Powell Says the Quiet Part Out Loud

The Fed Is Making It Up on the Fly

Did anyone else notice the Chairman of the Federal Reserve casually admit recently that our central bank has no long-term strategy for handling the banking crisis? Jerome Powell was asked recently, perhaps by someone who read this newsletter, what would happen in March of 2024 when loans begin coming due from the Bank Term Funding Program (BTFP). He literally said that they hadn’t thought that far ahead.

Powell & Co. created a $100+ billion bailout facility with no exit strategy, and now they talk about it like it’s nothing. The attitude extends even to major banking houses like Bank of America, which has openly admitted that it has hundreds of billions of dollars of unrealized losses on its books but expects to realize none of them. In other words, everyone, the Fed included, is acting like the BTFP is a permanent facility.

The BTFP allows banks to effectively dump depreciated assets on the Fed because Powell & Co. will accept them at par as collateral on 1-year loans. After creating systemic interest rate risk and coercing many banks onto the wrong side of the interest rate trade, the Fed papered over the problem with the BTFP.

The predicament of these banks mirrors the Fed’s balance sheet with $1.3 trillion in unrealized losses and its accumulation of negative remittances, labeled a deferred asset. Loaded with low-interest-rate assets on one side of the ledger and high-interest-rate liabilities on the other side, the predictable result is massive losses. The assets originated when rates were low, but the liabilities are being created today, at today’s higher rates. Two of the chief liabilities right now for the Fed are the interest on reserve policy and reverse repurchase agreement operations, both paying over 5% today, so the red ink is piling up. How bad are the accumulated realized losses at the Fed? Over $120 billion – with a “b”:

This is bad, and it’s worth noting that it takes a special level of incompetence to lose money when you have a money printer, but it’s a deviation from the problem at hand: unrealized losses and future losses at private banks. While discount window use has long since returned to normal and the FDIC is repaying its loans at a decent clip (after collecting higher assessment fees from your bank, which is passed on to you, by the way), the BTFP still looms large.

It would be one thing if all the depreciated assets handed over to the Fed as collateral were all Treasury bills, because their maximum term is 52 weeks. Since the reason for the BTFP was to alleviate interest rate risk and not default risk, that theoretically would solve the problem and the banks could walk away scot-free. When March 2024 comes around, the asset held by the Fed as collateral would have already turned into liquid cash and there’s no need to repay the principal. But that’s not the situation.

The last asset a bank would’ve given the Fed as collateral was a T-bill. For starters, because of their short terms, T-bills drop in price by less than Treasury notes or bonds when interest rates rise, so the mark-to-market losses are lower. T-bills would’ve been among the first depreciated assets sold in the leadup to the fiasco in March. Second, the soon-to-mature bills can easily be reallocated to new T-bills at higher interest rates upon maturity, alleviating the interest rate risk problem. The BTFP is loaded with long-term securities that will likely pay below-market rates for 2 to 30 years.

This has created a rachet effect with the new facility, where banks dumps securities on the Fed but can never really pay off the loans before the collateralized assets mature. That has pushed the BTFP to $114 billion, and it’s poised to continue creeping higher each time banks need cash and can’t liquidate the rest of their depreciated assets, except at a loss.

But the real question is “what happens on March 11, 2024?” Powell & Co. don’t seem a bit concerned about this doomsday countdown for the regional banks, and Treasury Secretary Janet Yellen sounds like she welcomes it, calling for further “consolidation” in the banking sector. The regional banks themselves (and a couple of big ones like BoA) don’t seem concerned in the least that they haven’t sufficiently cleaned up their balance sheets and secured an adequate cash position.

It’s possible that Powell & Co. are genuinely so bad at the banking business that the band aid they applied beginning in March 2023 was intended by them to be a long-term fix. Either that or they believed it bought them a year’s time to come up with a truly permanent solution. Clearly, Yellen’s preference in this regard is for Jamie Dimon to just “acquire” every small bank in the country—at taxpayer expense—and then reap massive profits, thereby creating a *checks notes* “safe and stable banking system.”

For the other bankers, they don’t seem too concerned that Powell & Co. are making everything up on the fly. Having tasted the sweet nectar that is a government bailout, the regional banks seem to want more, judging by their balance sheets. Instead of improving their position, especially regarding the interest rate trade, their balance sheets are arguably worse today than in late March or early April when total emergency lending peaked. Perhaps Powell & Co. are not the only ones content to make it up as they go.