Market Insights

Our Investment Committee's Thoughts
 

• The Bank Term Funding Program, set up to provide loans to distressed banks, is set to expire on March 11, despite a recent increase in loans to banks. However, the recent activity is not driven by distress but instead by an arbitrage opportunity, whereas many banks took advantage to make money, without risk, by gaining more interest from the Fed on bank reserves than it pays in interest.

 

• Following the Great Financial Crisis of 2008, banks were encouraged to hold less risky Treasury bonds. When excess COVID stimulus was deposited at banks in 2020 and 2021, they invested a significant portion of it in low interest long-term Treasury bonds that would lose value if interest rates increased.

 

• In 2022, the Fed aggressively raised rates to combat inflation, which caused Treasury bonds held by banks to lose a significant portion of their value, while making investing in Treasury bonds much more appealing. Investors started to pull lower interest generating bank deposits to buy higher yielding Treasuries, but when the banks had to sell the long-term Treasuries, they were forced to take a sharp loss. This was a Federal Reserve induced problem.

 

• In March of 2023, this scenario played out as a run that began at Silicon Valley Bank spread to other regional banks throughout the country.

 

• In response, the Fed created the Bank Term Funding Program, providing 1-year loans to swap cash for the long-term Treasuries so banks were not forced to sell at depressed prices, which allowed banks to meet their withdraw requests and restore confidence in the system.

 

• With the primary objective successful, banks have more recently used the program as a loophole to make free money by taking out loans they don’t need, because the interest charged on their loans from the Fed was less than the rate at which the government paid banks to hold reserves. Retiring this program will close that loophole.