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Is there anything preventing banks from buying treasures on open market by using funds they got from Fed by exchanging their treasuries on mark-to-maturity basi

by fuoqi 4y ago

Is there anything preventing banks from buying treasures on open market by using funds they got from Fed by exchanging their treasuries on mark-to-maturity basis? Looks like a bailout with extra steps.

arthurcolle 4y ago
Can you explain the steps that you're thinking and explain why they would matter at this scale?
- fuoqi 4y ago
  A bank has 10 year bond which trades 90 cents on the dollar on the open market. It gives the bond to Fed as collateral and receives 1 dollar. It uses this dollar to buy bonds on open market with rate higher than cost of the loan, after 90 days it sells the bond, gives the Fed 1 dollar and interest, and pockets the rate spread on 10 cents.
- iforgetti 4y ago
  A bond bought by a bank in the past at a lower interest rate than those offered today is worth less than those offered today. If the fed values those bonds at face value (rather than what the market would pay today) and allows the bank to borrow money using those as collateral, then a bank could simply borrow from the fed using the older less valuable bonds as collateral and then buy new more valuable bonds. The bank could then default on the loan and forfeit the original less valuable bond. This would effectively be the fed giving free money to the bank.
  - HDThoreaun 4y ago
    You can't just "default on a loan." The Fed would reposes their other assets...
HDThoreaun 4y ago
The interest rate on the loans is .1% higher than the 3 month T bills which is all they can get before the loan comes due. They would lose money with this strategy.
- fuoqi 4y ago
  They can buy longer duration bonds and sell them before the loan is due or even corporate bonds. Yes, it introduces certain risks, but with the endemic banks irresponsibility constantly bailed out by the government, I will not be surprised. But I guess, possible spreads are a bit too small for this scheme to matter.
  - agrajag 4y ago
    I mean, SVB did exactly this, and management got fired an equity zeroed out. Other banks aren’t looking at SVB and wishing that was them.
- iforgetti 4y ago
  But if they are using bonds which the fed has valued at face value rather than market value as collateral then this is still effectively free money. They are only losing .1% of bond value instead of the difference between face and market value.
  - HDThoreaun 4y ago
    I think you misunderstand what is happening here. It's not free money, it has a 4.7% interest rate. Taking this loan and using it to buy bonds would just be transferring .1% of the loan value to the fed as the bonds would pay out less than the banks owe.
    - iforgetti 4y ago
      They may be collateralized by bonds worth even less than that. If the bonds were worth 80 cents on the dollar than they just traded 80 cents on the dollar for 99.9 cents on the dollar. A good deal if your balance sheet is in such poor shape.
      - HDThoreaun 4y ago
        Unless the bank fails that doesn't matter. And the banks won't fail because the incentive to run them is gone now. Everyone will see their deposits are safe and the banks can give the money back with interest.
deleted 4y ago
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pgwhalen 4y ago
Of course there is. Assuming you're referring to the new Bank Term Funding Program (which this article is not referring to), collateral is only eligible if it was owned before the program began. https://www.federalreserve.gov/newsevents/pressreleases/files/monetary20230312a1.pdf https://www.federalreserve.gov/newsevents/pressreleases/file...

by fuoqi 4y ago

arthurcolle 4y ago

Can you explain the steps that you're thinking and explain why they would matter at this scale?

fuoqi 4y ago
A bank has 10 year bond which trades 90 cents on the dollar on the open market. It gives the bond to Fed as collateral and receives 1 dollar. It uses this dollar to buy bonds on open market with rate higher than cost of the loan, after 90 days it sells the bond, gives the Fed 1 dollar and interest, and pockets the rate spread on 10 cents.
iforgetti 4y ago
A bond bought by a bank in the past at a lower interest rate than those offered today is worth less than those offered today. If the fed values those bonds at face value (rather than what the market would pay today) and allows the bank to borrow money using those as collateral, then a bank could simply borrow from the fed using the older less valuable bonds as collateral and then buy new more valuable bonds. The bank could then default on the loan and forfeit the original less valuable bond. This would effectively be the fed giving free money to the bank.
- HDThoreaun 4y ago
  You can't just "default on a loan." The Fed would reposes their other assets...

HDThoreaun 4y ago

The interest rate on the loans is .1% higher than the 3 month T bills which is all they can get before the loan comes due. They would lose money with this strategy.

fuoqi 4y ago
They can buy longer duration bonds and sell them before the loan is due or even corporate bonds. Yes, it introduces certain risks, but with the endemic banks irresponsibility constantly bailed out by the government, I will not be surprised. But I guess, possible spreads are a bit too small for this scheme to matter.
- agrajag 4y ago
  I mean, SVB did exactly this, and management got fired an equity zeroed out. Other banks aren’t looking at SVB and wishing that was them.
iforgetti 4y ago
But if they are using bonds which the fed has valued at face value rather than market value as collateral then this is still effectively free money. They are only losing .1% of bond value instead of the difference between face and market value.
- HDThoreaun 4y ago
  I think you misunderstand what is happening here. It's not free money, it has a 4.7% interest rate. Taking this loan and using it to buy bonds would just be transferring .1% of the loan value to the fed as the bonds would pay out less than the banks owe.
  - iforgetti 4y ago
    They may be collateralized by bonds worth even less than that. If the bonds were worth 80 cents on the dollar than they just traded 80 cents on the dollar for 99.9 cents on the dollar. A good deal if your balance sheet is in such poor shape.
    - HDThoreaun 4y ago
      Unless the bank fails that doesn't matter. And the banks won't fail because the incentive to run them is gone now. Everyone will see their deposits are safe and the banks can give the money back with interest.

deleted 4y ago

[deleted]

pgwhalen 4y ago

Of course there is. Assuming you're referring to the new Bank Term Funding Program (which this article is not referring to), collateral is only eligible if it was owned before the program began. https://www.federalreserve.gov/newsevents/pressreleases/files/monetary20230312a1.pdf https://www.federalreserve.gov/newsevents/pressreleases/file...