Following the scare with Silicon Valley and Signature banks in 2023, the Federal Reserve started a special short term loan program in March 2023. The purpose was to “provide liquidity” for what they deemed financially sound institutions which nonetheless required additional funding for troubled bonds. However, the bonds are never described as “troubled” even though they are. The point is that this crisis was triggered because these banks had bought bonds with a 1% return rate. But the Fed raised rates and suddenly the bond market was flooded with offers 5% or more. Why buy something to get a 1% return, when you can get something, for about the same price, at 5%. So, these banks were now holding poor bond investments, but poor bond investments which lost a tremendous about capital value. Such bonds were now selling at subpar rates. So, instead of a par value of 100, now they were holding subpar bonds trading at 90 or less.
While perhaps exaggerated, one commentator described this program as a group of supports holding up a tall wobbly building. The suggestion is that taking away the supports will cause the bank to crash.
The program was started on March 13, 2023 and the banks were told this loan facility would be closed on March 11, 2024. Reportedly, just in the last few weeks, banks grabbed $165 billion in loans. Against a backdrop of trillions in outstanding debt, this is a small amount. Nonetheless, some express concern that bad loans or new liquidity squeeze’s can set off a domino effect. Well, enter stage left the overnight repo market.
Finally, there is a more diabolical reason to be suspicious of current banking activity. The commercial real estate (CRE) market is an outsized risk for regional and small banks. There is an ongoing expectation that the increase in interest rates will catalyze collapse of this banking sector.
In round numbers, over the last 5 or so years, small banks have shrunk from 17% to about 12%. Some see the current deterioration in the CRE market as part of an inevitable centralization of all banking. It is estimated that 70% of all CRE loans are held by the small banks. On its face this suggests small banks will collapse if the CRE market keeps getting worse. That is a reasonable expectation. However, there are many tools in the financial tool box of banks by which they can restructure these loans on the hope that the market will turn around over a longer period of time than the original loan.
There is a factor to consider. The links between the FBI, CIA, DHS and other surveillance agencies and the big banks are more extensive than most people appreciate. Killing the small bank sector will make the introduction of digital bank currencies that much easier along with the surveillance that goes with it. The CIA can hardly wait. However, the questions remain. What is really happening? Will there be a recession or not? Will banks collapse and there be no recession??
Who to believe? Look around at the confusing array of opinions about the financial markets. A remarkable number of accounts about the nation’s banks have suddenly turned dark and foreboding over the expiration of a temporary law passed by Congress in 2023 where additional loans were made for one year. We cite here one report that sounds particularly concerned. Well, that year was up on March 11th and the more negative prognosticators see bank runs and sudden closures in a matter of weeks if not sooner following the discontinuation of this liquidity for banks. These people may be over-reacting. The real question is how much risk are banks assuming in their bond portfolios?
Different banks have different investment philosophies when buy short and long term bonds. They will emphasize some bonds over others in order to optimize their returns. Silicon Valley and Signature banks were examples of mismanagement. Even though they had risky positions, better management would have avoided the problems which get them into trouble.
The termination of the Bank Term Funding Program is raising questions which cannot be answered yet. However, for background, the reader can start by consulting a FAQ the Federal Reserve. The language is difficult to understand, but one can infer from what is in the FAQ, that any other crisis that pops up will be kept under control.
The parting thought for this part is still the same. America’s financial system is incredibly resilient. Yes, you have these problems, but there are numerous ways to restructure loans, alter terms and condition, provide for forgiveness of debt.