America’s Distressed Banks: A $1.7 Trillion Nightmare


Evidence suggests that the scale of the banking crisis in the United States is much greater than previously thought. The estimated level of unrealized losses on bank balances and bank loans in the discount window of the Federal Reserve and  Federal Home Loan Banks (FHL Banks) indicates an economic situation in which many regional and smaller institutions need  financial assistance. justified or not. 

Adding to the mix is the fallout from the  Credit Suisse collapse and the central bank’s response to it, as well as the bank’s reference to UBS earlier this month. 

Bank failures are often easy to see in isolation—a single failure of bank governance and perhaps even regulatory oversight. But as with most past financial crises, the failure of one institution often raises questions about whether individual problems reflect similar problems elsewhere.
Here are just a few points and recent regulatory actions that may point to a larger problem.

Unrealized loss on the balance sheet 

Part of Silicon Valley Bank’s liquidation was due to a buildup of assets, such as long-dated US Treasury bonds and mortgage-backed securities, that were bought before the Federal Reserve began tightening monetary policy. When the Fed started raising interest rates, those securities became a paper loss on SVB’s balance sheet, but SVB was not alone. According to the president of the Federal Deposit Insurance Corporation (FDIC), US banks had $620 billion in such unrealized (or paper) losses at the beginning of March. In addition, some experts believe that this number is an underestimate, as two recent estimates suggest that the remaining losses could be as high as $1.7 billion.
It remains unclear where such unrealized losses lie in the banking system, whether they were large regional banks or more broadly small community banks.

Fed-discounted window lending is growing 

 It is clear  that the collapse of SVB led to an increase in  the Federal Reserve’s so-called soft window loans. Through its discount window, the Federal Reserve helps managers manage their liquidity risks and avoid actions that have negative consequences for their customers, such as increasing lending during times of market stress.
In October 2008, a month after the collapse of Lehman Brothers, the Fed lent a then-record $110 billion to banks in one week through the discount window. This amount is roughly equivalent to $153.8 billion in today’s money.  
 By comparison, in the week ending March 15, the Fed borrowed $152 billion in the discount window and  nearly $12 billion more under the emergency lending program announced last week after the failure of SVB. 

Federal Home Loans 

Another worrying sign  is the increase in bank loans from FHL Banks, which are agencies employed by regional governments that raise money to provide cheap loans to their members and are an important source of funding for regional banks.  FHL banks are often the preferred last stop for cash purchases before banks in need turn to the Federal Reserve as a last resort. 

According to the latest data, the Federal Home Loan Bank Board issued nearly $250 billion in debt in the second week of March to provide liquidity to regional and community banks.
“The $1.25 billion asset system of 11 regional banks issued a total of $136.5 billion in discounts and bonds on Tuesday and Wednesday [March 14 and 15], down from $111.8 billion on Monday, the highest level for mortgage banks largest issuance day in 90-year history,” said a US banker in a report.
Banks often turn to the FHLB during liquidity crises, said Kathryn Judge, an expert on banking crises at Columbia Law School. “I expected the loan to increase, so I’m not at all surprised by the numbers,” says Judge. “The interesting question this time is whether the FHLBanks can borrow enough to give advances to all the member banks that want them. The related challenge is that the FHL banking system has become much more dependent on short-term funding sources. So the system is also more vulnerable than it has been traditionally.

Central banks coordinate activities 

Late last weekend, major central banks announced plans to increase dollar liquidity through international exchanges.
“On March 20, the Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank, the US Federal Reserve, and the Swiss National Bank announced coordinated measures to increase liquidity through a US dollar liquidity swap,” he added. The Fed said in a statement
  The announcement came after Swiss regulators sealed talks for UBS to buy Credit Suisse for $3.25 billion after a tense weekend  to prop up the country’s banking system and  prevent the crisis from spreading to international markets.  The deal follows five days of efforts by Swiss regulators  to end the Credit Suisse crisis that threatened to topple the country’s second-biggest lender.  Liquidity risks at some US banks may be a far cry from  Credit Suisse’s long-term problems, but their timing suggests bank regulators are deeply concerned about the effects of contagion and a potential lack of confidence in the international banking system.

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