Quantitative Easing Or Not? A Primer On The Fed’s Shiny New Tool
The debate around whether or not the Bank Term Funding Program is a form of quantitative easing overlooks the most important point: Liquidity is the name of the game for global financial markets.
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Quantitative Easing Or Not?
The Bank Term Funding Program (BTFP) is a facility introduced by the Federal Reserve to provide banks a stable source of funding during times of economic stress. The BTFP allows banks to borrow money from the Fed at a predetermined interest rate with the goal of ensuring that banks can continue to lend money to households and businesses. In particular, the BTFP allows qualified lenders to pledge Treasury bonds and mortgage-backed securities to the Fed at par, which allows banks to avoid realizing current unrealized losses on their bond portfolios, despite the historic rise in interest rates over the past 18 months. Ultimately, this helps support economic growth and protects banks in the process.
The cause for the tremendous amount of unrealized losses in the banking sector, particularly for regional banks, is due to the historic spike in deposits that came as a result of the COVID-induced stimulus, just as bond yields were at historic lows.
Shown below is the year-over-year change in small, domestically chartered commercial banks (blue), and the 10-year U.S. Treasury yield (red).
TLDR: Historic relative spike in deposits with short-term interest rates at 0% and long-duration interest rates near their generational lows.
The reason that these unrealized losses on the bank’s security portfolios have not been widely discussed earlier is due to the opaque accounting practices in the industry that allow unrealized losses to be essentially hidden, unless the banks needed to raise cash.
Shown below is the year-over-year change in cash assets of small, domestically chartered commercial banks.
The BTFP enables banks to continue to hold these assets to maturity (at least temporarily), and allow for these institutions to borrow from the Federal Reserve with the use of their currently underwater bonds as collateral.
The impacts of this facility — plus the recent spike of borrowing at the Fed’s discount window — has brought about a hotly debated topic in financial circles: Is the latest Fed intervention another form of Quantitative Easing? Is all balance sheet expansion created equal?
In the most simple terms, quantitative easing (QE) is an asset swap, where the central bank purchases a security from the banking system and in return, the bank gets new bank reserves on their balance sheet. The intended effect is to inject new liquidity into the financial system while supporting asset prices by lowering yields. In short, QE is a monetary policy tool where a central bank purchases a fixed amount of bonds at any price.
A similar policy tool that can be viewed as an even more heavy-handed approach is yield curve control (YCC), where the central bank focuses on targeting specific interest rates along the yield curve of the government bond market. While similar to QE, YCC control can be thought of as a monetary policy tool where the central bank purchases a potentially unlimited amount of bonds to keep the market at a fixed price.
Now, let’s examine the Bank Term Funding Program.
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Comparisons between BTFP and yield curve control. 🚨
Looking back to the Fed intervention in the overnight repo market in 2019. 🌊
The way out of 120% debt-to-GDP… 🚧
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