Questions we would like to ask the Fed about its role as lender of last resort
Once again, the people have wisely failed to elect me to Congress, but my more expert colleagues and I still have questions!
The House Financial Services Committee is holding a hearing tomorrow on the Federal Reserve and its role as the lender of last resort. While the American system of government continues to work as intended in keeping me far away from the levers of power, that doesn’t mean I don’t have questions. Of course my more expert colleagues also have questions, so I put those first. Here they are:
From Tom Hoenig:
The Bank Term Funding Program is a new tool the Fed introduced in its role as lender of last resort. In this instance the Fed lends at par against collateral whose fair market value is below par. In this instance the Fed appears to be lending partially unsecured. Even in an emergency the Fed can provide sufficient amounts of liquidity to a solvent bank on acceptable collateral which has been discounted. Why the need for this facility at all?
From Prof. Eric Leeper:
What is lacking is a clear vision of where the Fed sees itself in the medium run. All the talk about the balance sheet is taking place in a vacuum, without any articulated policy about where the Fed is heading. When is the balance sheet the "right" size? What degree of intervention in financial market is "appropriate"?
Is it true that the Fed has no vision of what monetary policy will look like over the medium term?
From David Beckworth:
There is growing interest by many to have commercial bank’s borrowing capacity at the Fed’s Discount Window count towards their liquidity requirements. The Group of 30, the acting Comptroller of the Currency Michael Hsu, the Fed and other bank regulators are now calling for this approach. Such a change raises several questions.
First, can the Fed and other bank supervisors actually reduce the stigma surrounding the Discount Window’s use to make this happen?
Second, one potential implication of this shift would be far less demand for bank reserves and, therefore, a reduction in the size of the Fed’s balance sheet. How big do you think this reduction would be?
Third, do you think the Fed, who is now supporting this enhanced use of the Discount Window, appreciates and anticipate that it would need to potentially reduce its balance sheet even more if the new policy is adopted?
Fourth, should the Fed’s balance sheet significantly shrink because of this new policy, should it not start thinking about revising its operating framework too? That is, the Fed may need to reevaluate its abundant reserve system and reconsider a scarce reserve system under such a change. So maybe it is time for review of the Fed’s operating system too?
From Pat Horan:
In 2020, the Fed established 16 ad hoc lending facilities to address the crisis brought on by the Covid-19 pandemic. Columbia University Professor Lev Menand has described six of these programs as “liquidity facilities” because they deal with providing liquidity to financial firms in the shadow banking system. These facilities were consistent with the Fed’s traditional role as a monetary authority even if the loans were to shadow banks, not traditional banks.
The other 10 programs, however, were credit facilities. They dealt with extending credit to the “real economy” (.g., corporations, other businesses, and municipalities). This sort of lending blurs the line between monetary policy (the Fed’s responsibility) and fiscal policy (Congress’ responsibility). What steps can Congress take today to make ensure that the Fed does not need to resort reestablishing credit facilities, which potentially compromise the Fed’s status as an independent agency, in the event of a future crisis?
From Steph Miller:
Has the stigma problem has been resolved and if so, do we need these alternative lending facilities?
Would it be better to encourage more weak banks to voluntarily liquidate, as Silvergate did, rather than end with costly failure?
From Brian Knight:
How do we square the Fed’s role as lender of last resort, or beyond, with the idea that the banking market should be competitive? At some level isn’t preserving banking stability also insulating the market, and individual firms, from market discipline? Isn’t removing stigma or concealing who needs support, as has happened in the past, also preventing customers and investors from getting relevant information as to which banks are in good shape or are well run?
The Fed announced it was wrapping up its recent facility that allowed the Fed to lend with certain assets valued at par, rather than market value. This facility was described as providing liquidity to solvent banks, but if the assets were valued at above market value for collateral purposes isn’t it possible that in some cases it helped insolvent banks avoid facing the consequences of their insolvency?