A MARTÍNEZ, HOST:
After last month's collapse of Silicon Valley Bank, the Federal Reserve created a new way for troubled banks to borrow money. It's called the Bank Term Funding Program. Darian Woods and Mary Childs from our daily economics podcast, The Indicator, explain what it is and the risks that come with it.
DARIAN WOODS, BYLINE: The Fed is the bank for banks. That's why it will lend to banks in a panic when nobody else will. There is one way that it usually does this, called the discount window. And what's key to the discount window is collateral.
MARY CHILDS, BYLINE: So you can think of the discount window as kind of like a very nice pawnshop that lends to you in hard times. You know, you go and give it some collateral like some nice gold rings from your grandmother. The pawnshop gives you the cash - you know, not quite as much as those gold rings are worth on the market. There will be a discount. But you get the cash, and so you can, you know, as a bank, go meet withdrawals. But if the bank fails, the Fed, the pawnshop, has those gold rings and can go sell those and get its money back. And in this case, that would be things like Treasury bonds - you know, other government bonds, very high-quality corporate bonds. And the Fed can sell those bonds and recoup its money.
WOODS: Right. So let's go through what's different about the Bank Term Funding Program.
CHILDS: The big thing is that it values your collateral differently. Instead of valuing your gold rings at the market price - instead, this program essentially values them at what you paid for them. So let's do a simple example. Darian, you're the bank, and I get to be the Fed. And you're having a bad day, so I need you to bring collateral to me. OK?
WOODS: OK. So I've got these bonds, you know, and they promise to pay $100.
CHILDS: That's great. But in the years since you bought those bonds, interest rates have gone up. They are actually only worth $80 now.
WOODS: That's kind of unfortunate, but OK.
CHILDS: But I, the Fed - I will take your bond, which is worth $80 in the market, and I will lend you $100 because, you know, in 10 years that bond is going to pay $100. What do I care? I will still charge you some interest, but it will be small, just like with the discount window offer. Don't worry.
WOODS: OK. This is kind of a wildly different deal than the Fed normally makes, according to Amiyatosh Purnanandam. He is a professor of finance at the University of Michigan.
AMIYATOSH PURNANANDAM: I think this is one of the first times the Fed has come up with a program that is effectively a little bit unsecured.
WOODS: As in not covered. The Fed is exposed if I, the bank, default and I can't pay them back the money. The Fed could sell that bond and be down 20 bucks just because the market value right now is just 80. Or, you know, they could hold on to it until it matures if they really wanted to get that $400 back.
PURNANANDAM: But still, that doesn't make it whole to the taxpayers because there is an opportunity cost.
CHILDS: An opportunity cost, because the true cost of anything really isn't just what you pay and how much it pays out in the end. You also need to think about what else you could be doing with that money.
WOODS: Like, for example, if you're the government, you could have - I don't know - lowered taxes, or you could have spent it on education or highway maintenance - things that potentially had a better return on investment.
CHILDS: And maybe this was the right move for the Fed. Maybe the usual Fed tools wouldn't have worked to calm the markets after Silicon Valley Bank's collapse. But it is worth pointing out that this new banking Band-Aid has a new structure and a new kind of cost and risk.
Mary Childs.
WOODS: Darian Woods, NPR News.
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