Latest / The Federal Reserve Podcast with Fexingo: Interest Rates, FOMC Meetings, and Monetary Policy / Inside the FOMCs New Liquidity Tools for Stressed Banks
Transcript
- Lucas: So the FOMC meeting this week was Kevin Warsh's first as chairman, and while the rate decision was a no-brainer — hold at 3.63 percent — the real story was buried in the statement's last paragraph about liquidity tools. Luna: Yeah, I caught that. They announced enhancements to the Standing Repo Facility and hinted at a new Bank Term Funding Program version. What's actually changing? Lucas: Let's start with the Standing Repo Facility, or SRF. It's been around since 2021 but hardly used — average daily borrowing was maybe a few hundred million. Now the Fed is lowering the minimum bid rate from 4.50 to 4.25 percent and expanding eligible collateral to include agency mortgage-backed securities. Luna: That's a big shift. MBS is a huge market. Why now? Lucas: Because the repo market has been showing signs of stress again. The Secured Overnight Financing Rate, SOFR, spiked to 4.40 percent on June 15, which is 77 basis points above the Fed's interest on reserve balances rate. That's the kind of divergence that signals banks are hoarding cash. Luna: And the new BTFP? I thought that program expired in March 2024. Lucas: It did expire. But Warsh made it clear in the press conference that the Fed is designing BTFP 2.0 as a standing facility, not an emergency one. The key difference: loans under the new program will be priced at the one-year Overnight Index Swap rate plus 25 basis points, not the old fixed spread. That makes it more expensive — currently around 4.50 percent — but it's always available. Luna: So they're trying to destigmatize the discount window by creating a separate, predictable backstop. That's the big structural shift, right? Lucas: Exactly. The discount window has always carried a stigma — banks fear that tapping it signals weakness. The old BTFP in 2023 was a panic fix. What Warsh is doing is building a permanent tiered system: the SRF for overnight liquidity against Treasuries and MBS, the new BTFP for term funding against a broader set of collateral including CRE loans. Luna: And that CRE piece is crucial. We've got about $1.5 trillion in commercial real estate debt maturing between now and 2028, much of it held by regional banks. Vacancy rates in downtown offices are still around 20 percent in major cities. Lucas: Right. The Fed's own Financial Stability Report, released last month, flagged CRE as the top risk to the banking system for the third straight report. So by making the new BTFP explicitly accept CRE loans as collateral, they're giving banks a way to roll over maturing debt without fire-selling assets. Luna: But isn't that a moral hazard? If banks know the Fed will always backstop CRE, they might take on more risk. Lucas: That's a fair question. Warsh addressed it directly — he said the pricing is intended to be 'penalty-based' relative to normal market conditions. The one-year OIS plus 25 basis points might be 50 to 75 basis points above what a healthy bank could get in the private repo market. So it's not free money. It's insurance with a deductible. Luna: And the usage so far? I saw that as of June 18, the SRF had $12 billion outstanding. That's up from basically zero a month ago. Lucas: Yeah, $12.4 billion to be precise. And the new BTFP hasn't launched yet — it opens July 1. But the Fed has already pre-approved about 30 banks for the facility, mostly regional and mid-sized institutions. Luna: So the plumbing is being rebuilt before the stress hits. That's smart. Lucas: It is. And it ties into something else Warsh said: the Fed is moving from a regime of 'ample reserves' to one of 'minimal reserves' plus standing facilities. In other words, they're okay with reserves draining, as long as banks have a cheap, stigma-free way to borrow overnight when they need it. Luna: That's a huge philosophical shift. For the past 15 years, the Fed kept reserves abundant to control the fed funds rate. Now they're letting reserves shrink and using administered rates plus repo to steer policy. Lucas: Correct. And the data backs it up: reserve balances fell to $3.1 trillion in May, down from $3.4 trillion in January. That's the lowest since 2022. Meanwhile, the fed funds effective rate has been glued to the interest on reserve balances rate at 3.63 percent, right in the target range. The system is working. Luna: But if a real liquidity crunch hits — like 2023's Silicon Valley Bank run — would these tools be enough? The old BTFP was $50 billion at peak usage in 2023. The new one has no cap, but the higher price might deter banks. Lucas: That's the trillion-dollar question. Warsh said the Fed is also working on a 'committed liquidity facility' that would let banks pre-position collateral and get same-day funding at a fixed spread. That would be even faster than the current infrastructure. But it's not operational yet. Luna: So they're layering multiple backstops. SRF for overnight, BTFP for term, and maybe a real-time facility in the future. It's like a mutual fund of liquidity — diversified across instruments. Lucas: Exactly. And that's the theme of Warsh's first meeting: preparation, not panic. He's trying to normalize borrowing from the Fed so that when a real crisis hits, banks don't hesitate. Luna: It's interesting to think about this in terms of the yield curve, which is still inverted on the long end. The ten-year at 4.45 percent versus the fed funds at 3.63 percent — that's 82 basis points of inversion. If these tools make banks more comfortable, does that steepen the curve? Lucas: That's a nuanced connection. Here's my take: if banks stop hoarding cash because they trust the backstops, they might lend more short-term, which could ease some upward pressure on short rates. But the long end is driven by inflation expectations and term premiums. The ten-year breakeven is at 2.25 percent, down a tick from last week, so inflation expectations are anchored. I don't see these tools having a direct effect on the curve, but indirectly, by preventing a credit crunch, they support economic growth, which could push long rates higher. Luna: So the net effect is ambiguous. But it's a better experiment than waiting for a blowup. Lucas: Absolutely. And you know, listening to Warsh's press conference, he kept coming back to one phrase: 'normalizing the extraordinary.' He wants to make these facilities so routine that they're boring. No drama. Luna: That's the opposite of how the discount window has been treated for decades. It's almost a cultural change. Lucas: It is. And culture shifts at central banks happen slowly. But if the new BTFP works as planned, we might look back at this meeting as the moment the Fed stopped being a crisis responder and started being a liquidity utility. Luna: Speaking of things that become routine, if walking through the economy with us has made something click for you, that's the entire point of this show. We don't run ads, and listener support is what keeps it that way. Lucas: Yeah, honestly, if today was worth a coffee to you, that's the link — buy me a coffee dot com slash fexingo. No pressure, no perks, just a small way to say this kind of conversation matters. Luna: Exactly. And we appreciate every single one who does. Alright, back to the liquidity toolkit — one more thing I want to dig into: the international dimension. How are other central banks reacting to this? Lucas: Good question. The Bank of England held rates at 3.75 percent this week, and they've been very quiet about liquidity tools. But the ECB has a similar standing facility, and they actually expanded it in May. The trend is global. Luna: So the Fed isn't alone. This is part of a broader rethink of the lender of last resort role after 2023's banking turmoil. Lucas: Exactly. And the next test will come in September, when $1.2 trillion in Treasury general account cash is set to be drained as the debt ceiling debate resumes. If the new tools work, we should see repo rates stay smooth. If not, we'll know they need more tweaking. Luna: Alright, we'll be watching. Thanks Lucas. Lucas: Thanks Luna. Talk to everyone next time.