Mind on Money: End of bank ‘band-aid’ could open old wounds

Mind on Money: End of bank ‘band-aid’ could open old wounds

At the start of 2024 I had concerns about a couple of upcoming issues expected to unfold throughout the year. To name a few, items such as movement in interest rates, the unfolding of the pre-election cycle and the election itself were all occupying parts of my investor psyche. In addition to these popular concerns another lower profile topic with a set expiration threshold was also on the list. And the threshold on this item was crossed this week.

What I am referring to is a technical sounding financial program being implemented by the Federal Reserve called the Bank Term Fund Program, or BTFP. The BTFP is a policy rolled out fairly quickly around this time last year for the purpose of stabilizing the banking system.

As a refresher, remember the blissfully low interest rates borrowers enjoyed from 2009 to 2021? For some great examples, the mortgage on my home has a 2.75% interest rate, the interest rate on my wife’s Ford Explorer purchased in November 2021 is zero. I used to have a home equity loan with a rate of 3%. Money was cheap for over a decade, like the words to the '80s hair band song, “you don’t know what you got til it's gone.” And boy is it gone.

While we were all enjoying cheap money, the banks, on the other hand, struggled. Not only were American banks getting low interest on their consumer and business loans, but the investments the banks were encouraged to buy with their own capital (kind of like a bank emergency fund) by regulation, aka U.S. Treasury bonds and U.S. Agency mortgage-backed securities, were also paying low interest rates. As banks searched for some sort of investment yield during this long period of low interest rates, many desperately purchased piles of long-term bonds, because long-term bonds were expected to pay the higher yields which they badly needed at the time.

The very big problem was, and may continue to be, when interest rates go up, long-term bonds lose value, and when the Fed aggressively raised interest rates throughout late 2021 and 2022, some bonds lost as much as 40% of their value. They lost so much value that some of the calculations used to measure a bank’s health and safety were impacted, and impacted very severely, to the point where a few high-profile banks started to fail, potentially sparking a panic and impacting the entire banking system.

With a deeply divided federal government still roiled by the last bank bailouts in 2008, it was up to the Federal Reserve to help stabilize the banking system. In response, the Fed rolled out a plan, the BTFP, which enabled banks to access capital from the Fed using their bonds as collateral. Only in this program, the Fed did not take the collateral at the current market price of the bonds (some as low as 60 cents on the dollar), but rather at the face value of the bonds, which is typically the full dollar. The system stabilized and investors went on to focus on other things. This program was good for a year, and the year was up this week.

My analysis is the Fed’s intention was to stabilize the banks and give them a year to work out their bond issues. Until last week banks were still accessing the BTFP for capital.

These recent BTFP loans from the Fed also provide a term of one year, so I didn’t expect the ending of the BTFP to manifest like a light switch, but if the BTFP was functioning like a band aid to protect the system from the bond wounds hiding in the portfolios of American banks, the band aid has now been ripped off and we are going to begin to see just how much healing is going on underneath.

Nothing torments the financial markets like a banking crisis, and while there is no indication I can see of a banking crisis right now, if there is one lurking somewhere, now that the BTFP is wrapped up we might just find out sooner than later.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Stock investing includes risks, including fluctuating prices and loss of principal. No investment strategy can guarantee a profit or preserve against loss. Past performance is not a guarantee of future results. This material may contain forward looking statements; there are no guarantees that these outcomes will come to pass.