here is an exercise in deflecting blame for management’s decisions on these banks to borrow short, lend long and not tend to an effective interest rate risk management strategy,” he said.
By offering a discount window to deal with a liquidity crunch, the Fed put a floor under banks to stabilize the broader financial system, Brusuelas said. Once that returns, the central bank can turn its focus back to restoring price stability, he said.
“If the crisis intensifies, the Fed will probably lean toward the priority of financial stability for a short period of time,” he said, noting that a further deterioration this week could prompt Fed policymakers to hold off on its rate hikes.
“But until we get to the next meeting [in May]I think we will probably see a resumption of economic tightening by the Fed in terms of further hikes.”
At this stage, the Fed’s sole objective is to stabilize financial markets and, in particular, the banking sector, Sahm said.
“What we’re going to do next week with interest rates is really beside the point right now,” he said. “If they don’t get it under control, it’s bad. We are standing on the edge right now and the consequences if we go over the edge are not good.”
CNN’s Matt Egan contributed to this report.
