Fed’s new backstop shields banks from US$300 billion of losses

US authorities took extraordinary measures to shore up confidence in the financial system after the collapse of Silicon Valley Bank (SVB), introducing a new backstop for banks that Federal Reserve (Fed) officials said was big enough to protect the entire nation’s deposits.

The Sunday announcement by the Treasury Department, Fed and Federal Deposit Insurance Corporation (FDIC) followed a frantic weekend that saw the surprise closure of New York’s Signature Bank along with mounting concerns about spillover effects to other regional lenders and the wider economy. 

Regulators acted on a number of fronts to contain the potential fallout:

• The FDIC said it will resolve SVB in a way that “fully protects all depositors”. Similarly, “all depositors” at Signature will be made whole.

• The Fed also announced a new “Bank Term Funding Programme” that offers one-year loans to banks under easier terms than it typically provides. US$25 billion is available.

• The central bank relaxed terms for lending through its discount window, its main direct lending facility.

The response helped soothe investors worried about additional bank runs or the risk a fresh financial crisis would trigger a recession. US stock futures climbed on Monday after bank shares plunged last week by the most since the March 2020 pandemic shock.

In the UK, HSBC began Monday (Mar 13) by announcing it was acquiring the UK arm of SVB, the culmination of a weekend where ministers and bankers explored various ways to avert the SVB unit’s collapse.

Under the new US programme, which provides loans of up to one year, collateral will be valued at par, or 100 cents on the dollar. That means banks can get bigger loans than usual for bonds, reducing the pressure to generate cash by selling securities whose prices have tumbled.

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There were some concerns that the taxpayer could now be on the hook for covering losses suffered by banks and that questionable management and investments were now being protected by the government. 

Banks, for example, now can limit accepting losses or selling assets given they have access to easier funding. US banks were sitting on more than US$300 billion of losses on securities they planned to hold to maturity at the end of 2022.

On Mar 8, SVB’s parent company, SVB Financial Group, revealed it had sold US$21 billion of securities from its portfolio at a loss of US$1.8 billion. The Fed’s new safety net may have helped it avoid doing so.

“If the Fed is now backstopping anyone facing asset/rates pain, then they are de facto allowing a massive easing of financial conditions as well as soaring moral hazard,” said Michael Every and Ben Picton, strategists at Rabobank.

SVB’s meltdown offered an illustration of the costs of the Fed’s most aggressive monetary tightening campaign since the early 1980s. The lender had plowed money into longer-term bonds during the pandemic, the market values of which dropped as yields then soared. Meantime, SVB’s funding costs surged as the Fed kept jacking up its benchmark.

Fed officials said on a briefing call that their new facility was invoked under its emergency authority allowing for the establishment of a broad-based programme under “unusual and exigent circumstances”, which requires Treasury approval. It was unanimously approved by the Fed board.

The Treasury will “make available up to US$25 billion from the Exchange Stabilization Fund as a backstop” for the bank funding programme but the Fed doesn’t expect to draw on the funds, officials said.

With a senior Treasury official cautioning there were other banks that appeared to be in similar situations to SVB and Signature, the regulators’ top concern was assuring businesses and households they were made whole on their deposits. 

US Treasury Secretary Janet Yellen said the actions taken on Sunday will protect “all depositors”, signalling aid to those whose accounts exceed the typical US$250,000 threshold for FDIC insurance.

Normally, under the Fed’s main lending programme, known as the discount window, the Fed typically lends money at a discount against the assets provided as collateral, a practice known as haircuts. 

The central bank said the loans under the discount window, which are up to 90 days, will now be subject to the same collateral margins as the new bank funding facility.

The Fed’s emergency lending programme is “an admission not only of systemic risk but that the risks are so unusual and exigent that failure to invoke this liquidity could create a financial crisis,” said Peter Conti-Brown, associate professor at the University of Pennsylvania’s Wharton School.

US regulators emphasised that taxpayers won’t be on the hook for protecting SVB and Signature deposits, and Treasury and Fed officials rejected the idea that the banks are being bailed out – showcasing the potential political sensitivities of the weekend moves. The regulators said shareholders and certain unsecured debt holders will be wiped out, while management was fired.

President Joe Biden, in a statement Sunday night, said the solution “protects American workers and small businesses, and keeps our financial system safe.”

For the Fed, the collapse of two powerhouse regional banks will test their resolve as they decide their next move on rates. Chair Jerome Powell just last week opened the door to a re-acceleration to a 50 basis-point hike at the Fed’s Mar 21-22 meeting. 

Financial ructions may raise the bar for such a move, however.

While economists at JPMorgan retained their forecast for a quarter-point rate hike by the Fed next week, their counterparts at Goldman Sachs said they no longer expect the Fed to raise rates.

“While the Fed wants tighter financial conditions to restrain aggregate demand, they don’t want that to occur in a non-linear fashion that can quickly spiral out of control,” Michael Feroli, chief US economist at JPMorgan Chase, wrote in a note to clients. “If they indeed have used the right tool to address financial contagion risks (time will tell), then they can also use the right tool to continue to address inflation risks – higher interest rates.” BLOOMBERG