Quick and Dirty update on the Fed's rescue
Background:
SVB and SI were stuck with long-dated treasury bonds that have fallen greatly in price. When there was a sudden surge in customer withdrawals of funds, SVB and SI did not have a sufficient reserve. They have no choice but to firesale the bonds at a huge loss to meet customer withdrawal.
The Fed's rescue program:
This program, Bank Term Funding Program (BTFP), will allow these Banks to take up loans from Federal Reserve, using the bonds as collateral. The loan will price the bonds at the original value.
For example, if you bought the bonds for 100mil, and if the bonds market price is at 40mil, Fed will still provide you with 100mil liquidity.
As with all loans, the banks who take up this program will have to pay interest. And the rate is 1 year forward overnight rate + 10bps, which will be about 4.5%; this is a great deal if compare to selling the bonds for a huge loss.
Overly Simplified Analylogy for those who are still confused You owe $10mil to a friend. You don't have $10mil to return to your friend. But you own a property that you bought for $30mil. But currently, the property market price is $15mil. In order to return $10mil to your friend, you have no choice but to sell your property at a loss to get cash.
But the bank came and rescue you. Bank is willing to loan you $30mil, using your property as collateral. Because banks felt that when the economy improves in the future, your property value should go back up.
So instead of selling your property at a loss repay your friend. Now you get to keep your property and get a loan from the bank to repay the money. In this analogy, you are the bank (SVB). Your friend is your customer asking for a withdrawal. The Bank is the Federal Reserve. The Property is the Treasury Bonds that you are bag holding
What does this package mean:
The purpose of this package is to rescue uninsured depositors. If you have deposits with SVB or any bank with a liquidity crisis, your deposit is safe.
This will also stop any fear of bank runs from the market.
Those who are holding equities on the affected bank stocks are not protected. Bondholders of the affected banks are also not protected. They will still be subjected to market movement. This backstop should calm the market though.
Is this bullish for the Stock Market?
The recent drops in S&P500 were led by fear of a bank run. In short term, the market may undo the drop from last Thursday and Friday.
This program would increase the money supply by about $25 billion as it is the amount made available by the Department of Treasury for this program which will last until 11 March 2024 (1 year).
Consider this; Federal Reserve is currently unloading $ 60 billion worth of Treasury per month under their QT program. This $25bil "QE" for a year is almost an inconsequential number.
If we take this program and analyze it in a vacuum, it has minimal impact. An additional $25bil of the treasury bond on the Fed's Balance Sheet is inconsequential.
However, the market is now thinking ahead. If the Fed is willing to backstop the banks, then they should stop hiking in order to prevent more banks from becoming illiquid. Hence we see the 2 Year Yield collapsing today and stock futures rally. 50bps hike for March used to be at 40% probability, it is now at 0%.
If SI and SVB were isolated cases, Fed could provide a temporary backstop for the small number of affected banks and continue with their hiking plans.
If this is a huge sector-wide problem, then Fed would pause the hike for a year (duration of the BTFP program) and then resume hiking next year. But this is actually against their mandate.
We will have CPI numbers before FOMC in March. It will be extremely interesting what decision will Fed be making.
This sort of market surprise cannot be predicted and it is the reason why we MUST maintain a long/short portfolio. If the market were to aggressively rally, all we need to do is exit our current shorts at profit (AAPL/Seagate), and ride the profit on our longs (ANET, hopefully, CELH). If you were our Patreon subscriber, you should have a Long/Short Portfolio as well.
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