The Federal Reserve, Treasury Department and Federal Deposit Insurance Corporation took decisive action Sunday to stem what was clearly a potential bank run.
The $25 billion Bank Term Funding Program, announced Sunday night, was necessary to prevent a much larger crisis that would spread through the financial channel to the real economy and almost certainly tip the economy into recession.
The Bank Term Funding Program was necessary to prevent a much larger crisis.
The critical point here is that by accepting collateral at par—if a bank owns bonds that are trading at 60 cents to the dollar it can exchange it at the Fed’s discount window for $1 in liquidity—this effectively removes the risk of a bank run.
What’s more, it clears the way for the Fed to increase its policy rate by 25 basis points on March 22 at its next policy meeting.
The Fed will want to strike a careful balance between restoring price stability and financial stability so soon following a near miss on a financial panic.
Bank runs cause real economic damage, and the action taken by the Fed, Treasury and FDIC intends to avoid a much larger and more expensive set of policies later.
The time to stop a bank run is before it begins. It is easier for the central bank, Treasury and FDIC to step in now rather than wait for a “white knight” to step forward with a private capital solution.
That white knight did not step forward, requiring the large and decisive action taken.
The collapse and seizures of banks in the past week created the conditions for a classic run on banks that borrow short and lend long.
The mix of illiquid assets like business or mortgage loans and liquid liabilities like deposits, which may be withdrawn at any time, can easily give rise to self-fulfilling panics.
That is an apt description of the current moment and is what necessitated the creation of the $25 billion financing program.
The primary policy objective of the Bank Term Funding Program is to restore confidence in the banking system and protect the real economy by preventing a bank run.
In our estimation the policy approach put forward is the appropriate framework to address a liquidity crisis.
Financing will be made available through the creation of a new Bank Term Funding Program, offering loans of up to one year to banks, savings associations, credit unions and other eligible depository institutions pledging U.S. Treasury bonds, agency debt and mortgage-backed securities, and other qualifying assets as collateral.
These assets will be valued at par. The BTFP will be an additional source of liquidity against high-quality securities, eliminating an institution’s need to quickly sell those securities in times of stress.
Depository institutions may obtain liquidity against a wide range of collateral through the discount window, which remains open and available. In addition, the discount window will apply the same margins used for the securities eligible for the BTFP, further increasing lendable value at the window.
While all depositors will be made whole, shareholders and certain unsecured debtholders will not be protected. Senior management has also been removed. Any losses to the Deposit Insurance Fund to support uninsured depositors will be recovered by a special assessment on banks, as required by law.
This is a policy put in place to protect deposits and is not a bailout of the bank, shareholders or debtholders.
The Federal Reserve also announced it will make available additional funding to eligible depository institutions to help assure banks have the ability to meet the needs of all their depositors.