Normal process for banks in distress

2023-03-25 11:30:00 +07:00 by Mark Smith

I've extracted the following from a recent episode of the Eurodollar University podcast with Jeff Snider and Steve Van Metre. They discuss various topics but figured it was worth re-sharing the step by step process for better understanding of the dynamics at play.

In normal times banks going through distress for whatever reason would do the following:

  1. Go into illiquid loan book
  2. Take say 100 million dollars of illiquid loans out of the book
  3. Liquify that by pledging those 100 million dollars to a money dealer like Goldman Sachs or JP Morgan
  4. Borrow US treasuries, not at same value, there’s probably going to be a significant financial penalty, but at least they will lend the bank US treasuries
  5. Then go into the repo market with those treasuries, in order to secure some short term financing, so they can at least keep the doors open
  6. That will keep them from having to fire-sale assets

That process hasn’t been happening, at least not in enough banks. We know that because the amount of banks going directly to the FED asking for loans has sky rocketed. Total amounts via discount window are much bigger than usual.

Also 4 week treasury bills mid week (15 March which is typically a seasonally troublesome time) suddenly had a massive drop in treasury bill rates (~60 basis points), much lower than normal. The only reason people keep buying these treasuries at such low rates is likely (the argument goes) to be because they are being used for something other than investment. They are being used as collateral for loans.

The fact the FED can charge such low rates implies there is a massive need, so points to the fact that many many players (likely the smaller banks) are trying to get collateral in order to get loans.

Two systemic problems are occurring:

  1. Big banks don’t want to lend treasuries against illiquid assets
  2. Money dealers don’t want to lend cash against the treasuries

What do they know about the long term illiquid assets that the smaller banks don’t know?

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