Other Lenders of Last Resort
Although the Fed’s initial response to the crisis involved the use of traditional standing facilities, such as the Federal Funds Rate and the Discount Window, to provide liquidity to the markets, banks avoided borrowing from the Fed in fear of the stigma that surrounded borrowing from the central bank. Banks feared that investors would view them as weak and unstable if they were forced to resort to borrowing from the Fed. As a result, U.S. commercial banks in the bypassed the discount window and borrowed instead from other sources, and most significantly, the Federal Home Loan Banks (FHLB) (Ashcraft, Bech, Frame).
The Federal Home Loan Banks, or FHLB, is a GSE set up in 1932 to “establish a series of discount banks for home mortgages, performing a function for homeowners somewhat similar to that performed in the commercial field by Federal Reserve banks through their discount facilities.” - President Herbert Hoover - July 22, 1932
Basically, the FHLB system was set up by Congress to serve the savings and loans industry that didn’t have access to the Fed at the time. The 12 regional Federal Home Loan Banks established by the Federal Home Loan Bank Act and are located in Atlanta, Boston, Chicago, Cincinnati, Dallas, Des Moines, Indianapolis, New York, Pittsburgh, San Francisco, Seattle, and Topeka.
The Federal Home Loan Banks are government-sponsored enterprises, federally chartered but privately capitalized and independently managed. FHLB has priority over depositors and almost all other creditors (including FDIC) in the event of a default. Institutions must purchase stock in order to become a member. In return, members obtain access to low-cost funding, and also receive dividends based on their stock ownership. When institutions come time to borrow those funds from its Home Loan Bank, Federal Home Loan Banks require their members to put up collateral against the advances they receive. The collateral always meets or exceeds the value of the loans made to the lenders. Once the Home Loan Bank approves a loan to the lender, it advances the funds. The FHLBanks make loans, called “advances,” to their members and eligible housing associates on the security of mortgages and other collateral pledged by the borrowing member or housing associate. Advances are the largest category of assets of the FHLBanks on a combined basis, representing 68.8 percent of total assets at December 31, 2008 and 2007.
The Federal Home Loan Banks, or FHLB, is a GSE set up in 1932 to “establish a series of discount banks for home mortgages, performing a function for homeowners somewhat similar to that performed in the commercial field by Federal Reserve banks through their discount facilities.” - President Herbert Hoover - July 22, 1932
Basically, the FHLB system was set up by Congress to serve the savings and loans industry that didn’t have access to the Fed at the time. The 12 regional Federal Home Loan Banks established by the Federal Home Loan Bank Act and are located in Atlanta, Boston, Chicago, Cincinnati, Dallas, Des Moines, Indianapolis, New York, Pittsburgh, San Francisco, Seattle, and Topeka.
The Federal Home Loan Banks are government-sponsored enterprises, federally chartered but privately capitalized and independently managed. FHLB has priority over depositors and almost all other creditors (including FDIC) in the event of a default. Institutions must purchase stock in order to become a member. In return, members obtain access to low-cost funding, and also receive dividends based on their stock ownership. When institutions come time to borrow those funds from its Home Loan Bank, Federal Home Loan Banks require their members to put up collateral against the advances they receive. The collateral always meets or exceeds the value of the loans made to the lenders. Once the Home Loan Bank approves a loan to the lender, it advances the funds. The FHLBanks make loans, called “advances,” to their members and eligible housing associates on the security of mortgages and other collateral pledged by the borrowing member or housing associate. Advances are the largest category of assets of the FHLBanks on a combined basis, representing 68.8 percent of total assets at December 31, 2008 and 2007.
FHLB Role in Crisis:
Lenders turned to the FHLB as two main sources of funding, short-term IOUs backed by mortgages and mortgage-bond sales, began to dry up in August.
During the second half of 2007, the FHLB System increased its advance lending by $235 billion to $875 billion by the end of that year (a 36.7% increase). And ten FHLB members alone accounted for almost $150 billion of this new advance lending. Advances continued to grow into 2008, although at a slower rate, and stood at $914 billion as of June 30, 2008 (“FHLB Office of Finance”).
By second half of 2008, advances slowed dramatically when FHLBanks became “guilty by association” to Freddie and Frannie (GSEs) and borrowing rates increased; the Fed’s discount window became a more attractive option.
FHLB lending fell because many of their members were eligible for TAF. Since May 2008, TAF has been a cheaper source of funding then FHLB advances. The Term Auction Facility, as the new measure was called, proved to be popular with commercial banks. Increased access to the Fed Discount Window resulted in high volume borrowing and competition to FHLBanks (Ashcraft, Bech, Frame).
Lenders turned to the FHLB as two main sources of funding, short-term IOUs backed by mortgages and mortgage-bond sales, began to dry up in August.
During the second half of 2007, the FHLB System increased its advance lending by $235 billion to $875 billion by the end of that year (a 36.7% increase). And ten FHLB members alone accounted for almost $150 billion of this new advance lending. Advances continued to grow into 2008, although at a slower rate, and stood at $914 billion as of June 30, 2008 (“FHLB Office of Finance”).
By second half of 2008, advances slowed dramatically when FHLBanks became “guilty by association” to Freddie and Frannie (GSEs) and borrowing rates increased; the Fed’s discount window became a more attractive option.
FHLB lending fell because many of their members were eligible for TAF. Since May 2008, TAF has been a cheaper source of funding then FHLB advances. The Term Auction Facility, as the new measure was called, proved to be popular with commercial banks. Increased access to the Fed Discount Window resulted in high volume borrowing and competition to FHLBanks (Ashcraft, Bech, Frame).
FDIC: Temporary Liquidity Guarantee Program
The Federal Deposit Insurance Corporation (FDIC) originated in 1933 in order to mitigate the possibilities for bank runs that can cause banks to fail. Since then, the company has insured the deposits that people and businesses make at their respective banks so that, should the bank run out of money to pay back the deposits of its customers, the FDIC can pay back these deposits to the customers up to a certain amount.
Currently, this amount is set at $250,000. On October 14, 2008, the FDIC introduced a new program that basically extends their role beyond being a deposit insurer. The Temporary Liquidity Guarantee Program (TLGP) is intended to help to provide funds to banks that they can use to stabilize the financial markets. The credit crunch of 2008 and 2009 made borrowing and lending very difficult, but with the extended guarantee of the FDIC, some confidence was restored to financial markets.
The program consisted of two parts—the Debt Guarantee Program (DGP) and the Transaction Account Guarantee Program (TAGP).
Under the DGP, the FDIC guaranteed all new senior unsecured debt created between the program’s initiation and June 30, 2009. The debt would be guaranteed until December 31, 2012. This program has been rather successful as only a very small minority of banks decided to opt out of the program, and the FDIC has guaranteed over $300 billion of new debt. Most of this debt came in the form of medium-term loans. The graph below shows the term at issuance of the debts guaranteed.
The Federal Deposit Insurance Corporation (FDIC) originated in 1933 in order to mitigate the possibilities for bank runs that can cause banks to fail. Since then, the company has insured the deposits that people and businesses make at their respective banks so that, should the bank run out of money to pay back the deposits of its customers, the FDIC can pay back these deposits to the customers up to a certain amount.
Currently, this amount is set at $250,000. On October 14, 2008, the FDIC introduced a new program that basically extends their role beyond being a deposit insurer. The Temporary Liquidity Guarantee Program (TLGP) is intended to help to provide funds to banks that they can use to stabilize the financial markets. The credit crunch of 2008 and 2009 made borrowing and lending very difficult, but with the extended guarantee of the FDIC, some confidence was restored to financial markets.
The program consisted of two parts—the Debt Guarantee Program (DGP) and the Transaction Account Guarantee Program (TAGP).
Under the DGP, the FDIC guaranteed all new senior unsecured debt created between the program’s initiation and June 30, 2009. The debt would be guaranteed until December 31, 2012. This program has been rather successful as only a very small minority of banks decided to opt out of the program, and the FDIC has guaranteed over $300 billion of new debt. Most of this debt came in the form of medium-term loans. The graph below shows the term at issuance of the debts guaranteed.
The other part of the TLGP—the TAGP—guarantees all transaction accounts such as the everyday checking account and business payroll accounts so that people would continue to make deposits in to these accounts making the funds available to banks to loan. The most significant feature of this program is that there is essentially no limit to how much the FDIC will guarantee on transaction accounts compared to the limit of $250,000 that would normally apply.
Overall, the TLGP is regarded as a successful response to the poor credit conditions of 2008 and 2009. The FDIC’s implementation of this program is actually very interesting because of the kind of role it is now playing. In the past, the FDIC played more of a passive role in financial markets with a primary purpose of acting as a lender of last resort to depository institutions. The TLGP, however, gave the FDIC a much more active role in the financial markets as they tried to stimulate liquidity conditions.
The FDIC stepped beyond its historical role as a deposit insurer with the TLGP. This program, in a way, is competition for the Federal Reserve Bank’s programs, yet they all have the common goal of promoting liquidity in the struggling financial markets. In a time of need, it is understandable that the FDIC is doing what it can to help, but programs such as the TLGP carry a decent amount of risk. If lending were backed by the FDIC all of the time, it would likely encourage more risky lending with greater frequency. For the time being, it is a temporary risk worth taking if it can promote liquidity—so far it has.
*This and further information available at http://www.fdic.gov/regulations/resources/tlgp/index.html and Getter: 2009
Overall, the TLGP is regarded as a successful response to the poor credit conditions of 2008 and 2009. The FDIC’s implementation of this program is actually very interesting because of the kind of role it is now playing. In the past, the FDIC played more of a passive role in financial markets with a primary purpose of acting as a lender of last resort to depository institutions. The TLGP, however, gave the FDIC a much more active role in the financial markets as they tried to stimulate liquidity conditions.
The FDIC stepped beyond its historical role as a deposit insurer with the TLGP. This program, in a way, is competition for the Federal Reserve Bank’s programs, yet they all have the common goal of promoting liquidity in the struggling financial markets. In a time of need, it is understandable that the FDIC is doing what it can to help, but programs such as the TLGP carry a decent amount of risk. If lending were backed by the FDIC all of the time, it would likely encourage more risky lending with greater frequency. For the time being, it is a temporary risk worth taking if it can promote liquidity—so far it has.
*This and further information available at http://www.fdic.gov/regulations/resources/tlgp/index.html and Getter: 2009
