Banks Still Need Fed Help As Pressure Mounts

In addition to providing needed capital to the struggling sector, the Federal Reserve has also provided an indication of how deep the problems go for the troubled sector as it demonstrates that the problem runs deep.

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It is believed that nearly $300 billion in liquidity was provided by the Federal Reserve in the days following the bankruptcy of Silicon Valley Bank and Signature Bank in the form of short-term loans, according to Fed data released late Thursday by the Fed. In the case of SVB and Signature, a good chunk of the money went to them, but a considerable amount was given to other banks that needed capital to remain operational.

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It was good news that banks were willing to ask for help from the Fed, and the Fed was willing and capable of helping. Unfortunately, there is bad news for them: The amount of help they needed was that high.

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Danielle DiMartino Booth, the former senior official at the Dallas Fed and CEO and chief strategist of Quill Intelligence, said, "We are in the sea of the unknown right now.".

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Financial sector uncertainty stems from the depth of the problems and how much assistance is needed.

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In the wake of the collapses of the two banks, the Federal Reserve started a pair of actions - on March 12 - which involved setting up a special lending facility called the Bank Term Funding Program as well as loosening the conditions of its discount window to allowing more borrowings to be made.

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It used to be known that a visit to the discount window was a sign that a customer was experiencing financial difficulties and could not raise capital through normal market channels due to financial difficulties. It is not uncommon for programs like the BTFP to have a stigma of their own, but in this case, the Fed made the conditions a bit simpler than those of the discount window.

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There is, however, no denying that banks borrowed from the discount window to the tune of $152 billion, but the uptake at the new program was only just under $12 billion, despite the fact that the new program offered one-year loans instead of 90 days with the discount window. As part of the BTFP program, securities offered for cash are paid for their par value, while those offered in exchange for cash are paid for their market value in the discount window.

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It is a deal that the discount window will take no prisoners. It will take all your thrown garbage, it will give you a haircut, and it will hook you up with a lifeline, but you will pay for it," Booth said, who used to advise the former Dallas Federal Reserve president Richard Fisher.

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She pointed out that the discount window has seen the largest uptake in history. And that is equivalent to the heights of the financial crisis in 2008 and other signs that the banking system is experiencing severe liquidity strains which are resulting in severely impaired credit creation in the future.

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Speculation also held that the lack of uptake on the BTFP could be due to its newness. Data released by the meeting this Thursday could provide a more precise picture of the amount of liquidity demand, and the fragility of the system as a whole.

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There was a lot of buzz on Wall Street when the demand for the two funding avenues reached its peak.

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The sharp increase in banks' emergency borrowing from the Fed's discount window indicates a serious financial strain on banks, caused in part by weakening depositor confidence after one bank winddown and two bank failures. As Moody's Investor Service noted in its report last week, banks are experiencing increasing difficulties in terms of funding and liquidity. According to Moody's Investor Service, the entire banking sector is facing a recession due to the recent stress.

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After the Fed's global dollar swaps program was implemented on March 12, a new initiative was rolled out on Sunday, which increased the frequency of the program from a weekly to a daily basis.

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The central bank joined forces with multiple global counterparts to head off any potential problems before they happen, though there doesn't seem to be any signs of dollar shortages. Similar announcements were made during other uncertain periods of the financial system, such as the 2008 financial crisis and the early stages of the Covid pandemic in 2020.

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ING's Padhraic Garvey, regional head of research, Americas, described the swaps move as 'precautionary' amid a bit of a rise in dollar demand, particularly from the European Central Bank.

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"There are a lot of safety nets in place now," Garvey explained. "The burning question is how strong are the weakest links, and how do we deal with them if they fall apart."

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On Tuesday, the Fed begins a two-day policy meeting that will tackle a wide range of issues.

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Chairman Jerome Powell will be called to explain the central bank's policy response after the meeting, while officials will offer some clues as to where the economy and financial system are headed.

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After a nine-month rundown of $573 billion during a process known as quantitative tightening, the Fed balance sheet rose to nearly $8.7 trillion during the first week of the new lending facility.

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A reminder was also provided that the Fed faces difficulties reducing its holdings of securities without altering the market's functioning once it pumps up its holdings of securities.

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Former Fed official Christopher Whalen, the founder of Whalen Global Advisory, says the Fed has learned in the past 30 days that quantitative easing worked well when it was buying bonds. Trying to stop it is difficult not only because it's hard to remove the liquidity, but also because of the massive purchases they made in 2021, they can't move.

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If the Fed decides to raise rates this week, it will have to take into account the various crosscurrents. According to Evercore founder Roger Altman, a pause could undermine confidence, since he believes that not raising rates could increase concerns about instability.

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Although the market is generally expecting a quarter-point increase this week, that isn't universally shared.

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Mark Zandi, the chief economist at Moody's Analytics, said raising interest rates would only make you appear detached from reality. "The system is obviously under a lot of stress, and an attempt to convince everyone it is not will just do the opposite."