How Bankers are Exploiting the Fed’s BTFP at Your Expense

American bank depositors sincerely trust the Federal Deposit Insurance Corporation (FDIC).  They are as certain as the sky is blue, that the FDIC will protect the money in their bank accounts.  Thus, they do not withdraw dollars from their accounts in a banking crisis.

This confidence has minimized the outbreak of full-blown bank runs at American banks since the FDIC was established in 1934.  But that doesn’t mean fractional reserve banking isn’t fundamentally flawed.

When you have an interest-bearing savings account at a bank, you’re the bank’s customer.  But you also supply the product.

In fact, the modern banking system is built on the lie that the bank will pay you interest by lending out your deposit, but that you can also get your money back at any time – wink, wink.  The FDIC serves to make this lie true.

The most common reason for a bank failure is that the bank has loaned money to purchasers of longer-term assets, such as real estate, which isn’t paid back for years, yet depositors have the right to withdraw money at any time.  The banks borrow short and lend long.

This works mostly well most of the time.  Say the bank earns 7 percent on a home loan while paying depositors 2 percent.  The bank pockets the spread, the net interest margin.  Easy money.

All banks do it.  Every single one of them.  The ones that fail have merely indulged in long-term lending more than the average bank.  In these instances, the FDIC acts quickly to sweep the mess under the rug.

Community Service

To document the success of the unique community service it provides, the FDIC publishes a running list of every U.S. bank that has failed since October 1, 2000.  At the time of this writing, this FDIC list includes 568 bank failures.

On average, this comes to about 24.7 bank failures per year.  Of course, some years are worse than others.  While other years are better than some.

For example, no banks failed between October 24, 2020, and March 11, 2023 – a stretch of roughly 28 months.  But in 2010, there were 157 bank failures.  Hence, a bank failure occurred every 2.3 days, including weekends and holidays, for the entire year.

By comparison, the number of bank failures in 2023, while a six year high, has been relatively moderate.  With just 11 days remaining in the year, that number stands at five.  These include Silicon Valley Bank, Signature Bank, First Republic Bank, Heartland Tri-State Bank, and Citizens Bank.

There was also the demise of Silvergate Bank.  Though it met its end through voluntary self-liquidation rather than overt failure.  So, it did not make the FDIC’s list.

What’s notable about the FDIC’s list of 2023 bank failures is not so much the number, but the magnitude.

The largest bank failure in U.S. history was Washington Mutual Bank.  It bit the dust on September 25, 2008, with $307 billion in assets on the books.

After that comes First Republic, Silicon Valley Bank, and Signature Bank.  These banks, having had respective assets of $212 billion, $209 billion, and $110 billion, all disappeared from the face of the earth in 2023.

As the year approaches its close it’s important to revisit what precipitated these mega bank failures, how the Federal Reserve responded, and how bankers are now exploiting the response to line their pockets at your expense.

The Era of Digital Bank Runs

To understand what went wrong for these banks in 2023 you must understand what happened in the preceding years.  When federal, state, and local governments shutdown the economy as part of the coronavirus fiasco the Fed answered the call with extreme credit market intervention.

In short, the Fed pressed the federal funds rate to zero and held it there for 2 years (March 2020 to March 2022) while pumping $5 trillion of credit created from thin air into Treasuries and mortgage-backed securities.  This drove yields across the range of maturities to 5,000-year lows.  And by 2022 consumer price inflation was raging at a 40-year high.

To combat the consumer price inflation of its making, the Fed jacked up the federal funds rate starting in March 2022, inverting the yield curve.  Short term yields went higher than long term yields.  And banks, having borrowed short to lend long, had negative carry.

Perhaps it would have all worked out for the banks if depositors stayed put.  But in a world where you can score nearly 5 percent from Treasury Direct – with no brokerage fees – why keep excess deposits in the bank when you only get a fraction of a percent?

This insight simultaneously dawned on customers at Silicon Valley Bank on March 9, 2023.  On that day, SVB customers withdrew more than $1 million per second for 10 hours straight – totaling $42 billion – before the FDIC seized the bank and declared it insolvent.

This, in essence, was an old-fashioned bank run with a twist.  The digital age pushed the bank run into hyperdrive.

Fake Insurance

SVB isn’t the first bank to go bust borrowing short and lending long.  It also isn’t the last.  There already have been several others.  Citizens Bank, on November 3, being the most recent.  Certainly, there will be many, many more.

Quite frankly, we don’t care what banks go bust.  What we’re really interested in is what happens after these banks go bust.

In theory, if you have deposits under $250,000 in a bank that fails you are protected by the FDIC.  But how safe is your money, really?

Several weeks ago the FDIC reported its Deposit Insurance Fund had a balance of $117 billion.  This comes to a reserve ratio of 1.10 percent of the total insured deposits.

By our estimation, insurance reserves of 1.10 percent of potential obligations are not real insurance.  Rather, these reserves are fake insurance that pays for an extremely fragile trust which says, ‘if you don’t pull your deposits, I won’t pull mine.’

In a real panic, FDIC reserves would be vaporized in less than a day.  Still, confidence remains the name of the game.  And when the majority of depositors have balances greater than $250,000, as was the case at SVB and Signature Bank, the FDIC’s fake insurance doesn’t cut it.

In a fiat money system, the supply of credit is without limit.  The question, however, is a question of quality.  As excess credit is issued, repeatedly, to bailout the banking system, the quality of that credit ultimately turns to bird cage liner.  The actual break point, however, is unknown.

After the rash of big bank failures in March, the Fed rolled out something called the Bank Term Funding Program (BTFP) to fill the void of FDIC’s coverage limitations.  What you need to know about the BTFP is that it’s code for socializing losses.

And like any ‘heads I win, tails you lose’ government program for the big banks, it is ripe for exploitation.

How Bankers are Exploiting the Fed’s BTFP at Your Expense

The BTFP offers loans up to one year to banks that pledge U.S. Treasuries and agency debt as collateral valued at par.  The rate for these loans is the one-year overnight index swap rate plus 10 basis points.

To be clear, the BTFP has nothing to do with free market capitalism.  It is an instrument of central planning, instituted by the Fed, to bail out the reckless decisions of its cohorts in the banking sector.

Yet rather than graciously accepting their gift, and the gift of forthcoming rate cuts, bankers are now exploiting the spread between the Fed’s overnight rate and the BTFP rate to line their pockets.

Expectations of a Powell pivot, and the recent decline in Treasury yields, have inadvertently delivered a unique arbitrage opportunity.  Lou Crandall, of Wrightson ICAP, recently detailed the scam in a note to clients:

“At first glance, that 10 basis point markup might appear to qualify as the kind of penalty rate typically associated with ‘lender of last resort’ facilities.  In practice, however, the BTFP pricing formula turns it into a subsidy rate when the yield curve is downward sloping.

“The drop in BTFP borrowing costs means that there’s a larger arbitrage for banks to take advantage of, where institutions borrow from the facility [BTFP] and then park the proceeds in their account at the Fed to earn interest on reserve balances — currently 5.40 percent.  That spread is currently 44 basis points after jumping to 51 basis points on Dec. 14.”

This rate-arbitrage subsidy for banks, made possible by playing Fed policy and Fed programs off of each other, is free money for bankers.

The deadline for new BTFP loans expires on March 11, 2024.  But, alas, like the advent of quantitative easing in 2008, these programs – and the moral hazards they provoke – never go away.

The Fed’s future playbook has been revealed.  When the next liquidity crisis arrives in 2024, perhaps from the impending commercial real estate apocalypse, the Fed will be poised to deliver its next iteration of the BTFP.

And, once again, bankers will line their pockets at your expense.

Merry Christmas!

[Editor’s note: Today, more than ever, unconventional investing ideas are needed.  Discover how to protect your wealth and financial privacy, using the Financial First Aid Kit.]


MN Gordon
for Economic Prism

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