Another Fed Intervention: Lender Of Last Resort
The Federal Reserve balance sheet increased by $300 billion since last week, leading to debate about whether these actions qualify as quantitative easing, but the bigger issue is systemic fragility.
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The Lender Of Last Resort
Just days after the fallout from Silicon Valley Bank and the establishment of the Bank Term Funding Program (BTFP), there’s been a significant rise in the Federal Reserve’s balance sheet after a full year of decline via quantitative tightening (QT). The PTSD from extensive quantitative easing (QE) is causing many people to sound the alarms, but the changes in the Fed’s balance sheet are a lot more nuanced than a new regime shift in monetary policy. In absolute terms, it’s the largest increase in the balance sheet we’ve seen since March 2020 and in relative terms, it’s an outlier that’s catching everyone’s attention.
The key takeaway is that this is much different than the QE spree of asset buying and the stimulative easy money with near-zero interest rates that we’ve experienced over the last decade. This is about select banks needing liquidity in times of economic distress and those banks getting short-term loans with the goal of covering deposits and paying the loans back in quick fashion. It’s not the outright purchase of securities to indefinitely hold on the balance sheet from the Fed, but rather balance sheet assets that should be short-lived while continuing QT policy.
Nonetheless, it is a balance sheet expansion and a liquidity increase in the short-term — potentially just a “temporary” measure (still to be determined). At the very least, these liquidity injections help institutions not become forced sellers of securities when they otherwise would be. Whether that’s QE, pseudo QE, or not QE is besides the point. The system is showing fragility once again and the government has to step in to keep it from facing a systemic risk. In the short-term, assets that thrive on liquidity increase, like bitcoin and the Nasdaq which have ripped higher at the exact same time.
However, this is not an overall bullish, sustained sign for the market that the Fed must use its lending of last resort powers. Historically, bear markets face the worst drawdowns after the Fed intervenes and reverses policy via rate cuts.
This specific increase of the Fed’s balance sheet is due to a rise in short-term loans across the Fed’s discount window, loans to FDIC bridge banks for Silicon Valley Bank and Signature Bank and the Bank Term Funding Program. Discount window loans were $152.8 billion, FDIC bridge bank loans were $142.8 billion and BTFP loans were $11.9 billion for a total of over $300 billion. Continuing with their QT policy, the Federal Reserve Statistical Release stated:
“Factors affecting reserve balances of depository institutions (table 1) "other credit extensions" reports loans that were extended to depository institutions established by the Federal Deposit Insurance Corporation (FDIC). The Federal Reserve Banks' loans to these depository institutions are secured by collateral, and the FDIC provides repayment guarantees.”
The more alarming increase is in the discount window lending as that is a last resort, high cost liquidity option for banks to cover deposits. It was the largest discount window borrowing on record. Banks using the window are kept anonymous as there is a legitimate stigma issue from finding out who’s in need of short-term liquidity.
Source: WSJ, Federal Reserve
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Why this liquidity injection is reminiscent of 2019. 💉
Expectations for the FOMC meeting next week. 📂
Potential Federal Reserve intervention in the future. 🔮