[House Hearing, 118 Congress]
[From the U.S. Government Publishing Office]
LENDER OF LAST RESORT:
ISSUES WITH THE FED DISCOUNT
WINDOW AND EMERGENCY LENDING
=======================================================================
HEARING
BEFORE THE
SUBCOMMITTEE ON FINANCIAL
INSTITUTIONS AND MONETARY POLICY
OF THE
COMMITTEE ON FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED EIGHTEENTH CONGRESS
SECOND SESSION
__________
FEBRUARY 15, 2024
__________
Serial No. 118-75
Printed for the use of the Committee on Financial Services
[GRAPHIC NOT AVAILABLE IN TIFF FORMAT]
www.govinfo.gov
__________
U.S. GOVERNMENT PUBLISHING OFFICE
56-280 PDF WASHINGTON : 2026
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HOUSE COMMITTEE ON FINANCIAL SERVICES
PATRICK McHENRY, North Carolina, Chairman
FRENCH HILL, Arkansas, Vice MAXINE WATERS, California, Ranking
Chairman Member
FRANK D. LUCAS, Oklahoma SYLVIA R. GARCIA, Texas, Vice
PETE SESSIONS, Texas Ranking Member
BILL POSEY, Florida NYDIA M. VELAZQUEZ, New York
BLAINE LUETKEMEYER, Missouri BRAD SHERMAN, California
BILL HUIZENGA, Michigan GREGORY W. MEEKS, New York
ANN WAGNER, Missouri DAVID SCOTT, Georgia
ANDY BARR, Kentucky STEPHEN F. LYNCH, Massachusetts
ROGER WILLIAMS, Texas AL GREEN, Texas
TOM EMMER, Minnesota EMANUEL CLEAVER, Missouri
BARRY LOUDERMILK, Georgia JAMES A. HIMES, Connecticut
ALEXANDER X. MOONEY, West Virginia BILL FOSTER, Illinois
WARREN DAVIDSON, Ohio JOYCE BEATTY, Ohio
JOHN W. ROSE, Tennessee JUAN VARGAS, California
BRYAN STEIL, Wisconsin JOSH GOTTHEIMER, New Jersey
WILLIAM R. TIMMONS, IV, South VICENTE GONZALEZ, Texas
Carolina SEAN CASTEN, Illinois
RALPH NORMAN, South Carolina AYANNA PRESSLEY, Massachusetts
DANIEL MEUSER, Pennsylvania STEVEN HORSFORD, Nevada
SCOTT FITZGERALD, Wisconsin RASHIDA TLAIB, Michigan
ANDREW R. GARBARINO, New York RITCHIE TORRES, New York
YOUNG KIM, California NIKEMA WILLIAMS, Georgia
BYRON DONALDS, Florida WILEY NICKEL, North Carolina
MIKE FLOOD, Nebraska BRITTANY PETTERSEN, Colorado
MICHAEL LAWLER, New York
ZACHARY NUNN, Iowa
MONICA DE LA CRUZ, Texas
ERIN HOUCHIN, Indiana
ANDREW OGLES, Tennessee
Matthew Hoffman, Staff Director
------
SUBCOMMITTEE ON FINANCIAL INSTITUTIONS AND MONETARY POLICY
ANDY BARR, Kentucky, Chairman
BARRY LOUDERMILK, Georgia, Vice BILL FOSTER, Illinois, Ranking
Chairman Member
BILL POSEY, Florida AYANNA PRESSLEY, Massachusetts,
BLAINE LUETKEMEYER, Missouri Vice Ranking Member
ROGER WILLIAMS, Texas NYDIA M. VELAZQUEZ, New York
JOHN W. ROSE, Tennessee BRAD SHERMAN, California,
WILLIAM R. TIMMONS, IV, South GREGORY W. MEEKS, New York
Carolina DAVID SCOTT, Georgia
RALPH NORMAN, South Carolina AL GREEN, Texas
SCOTT FITZGERALD, Wisconsin JOYCE BEATTY, Ohio
YOUNG KIM, California JUAN VARGAS, California
BYRON DONALDS, Florida SEAN CASTEN, Illinois
MONICA DE LA CRUZ, Texas
ANDREW OGLES, Tennessee
C O N T E N T S
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Thursday, February 15, 2024
OPENING STATEMENTS
Page
Hon. Andy Barr, Chairman of the Subcommittee on Financial
Institutions and Monetary Policy, a U.S. Representative from
Kentucky....................................................... 1
Hon. Bill Foster, Ranking Member of the Subcommittee on Financial
Institutions and Monetary Policy, a U.S. Representative from
Illinois....................................................... 3
STATEMENTS
Hon. Maxine Waters, Ranking Member of the Committee on Financial
Services, a U.S. Representative from California................ 4
WITNESSES
Professor Hal Scott, Nomura Professor of International Financial
Systems, Emeritus, Harvard University.......................... 5
Prepared Statement........................................... 7
Mr. William Nelson, Executive Vice President and Chief Economist,
Bank Policy Institute.......................................... 23
Prepared Statement........................................... 25
Professor Simon Johnson, Ronald A. Kurtz (1954) Professor of
Entrepreneurship, MIT Sloan School of Management............... 30
Prepared Statement........................................... 32
APPENDIX
ADDITIONAL MATERIAL SUBMITTED FOR THE RECORD
Hon. Andy Barr:
American Bankers Association................................. 68
Council of Federal Home Loan Banks (FHLBanks)................ 73
Hon. Brad Sherman
Priority lien Position for FHL Banks......................... 75
RESPONSES TO QUESTIONS FOR THE RECORD
Written responses to questions for the record from Mr. Hal Scott. 77
Written responses to questions for the record from Mr. William
Nelson......................................................... 80
LENDER OF LAST RESORT: ISSUES WITH THE FED DISCOUNT WINDOW AND
EMERGENCY LENDING
----------
Thursday, February 15, 2024
U.S. House of Representatives,
Subcommittee on Financial Institutions
and Monetary Policy,
Committee on Financial Services,
Washington, DC.
The subcommittee met, pursuant to notice, at 10:05 a.m., in
room 2128, Rayburn House Office Building, Hon. Andy Barr
(chairman of the subcommittee) presiding.
Present: Representatives Barr, Posey, Luetkemeyer,
Loudermilk, Rose, Timmons, Fitzgerald, Kim, Donalds, De La
Cruz, Ogles, Foster, Sherman, Scott of Georgia, Green, Beatty,
Vargas, and Casten.
Chairman Barr. The committee will come to order. Without
objection, the chair is authorized to declare a recess of the
committee at any time.
This hearing is titled ``Lender of Last Resort: Issues With
the Fed Discount Window and Emergency Lending.''
Without objection, all members will have 5 legislative days
within which to submit extraneous materials to the chair for
inclusion in the record.
I now recognize myself for 5 minutes to give an opening
statement.
OPENING STATEMENT OF HON. ANDY BARR, CHAIRMAN OF THE
SUBCOMMITTEE ON FINANCIAL INSTITUTIONS AND MONETARY POLICY, A
U.S. REPRESENTATIVE FROM KENTUCKY
In performing lender of last resort functions, central
banks have long been told to abide by recommendations
memorialized by British journalist Walter Bagehot in the late
1870s. Bagehot advised that in panics and times of unusual
liquidity needs, central banks should lend freely at a penalty
interest rate to solvent borrowers who post good collateral.
Following the speed of the bank runs last March, perhaps
lending freely also means that the Federal Reserve (Fed) should
be prepared to lend quickly on good collateral.
There are two main ways in which the Fed performs its
lender of last resort function. One is by lending to financial
institutions at the Fed's discount window against good
collateral to solvent borrowers. Another is by using lending
authority in Section 13(3) of the Federal Reserve Act to make
emergency loans in unusual and exigent circumstances.
Among other things, today we will explore the difference
between the discount lending and emergency 13(3) lending,
whether we are to rely on the Fed too much in times of stress
and the issue of stigma that banks face in accessing the
discount window.
The recent history of increasing Fed intervention into
private markets traces back to the financial crisis in 2008. At
that time, the Fed used its emergency powers to lend, to save
individual companies that were teetering on the brink of
failure, such as Bear Stearns and American International Group
(AIG). Those actions proved unpopular, as the Fed appeared to
be propping up individual companies and potentially exposing
innocent taxpayers to private sector losses.
In partial response, the Fed's emergency lending authority
was amended in the Dodd-Frank Act to provide greater clarity on
liquidity requirements, more transparency in Fed emergency
lending, and approval of the Treasury Secretary.
Emergency lending was also changed to try to prevent the
Fed from acting to save an individual firm by requiring that
emergency lending must be undertaken in a broad-based program
to provide support for more than just one single firm.
Next, in 2019, in the face of liquidity shortages and
volatility in money markets, including markets for Treasury
securities, the Fed intervened, using repo facilities that were
eventually made permanent.
Following that, at the onset of the pandemic, the Fed
intervened further in markets. The CARES Act provided backstop
funding at the Treasury to help the Fed use its 13(3)
authorities to massively expand its reach, lending far and
wide, as Congress instructed.
Most recently, the Fed set up a new lending facility called
the Bank Term Funding Program in response to the March 2023
bank failures and interest rate risks facing financial
institutions.
Following the bank failures, the Fed has reportedly been
working to reexamine operations of its discount window, given
that operations appeared, as Chair Powell has stated, clunky.
Part of that reexamination involves the role played by Federal
Home Loan Bank loans in the provision of liquidity to banks,
which we can discuss today, though I am skeptical that Home
Loan Banks were integral to the Fed's emergency lending
clunkiness last March.
As the Fed reexamines its operations, an open question is
whether legislation may be needed to address some of the
problems in the Fed's liquidity provision present last March.
Meanwhile, Federal banking agencies appeared to be examining
new liquidity rules for financial institutions, some of which
could have implications for markets, for Treasury securities.
Let us hope that the Fed does better at analyzing such things
than it did with its under-analyzed recent Basel bank capital
proposal.
I thank our witnesses for appearing today and look forward
to hearing their views on all these important issues.
The chair now recognizes the ranking member of the
Subcommittee On Financial Institutions And Monetary Policy, the
gentleman from Illinois, Dr. Foster, for 4 minutes for an
opening statement.
OPENING STATEMENT OF HON. BILL FOSTER, RANKING MEMBER OF THE
SUBCOMMITTEE ON FINANCIAL INSTITUTIONS AND MONETARY POLICY, A
U.S. REPRESENTATIVE FROM ILLINOIS
Mr. Foster. Thank you, Chairman Barr, and to our witnesses
today.
When the Federal Reserve was created in 1913, one of its
core roles was to serve as a lender of last resort, providing
emergency liquidity to banks during times of financial stress.
Since then, the Fed's role as an emergency liquidity provider
has evolved.
The Great Depression led Congress to grant the Federal
Reserve authority to provide liquidity to firms, in quote,
``exceptional and exigent circumstances,'' under Section 13(3)
of the Federal Reserve Act.
These authorities were ultimately narrowed and safeguards
were placed by the Dodd-Frank Act following the 2008 financial
crisis when the Fed made targeted and controversial loans to
individual firms, like Bear Stearns and AIG. The depression
also spurred the creation of the Federal Home Loan Bank system,
which developed over the years to become an important liquidity
tool for banks, credit unions, insurance companies and
Community Development Financial Institutions (CDFIs).
It also provided key competitive advantages due to the
smaller institutions that they serve, and this I believe is one
of the things where there is strong bipartisan concern about
maintaining a healthy size distribution in banks.
I know from my time starting a small business and watching
it grow, it is hard for small businesses to get the attention
of very many banks for the small amount of business they have,
and it is a huge advantage for small businesses to have a
variety of institutions of different sizes bidding for their
business. That will not happen if the natural forces as banks
become more digital cause them to consolidate more and more.
So having institutions like the Federal Home Loan Bank
system that level the playing field to some extent between the
larger and smaller institutions is another key role that we
should not overlook.
In this hearing, we are going to be discussing how the
Fed's discount window and other emergency lending authorities
have performed during recent economic shocks, and the stigma
associated with the use of the discount window, and the
interplay between the Fed's liquidity tools and the other
government lending programs, like those operated by the Home
Loan Banks and the National Credit Union Administration's
(NCUA's) Central Liquidity Facility.
As we saw with the regional bank failures last spring, the
social media and the 24-hour banking have the potential to
accelerate bank runs, by facilitating the rampant deposit
withdrawals and exacerbating shifts in market behavior.
I am afraid we are soon going to be living in a world where
individuals' artificial intelligence financial advisers on
their phones will be continuously monitoring social media buzz,
seeing if the bank at which you have your deposits looks like
it is rumored to be getting in trouble and pulling your money
automatically.
We are talking about something that will not proceed at the
speed of social media but at the speed of artificial
intelligence. We have to make sure that we have some defense
against this, which is not so much prepositioned capital but
prepositioned capital flight, which is what I am afraid we are
going to see when everyone has their financial advisers
automated or at least enough people to really put banks at
risk.
Then there is the whole separate issue of short sellers and
deliberate attacks on a bank when banks depend so much on their
reputation. If a deliberate attack is made on a bank's
reputation for illegitimate reasons, which is not a rare thing
to happen on social media, we have to make sure that there is a
defense for well-run banks against this kind of attack.
You know, we saw probably the first big example of this
when Silicon Valley Bank's depositors were spooked by
announcements that the bank was seeking additional capital,
just saw the thing amplified on social media and the whole
thing take off.
Anyway, and we also saw just an incredible rate of capital
flight, $42 billion within 24 hours. We have never seen
anything like that, and it is only going to get worse.
So this is an important hearing. I want to thank our
witnesses and our chairman for convening today.
Chairman Barr. Thank you, Dr. Foster.
Finally, the chair recognizes the ranking member of the
committee, the gentlewoman from California, Ms. Waters, for 1
minute.
STATEMENT OF HON. MAXINE WATERS, RANKING MEMBER OF THE
COMMITTEE ON FINANCIAL SERVICES, A U.S. REPRESENTATIVE FROM
CALIFORNIA
Ms. Waters. Thank you very much. It has been nearly a year
since we faced the sudden failures of Silicon Valley Bank,
Signature Bank, and First Republic Bank. I was pleased Treasury
Secretary Yellen, the Federal Reserve, and the Federal Deposit
Insurance Corporation (FDIC) took swift action to stabilize the
situation.
Going forward, I support efforts by Biden's regulators to
encourage the use of the Fed's discount window by banks that
need liquidity. I also support Federal Housing Finance Agency's
(FHFA's) work to ensure Federal Home Loan Banks use their
advances to support housing and community development instead
of propping up failing banks.
Last, I hope we can act on my bill to address NCUA's
bipartisan request to give small credit unions access to
emergency liquidity through the Central Liquidity Facility, as
we did during the pandemic.
I look forward to hearing the witnesses' testimony this
morning on these issues.
I yield back.
Chairman Barr. Thank you.
Today, we welcome the testimony of Professor Hal Scott. Mr.
Scott is the Nomura Professor of International Financial
Systems at Harvard University.
Mr. William Nelson. Mr. Nelson is Executive Vice President
and Chief Economist at the Bank Policy Institute. Professor
Simon Johnson. Mr. Johnson is the Ronald A. Kurtz Professor of
Entrepreneurship at MIT Sloan School of Management.
We thank each of you for your time and being here today. We
would ask each of you, after being recognized for your 5
minutes, to give an oral presentation of your testimony.
Without objection, each of your written statements will be
made part of the record.
Professor Scott, you are now recognized for 5 minutes for
your oral remarks.
STATEMENT OF PROFESSOR HAL SCOTT, NOMURA PROFESSOR OF
INTERNATIONAL FINANCIAL SYSTEMS, EMERITUS, HARVARD UNIVERSITY
Mr. Scott. Thank you, Chairman Barr, Ranking Member Foster,
and members of this subcommittee, for inviting me to testify
before you today on this topic of lender of last resort.
My testimony is my own and does not necessarily reflect the
views of the Committee on Capital Markets Regulation or its
members.
The Fed's lender of last resort function is of critical
importance to the U.S. financial system. It needs reform to
better respond to today's financial panics.
Here are my recommendations:
First, the Fed needs to clarify its collateral policies.
Under the discount window, the Fed need only have collateral to
its own satisfaction. After Silicon Valley Bank (SVB) failed,
the Fed established the Bank Term Funding Program under Section
13(3) of the Federal Reserve Act and valued hold-to-maturity
government securities at par rather than at market, as they had
done under the discount window. Why did the Fed not make this
adjustment under the discount window before SVB failed, as it
had the power to do so? So it needs to, I think, clarify its
collateral policies, particularly in crisis.
Second, operational improvements to lender of last resort
are necessary. The failure to extend the operating hours of
Fedwire on March 9 to allow SVB to borrow from the Fed
contributed to SVB's failure. Recent proposals have suggested
that banks preposition collateral at the Fed in sufficient
amount to cover their runnable liabilities. A more workable and
perhaps less costly approach would be to design a system by
which collateral and funds can be instantly transferred at the
push of a button.
Third, acting as lender of last resort should be the
responsibility of the Fed alone. I do not think the Federal
Home Loan Banks should have this role, as lender of last
resort.
Fourth, lender of last resort facilities just for banks
should occur through the discount window and not under Section
13(3). Whereas discount window lending is within the sole
discretion of the Fed, Section 13(3) lending requires Treasury
approval. To my knowledge, the 2023 crisis was the first time
Section 13(3) has been used to create a lending facility just
for banks. This facility was not needed to value government
securities collateral at par. This could have been done under
the discount window. It was not necessary to avoid stigma.
Stigma potentially comes from borrowing from any lender of last
resort facility. The Fed may be seeking to pull back from
acting as lender of last resort on its own under the discount
window, seeking cover from the Treasury approval required under
Section 13(3), but the Fed needs to maintain its independence
as a liquidity provider, given its clear mandate under Section
10(b) to act independently.
Fifth, the respective roles of lender of last resort and
deposit insurance in stemming contagion must be re-examined. In
the 2023 crisis, the Treasury invoked the systemic risk
exception to protect the uninsured depositors of SVB and
Signature when they were already in receivership. Due to Dodd-
Frank, this power can only be used for banks in receivership.
It can no longer be used to protect all depositors of the
banking system without a joint resolution of Congress, which I
regard under these circumstances as impractical. Congress
should consider restoring the ability to increase deposit
insurance in a crisis, and it should also consider increasing
the general limits for accounts that present greater run risks
and cannot be managed to the current $250,000 limit, such as
business payments.
Sixth, under--and I stress this--appropriate circumstances,
executive compensation should be clawed back if a bank has
received lender of last resort funding from the Fed or has
imposed cost on the FDIC or the government more generally.
Seventh, the Fed's emergency lending facilities--and this
is a lesson from the coronavirus disease (COVID)--should be
limited to liquidity provision and not entail fiscal policy,
which results when there is substantial credit risk to the Fed,
as was the case with lending to small businesses, nonfinancial
firms, under COVID's main street lending program and other
facilities that the Fed designed.
In summary, we need to reform the lender of last resort
role of the Federal Reserve to better deal with financial
panics.
Thank you again for inviting me.
[The prepared statement of Mr. Scott follows:]
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Chairman Barr. Thank you.
Now, Mr. Nelson, you are recognized for 5 minutes for your
oral testimony.
STATEMENT OF WILLIAM NELSON EXECUTIVE VICE PRESIDENT AND CHIEF
ECONOMIST, BANK POLICY INSTITUTE
Mr. Nelson. Chairman Barr, Ranking Member Foster, members
of the subcommittee, thank you for the opportunity to testify
today. My name is Bill Nelson, and I am the Chief Economist of
the Bank Policy Institute.
Prior to joining Bank Policy Institute (BPI), I was the
deputy director of the Division of Monetary Affairs at the
Federal Reserve Board, where I helped develop the Fed's
discount window policy and oversaw the lending operations of
the 12 Federal Reserve Banks, including regular discount window
lending to banks and emergency lending to nonbanks.
The Fed extends discount window loans as collateralized
advances under the authority granted under Section 10(b) of the
Federal Reserve Act. Loans can generally be extended for
maturities of up to 4 months and must be secured to the
satisfaction of the lending Reserve Bank. Most discount window
collateral is prepositioned at a Federal Reserve Bank, and 80
percent of that collateral is loans to businesses and
households.
Most central bank lending to banks is unremarkable. Prior
to the global financial crisis, discount window lending was an
important tool for monetary policy implementation. If the Fed
inadvertently left the system short of reserves on any given
day, the Fed fund's rate would rise up until some bank
borrowed, creating more reserves.
Smaller banks borrowed to address short-term funding needs,
such as might be caused by losing a large municipal deposit,
for example. To be sure, the discount window is also and has
always been the Fed's first line of defense against broader
financial turmoil.
In part because of the dual nature of discount window
lending, both unremarkable monetary policy tool and source of
contingency funding, there has been a stigma associated with
borrowing from the discount window at least since the 1920s.
Tapping your contingency funding inevitably suggests something
has gone wrong.
Stigma got much, much worse in the aftermath of the global
financial crisis, when borrowing from the discount window was
conflated with having received a bailout, even though the loans
were fully collateralized, extended at an above market rate,
and all repaid on time with interest. Because of the pillorying
banks that borrowed received, many banks now refuse to borrow
under any circumstances except perhaps an obvious glitch
affecting the entire payment system. Consequently, one of the
Fed's most important monetary policy and financial stability
tools does not work well.
Another source of stigma is that the post-Global Financial
Crisis (GFC) liquidity requirements do not recognize access to
the discount window and prepositioned collateral as a source of
liquidity. Banks are not allowed to assume that they borrow
from the discount window in either their liquidity coverage
ratio or their internal liquidity stress tests.
Not only do these restrictions depart from reality, a bank
prepared to use the window is more liquid than one that is not.
They miss an opportunity to create a strong incentive for banks
to be so prepared. Moreover, efforts by the banking agencies to
convince banks that they should be willing to borrow from the
discount window ring hollow if banks are told that
contemplating such borrowing is verboten when the banks test
their liquidity needs under stress.
In the wake of the bank failures in spring 2023, there has
been an increased recognition of the importance for liquidity
risk management of being prepared to borrow from the discount
window. There appear to be several different approaches
floating around for encouraging such readiness, but all involve
requiring banks to have discount window borrowing capacity
that, when combined with deposits at the Fed, exceed some proxy
for short-term funding needs under stress.
A common thread across the proposals is a recognition that
a bank that is prepared to borrow from the discount window is
more liquid than one that is not, and that weaving that thread
into the weft of regulatory and supervisory assessments of bank
liquidity will make those assessments more accurate and
increase incentive for banks to be prepared to borrow.
A critical ingredient of any such new requirement is
reducing discount window stigma. While there is no easy way to
reduce discount window stigma, as a first step the leadership
of the Fed and other banking agencies need to educate the
public, Congress, bank examiners and bank investors that
borrowing from the discount window is a business decision of
the borrowing bank and neither a bailout nor an indication that
the bank is in trouble.
Any requirement that banks maintain minimum amounts of
discount window borrowing capacity would, of course, need to go
through a notice of common process. In this case, given the
novelty, importance, and systemic implications of any such
requirement, a better approach would be through an advance
notice of proposed rulemaking, which would allow the agencies
to receive input on the general idea from bankers, central
bankers, academics, and other stakeholders before drafting a
specific rule.
Thank you. I would be happy to answer any questions.
[The prepared statement of Mr. Nelson follows:]
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Chairman Barr. Thank you.
Professor Johnson, you are now recognized.
STATEMENT OF PROFESSOR SIMON JOHNSON, RONALD A. KURTZ (1954)
PROFESSOR OF ENTREPRENEURSHIP, MIT SLOAN SCHOOL OF MANAGEMENT
Mr. Johnson. Thank you, Mr. Chairman.
I would like to make three points. In making the first
point, I would like to read two statements or two quotes for
the record. The first, and the quote begins, Silicon Valley
Bank, like our mid-size bank peers, does not present systemic
risks, end quote. That is a statement that Greg Becker, the CEO
of Silicon Valley Bank, submitted to the Senate Banking
Committee for their hearing on March 24, 2015.
The second quote is from a joint statement by the
Department of the Treasury, the Federal Reserve, and the FDIC
on March 12, 2023, which reads, ``We are also announcing,'' in
addition to what they are doing for Silicon Valley Bank, ``a
similar systemic risk exception for Signature Bank, New York.
New York, which was closed today by its State chartering
authority. All depositors of this institution will be made
whole.''
Now, the total assets of Silicon Valley Bank, as I am sure
you know, Mr. Chairman, when it fell it was something slightly
above $200 billion and Signature Bank was about $100 billion.
While we have been discussing many of these issues for a long
time among ourselves and with you and your colleagues, I think
we have learned over the past 10 or 15 years that this category
of banks around $100 billion or slightly over $100 billion can,
indeed, pose systemic risks. I think Mr. Becker, unfortunately,
in 2015 was not correct in his statement.
My second point is I think a combination, actually, of what
you said at the beginning, Mr. Chairman, and what Dr. Foster
said, which is I think there are three issues bundled together
as we discuss the Fed discount window.
The first is, is it clunky? The answer is absolutely yes,
you are quite right. I think Professor Scott and Dr. Nelson
have both got proposals to make it less clunky, and I think we
just need to find technically the better solution, and maybe we
have a couple of them and have the Fed try them out.
The second issue is the stigma, and this is something that
Dr. Nelson has spent a long time working on. I completely agree
that we should press on these dimensions. It is a very hard
problem to overcome because, as you know, Mr. Chairman, within
banking this signaling virtue is done in various ways, and one
of them is staying further away from anything that could look
like on a regular basis being emergency lending. Now, if, of
course, there is a systemic crisis and the Fed says, we are
invoking 13(3), we will lend to you on very advantageous terms,
that removes the stigma. That encourages people to come in.
That was the dynamic of 2023. Very hard to overcome that.
I would like to overlay on this and emphasize what Dr.
Foster said, which is the speed of these runs is only going to
accelerate. I think Dr. Foster's world with the AI advisers is
not an imaginary or futuristic world at all. I think that we
already live in that world. Having those advisers speed up the
bank runs will be coming for sure.
So in addition to dealing with the clunkiness and removing
or attempting to address the stigma, I do urge consideration of
revisiting the Transaction Account Guarantee Program, which
previously before Dodd-Frank could be put in place by a two-
thirds majority of the FDIC board with the agreement of the
Treasury Secretary, consulting with the President.
After Dodd-Frank, as you know, it is locked up and requires
congressional approval. There is specifically a fast track
process for approval of the Transaction Account Guarantee (TAG)
through the Senate but not through the House, and I have not
yet found someone who could explain to me why there is that
differential. I think at least a fast-track process in the
House to match the one in the Senate would be helpful, but I
actually think that putting the ability to invoke the TAG back
into the hands of the executive branch, the FDIC, the Fed could
certainly be involved, and the Treasury Secretary. I think that
would be wise as a complement to all the other measures that
you are considering.
The third point that I want to make is a little more
awkward, and I am sorry that I need to bring this up, but you
mentioned Bear Stearns, Mr. Chairman, and I think that is a
good parallel and an important historical example. I am sure
you and others will remember that at the time the Fed provided
support to the transaction, which was the purchase. Ultimately,
JPMorgan Chase was able to buy Bear Stearns. A senior executive
of JPMorgan Chase was on the board of the New York Fed, and the
New York Fed was instrumental in designing and implementing
that transaction.
Now, I understand the governance within the Federal Reserve
system is complicated. We can talk about that. I know the Board
of Governors ultimately has overriding authority, and I know
that is true particularly with regard to bank supervision.
It is a very unfortunate fact that Mr. Becker, who I
previously mentioned, who was still the CEO of Silicon Valley
Bank in March 2023, was sitting on the board of the San
Francisco Fed. This does not look good. It may just be an
optics problem, but it really does not look good. It is not
good for the Fed, and it is not good for any of these technical
fixes or any of the other--all the political support they need
to remove the stigma problem, for example.
So I understand Dodd-Frank attempted to address this. I
know steps were taken. I understand the difference between
Class A and B and C directors of Federal Reserve Banks, but I
really think the banks should no longer--member banks should no
longer sit on the board of directors of member banks of the
Federal Reserve system. Thank you, sir.
[The prepared statement of Mr. Johnson follows:]
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Chairman Barr. Thank you for your testimony. We will now
turn to member questions.
The chair now recognizes himself for 5 minutes for
questioning.
Professor Scott, I will start with you.
Are we relying too much on the Federal Reserve to intervene
in financial markets and the economy and sometimes expecting
the Fed to engage in emergency lending that could be done as a
fiscal policy operation using a program housed at the Treasury
instead?
Mr. Scott. Yes. As one of my points that I mentioned in my
oral testimony is I do not think that the Fed should be taking
substantial credit risk when it makes loans and that occurs
when there is not sufficient collateral. Under 13(3) during
COVID, that gap was made up by Treasury's backing of the Fed's
loans, but was this backing sufficient? The Fed was still
taking risk, substantial credit risk. In my view, that is
fiscal policy. That should be done by the Federal Government,
not the Fed. So main street should be PPP, not main street,
okay?
Second, when you loan under 13(3), there is kind of a dual
sign-off. The Fed has to sign off and the Treasury has to sign
off and I can tell you, during COVID in the operation of main
street--and I wrote op-eds on this subject--it was very hard to
say who was responsible for the design of main street. Was it
the Treasury or is it the Fed? So when you have two sign-offs,
as we have on 13(3), it is very hard to pin responsibility.
So, for those two reasons, I would say if the Fed is taking
substantial credit risk, it should not be the Fed lending, it
should be the government.
Chairman Barr. Thank you.
Mr. Nelson, what, if anything, would you recommend that the
Fed do to reform its discount window or 13(3) policies,
procedures, and operations?
Mr. Nelson. As part of a preparation of requiring banks to
pledge more collateral to the discount window, I think the Fed
should certainly review its discount window policy, collateral
operations and procedures, to make sure that they are as
efficient as possible.
I say that, but I also recognize that the Fed has always
sought to make the collateral pledging process as efficient as
possible, and almost all collateral is already prepositioned at
the Fed subject to keeping the Federal Reserve and taxpayers
safe. I am not really certain that there is a lot of low-
hanging fruit available there. In fact, my guess would be that
there is not, first of all because Fed staff would have already
plucked it, but also because I have talked to many of my member
banks of the The Bank Policy Institute (BPI) about this issue.
Many of them indicated--they have not generally indicated
dissatisfaction with the collateral pledging process from the
Federal Reserve Bank.
In addition, I think that the Fed needs to go back to
review how it is doing things, go back to its 2003 revision,
the last time it revised Regulation A, and move the discount
window to an above-market rate so that it could let the rate
itself govern a bank's decision to borrow and remove any
questioning.
I would go around and talk to the reserve banks and make
sure that the borrowing was kept secret. We had a joint
Supervision and Regulation (SR) letter written by the
supervisory agencies, recognizing that the discount window is
an important tool for liquidity risk management.
So I think that the Fed needs to redouble--and that was
working. Over time, that was gradually reducing the amount of
stigma that was available. So I think going back to that, no
questions asked, it is a bank's decision to borrow, educating
the public, educating Congress about the importance of the
discount window would be a critical change.
Chairman Barr. Yes. I am very intrigued by your
recommendation, when you say banks are not allowed to assume
that they borrow from the discount window in either the
liquidity coverage ratio or their internal liquidity stress
tests.
What does the Basel III end game proposal do about this in
exacerbating that problem, and do you believe that Congress
needs to legislate in that area to remove the stigma?
Mr. Nelson. Basel III does not mention the discount window.
It does not come up.
Chairman Barr. Would it exacerbate the stigma?
Mr. Nelson. It should not really have an effect either way.
Chairman Barr. An effect. Would you recommend that Congress
take action or just the Fed in the application of stress tests
and the Liquidity Coverage Ratio (LCR)?
Mr. Nelson. One action that Congress could take that would
help with stigma is to go back to keeping borrowing secret. It
is true that when you borrow from the discount window, the
names and the identities of the borrowers are released after a
2-year lag. That may not seem to matter much, but I have been
assured by bankers that actually really does matter.
Moreover, when I used to go around to banks and try to
assure them--try to convince them to use the window, it
mattered a lot that I was able to say, this is kept secret. It
is less compelling to say, this is kept secret for 2 years and
then it is revealed.
Chairman Barr. My time has expired but, Professor Scott, if
you could, in answers to other questions, throw in the lessons
that you think we should take from the experiences of last
March and ways to improve the Fed discount window lending and
the role of the Federal Home Loan Bank lending to financial
institutions.
With that, the gentleman from Illinois, Dr. Foster, is now
recognized.
Mr. Foster. Well, thank you, Mr. Chair and our witnesses. I
would just like to start out by saying that I agree with
Professor Scott about the desirability of separating the Fed's
role as a lender of last resort with basically bailing out
businesses that were in trouble that we think deserve bailing
out, and so I think if we can find a way to do that.
The issue that I saw at the time was just the capacity of
the Fed when we had to get a lot of money to a lot of different
businesses really fast. The Fed was the only--and so we have to
preposition the pipelines to make--if we have to do a broad-
based business bailout that we have to find a mechanism that is
well-defined ahead of time to make that work.
Professor Scott, are there any specific proposals that you
are aware of for separating those two functions explicitly?
Mr. Scott. I think the Fed could remain the distributor of
funds without being the lender of those funds. So the critical
thing to me is when we are dealing with fiscal policy, it
should be the government.
The government can use the Fed to distribute those funds.
The Fed can play an operational role in getting those funds to
small business if the Congress and the government so order
them.
So what I would like to see is the Fed not be the lender
under those circumstances.
Mr. Foster. Okay. I agree with everyone's comment about the
stigma. Just some elementary questions: Do the large banks at
least exercise the ability to do transfers out of the window?
Are the pipelines in place and are they tested with some
trivial amount of money regularly?
I know of at least one bank where I have asked that
question and they said, yes, of course. It is some microscopic
amount of money so that they do not feel the stigma.
Is that a universal practice or should it be made a
universal practice to at least exercise the window?
Mr. Scott. Actually--I am sorry.
Mr. Foster. Go ahead. Sure.
Mr. Scott. During March 9, when SVB was trying to transfer
its collateral to the Fed through the bank of New York Mellon,
it could not be done because we had to have a test procedure to
determine whether such transfer could be made, okay?
That should be like automatic at this point. You should not
be running test procedures when you have a bank in distress.
Just one further comment on stigma, because it has come up
here. Part of the reason the Bank Term Funding Program (BTFP)
was created or one of the aspects of it was the rate at which
people could borrow from that facility compared to the rate
that they could borrow from the window. It was lower.
As a result, it was so low that they could borrow from
BTFP, and did, and make an arbitrage by putting their money in
the reserves and getting a higher rate from the reserve
account. The Fed put an end to that in January.
What it underlies is the response to stigma was to lower
the borrowing rate so people could say, hey, I am not borrowing
because I am in trouble. I am borrowing because it is a great
rate, okay? In the financial crisis----
Mr. Foster. That was not optimal. There were letters in the
Fed to--in preparation when the Fed made that move, because it
is----
Could you say a little bit, any of our witnesses, about
sort of the nuts and bolts of prepositioning capital at the
window. What exactly--what does that mean? What are the
downsides? What are the costs of doing that? Why is it not a
uniform practice already to preposition an amount of capital?
Also, to do that, you have to understand what fraction of
deposits and so on are actually flighty if you are going to
say, you should preposition adequate for, quote/unquote,
flighty capital. Are there clean definitions of what is
required there?
Mr. Nelson, do you want to have a swing at it?
Mr. Nelson. So the Fed has always accepted collateral--at
least for decades accepted collateral and maintained pools of
collateral from banks prepositioned at the window. That is how
it is done. Eighty percent of the lendable value of bank
collateral are loans to businesses and households, and those
all have to be prepositioned.
Mr. Foster. When people refer to the costs of doing that,
are the costs significant? Since nothing has actually happened
if it is sort of prepositioned, is my understanding, they are
not----
Mr. Nelson. Well, there are costs. There are a few costs to
consider. One is that it does take time and work to set up the
arrangement, and banks do need to provide the Fed with
information on the loans that are pledged. The bank maintains
possession of the loan collateral, but then provides the
information that is necessary in order to value the collateral
and apply a haircut to come up with a lendable value.
It is also true that banks use collateral for lots of
things. They collateralize municipal deposits. They
collateralize their Federal Home Loan Banks and those things.
So there is a cost to keeping that collateral.
Mr. Foster. If, actually, any of you want to respond to the
record of a stronger version of prepositioning collateral and
the standards for how much you would have to preposition, what
that could actually look like at a sort of operational level, I
would appreciate it?
Chairman Barr. The witnesses can submit that for the record
and the gentleman's time is expired.
The gentleman from Missouri, Mr. Luetkemeyer, is
recognized.
Mr. Luetkemeyer. Thank you, Mr. Chairman.
Thanks to the panel for being here this morning. Great
thought leaders here.
Mr. Johnson, you brought up a subject that is kind of near
and dear to my heart. That after the debacle of last spring
with our banks, I came up with, as looking at this from outside
the box here and coming up with some ideas of the kind of risks
that we are taking there.
From the standpoint that the gentleman was sitting actually
in Mr. Scott's seat, who was the chairman or the president of
the board of SVB, and said he had $42 billion run out in 10
hours. To me, this is--as a result of a tweet.
We are living in a different world than we did 2 years ago,
5 years ago, 2 months ago. Now you brought up something in your
comments with regards to artificial intelligence.
I sit on the China Select Committee. It scares the heck out
of me, because we have just handed the Chinese the way to mess
with our banking system and our economy. All you do is short
sell tonight, go up tomorrow morning with a tweet, or have an
artificial intelligence Facebook post of Larry Kudlow,
Bloomberg, Dave Ramsey, somebody who is respected in the
investment field.
It could be an artificial individual on there and nobody
could tell the difference. I have seen these commercials
myself. You cannot tell the difference between--and you have
somebody of that reputation go up there and say, I have a
hundred banks that are in trouble. Suddenly, it is like, wow.
You have real-time payments. You have instantaneous ability to
make these transfers. All of a sudden now you do have a run.
People kind of laugh at me when we talk about runs. I say
we had a run on toilet paper 3 years ago. Do not tell me you
cannot have runs. I think people value their money more than
their toilet paper.
One of the things I think that we need to do is have the
ability of the regulators, the FDIC in this situation--and you
made this comment with regard to transaction guarantee of
accounts for a short period of time--to be able to stymie this
sort of run, nip it in the bud before there is a contagion here
that goes through the entire system.
I would appreciate your comments on that.
Mr. Johnson. Congressman, I think you are exactly right on
all the dimensions there, including the fact that the AIs can
already fake images and messages very credibly. Then the point
made by Gary Gensler, actually, when he was still on the
faculty of MIT before he joined the Securities and Exchange
Commission (SEC), was we should think about a future in which
financial institutions tend to use similar AI engines
themselves internally, which will be reacting to the messages
from the outside, which will just exacerbate the speed of runs.
So that is exactly why having the FDIC, with the Treasury
and arguably with the Fed, because they can all move fast,
giving them the ability to put a temporary Transaction Account
Guarantee Program in place very quickly I think is exactly the
right direction to go.
This would not be a substitute for the other things we are
talking about today with the discount window, but it would be a
complement and I think it would be very consistent with the
objectives of this committee.
Mr. Luetkemeyer. Oh, I think it is a tool. The regulators
need to have a toolbox. I am not trying to protect a single
bank here. I am trying to protect the system from going down.
When you have a run, that can make contagion that can spread
through everything.
Mr. Scott, I know your comments in your written testimony
were similar along that line. Would you like to comment at all?
Mr. Scott. On this point?
Mr. Luetkemeyer. Yes.
Mr. Scott. Well, I agree with Professor Johnson that I
think this power needs to be restored. I think a key idea of
the Congress at the time was it could restore by a joint
resolution. I think, given the speed by which these runs occur,
that is impractical. To get a joint resolution in time to
actually get the authority to extend----
Mr. Luetkemeyer. That is the point of my bill is the fact
that we cannot sit here and wait for Congress. The regulator
has to have this tool in a toolbox that they can instantly make
this situation resolved and not have to wait on Congress.
Mr. Scott. Yes.
Mr. Luetkemeyer. So for a short period of time they have
the authority to do this. At the end of 30, 60 days, we pick a
timeframe. Then Congress can extend it or not extend it, and
then you are off and running, but we live in a different world
where this instantaneous ability to do things today is such
that we have to be able to instantaneously react. If we do not,
I am fearful. I have a bill to do that, and I appreciate your
comments on that.
Mr. Scott, with regards to the term funding, the short-term
funding programs that the Fed has put together here, I would
kind of like them to keep this program up and running. I know
you are not a big fan of that.
So the question, I think it is a question that the problem
that happened last spring in which you had some interest rate
problems, some banks were upside-down interest rates in the
long term/short term.
Have those rate problems dissipated yet? I guess, do we
have some banks still with liquidity problems as a result of
long-term assets being for lower rates?
Mr. Scott. I am sorry. I am a little hard of hearing
sometimes.
Mr. Luetkemeyer. Okay.
Mr. Scott. I do not think--no, I do not think they need to
keep it in place, because my basic point is it is not necessary
at all. If they are going to do this kind of thing, it should
be through the window, through the discount window authority.
Mr. Luetkemeyer. Is the window for short-term lending
versus the need to have some long-term liquidity here?
Mr. Scott. In terms of having this liquidity?
Mr. Luetkemeyer. Yes.
Mr. Scott. I think the policies under----
Chairman Barr. The gentleman's time has expired.
Mr. Scott. I do not think we need to extend those
facilities.
Mr. Luetkemeyer. Thank you. I yield back.
Chairman Barr. The gentlewoman from California, Ms. Waters,
is now recognized.
Ms. Waters. Thank you very much.
Professor Johnson, we will soon be marking the 1-year
anniversary when we witnessed the sudden collapse of Silicon
Valley Bank and Signature Bank last March and then shortly
after the First Republic Bank. Those were three of the four
largest bank failures in United States history.
On the weekend that SVB and Signature Bank failed, I
convened a number of member calls with the regulators, and I
was pleased to see how the Biden administration, led by
Secretary Yellen, worked closely with the Federal Reserve and
the FDIC and used their emergency tools to quickly stabilize
the situation.
As part of their actions, the agencies invoked a systemic
risk exception to protect uninsured depositors, and the Fed
used its emergency lending authority to set up the Bank Term
Funding Program to help other banks that had securities
portfolios with large amounts of unrealized losses to be able
to have access to liquidity.
Professor Johnson, do you think that these quick actions of
Secretary Yellen, Chair Powell, and others were appropriate and
helped prevent a broader financial crisis?
Mr. Johnson. Yes, Congresswoman. I think those actions,
under the circumstances and given the constraints which we were
just discussing in terms of the fact that the Transaction
Account Guarantee Program was not available on short notice
because of the terms of Dodd-Frank, I think the measures that
they took, both individual measures and the packaging ways they
put them together, were entirely responsible and saved us from
a much more severe financial crisis.
Ms. Waters. Thank you.
Professor Johnson, you also raised how important it is for
banking regulators to finalize the Basel III end game proposal
to strengthen bank capital requirements. I agree with you, but
we received all sorts of statements from the banking industry
claiming the sky will fall and banks will stop offering loans
to underserved communities if the rule is finalized.
Should we believe their statements, like some believed
SVB's CEO back in 2015 that it was okay to deregulate regional
banks since they never pose a systemic risk? Would you discuss
why this rule is so important.
Mr. Johnson. Congresswoman, so as I reference in my written
testimony, I am the co-chair of the Chartered Financial Analyst
(CFA) Institute Systemic Risk Council, the body that was
founded by Sheila Bair, the former chair of the FDIC.
We sent a letter quite recently to the regulators with
regard to Basel III and our position. The Systemic Risk Council
is compromised of various Republican, Democratic, and
international European former officials. Our view is that
completing Basel III at this stage and at this moment for the
United States is important.
We are not convinced by the arguments that it will cause
economic exceptional difficulty. In fact, our view is that
well-capitalized banks are more likely to be robust lenders
throughout the business credit cycle; therefore, strengthens
economic growth prospects for everyone in the United States.
Ms. Waters. Well, I heard someone say, oh no, it had
nothing to do with capital that caused those banks to fail. It
was all about mismanagement.
Is not a lack of enough capital mismanagement? How could
you separate the two?
Mr. Johnson. The lack of capital or potential insolvency is
absolutely intertwined with issues of liquidity pressure in
many financial crises, and it was absolutely in the case of
Silicon Valley Bank, where investors came to believe, in part
through the rumor mill but there was definitely some foundation
for this, that Silicon Valley Bank had a potential solvency
problem and, therefore, it might be a good idea to move their
deposits, their uninsured deposits elsewhere.
So that the liquidity problem or the run on the bank as
people were trying to not go to cash but go to other safer
banks, that was absolutely intertwined and really tightly
connected, Congresswoman, as you are saying, with the capital
deficiency or the lack of capital and potential insolvency.
Ms. Waters. Some believed SVB's CEO back in 2015, that it
was okay to deregulate regional banks since they never pose a
systemic risk.
Would you take a minute and discuss why this rule is so
important.
Mr. Johnson. As I mentioned, Mr. Becker, the CEO of Silicon
Valley Bank, did send a letter saying exactly that to the
Senate Banking Committee in 2015. I testified to that committee
on the other side of that argument.
I have to say I think Mr. Becker's letter is entirely
wrong. I think that Silicon Valley Bank absolutely and
manifestly did end up posing systemic risks.
Ms. Waters. Thank you very much. I yield back.
Chairman Barr. The gentlelady yields.
The gentleman from Georgia, Mr. Loudermilk, the vice chair
of the subcommittee, is now recognized.
Mr. Loudermilk. Thank you, Mr. Chairman. Thank you all for
being here.
Mr. Nelson, earlier the chairman of the subcommittee
outlined the number of times 13(3) has been used since 2008,
and especially the increased frequency that it has been used in
the last few years.
Do you see this increasing use of 13(3) facilities as a
general trend toward reliance, or is it still as a response to
specific conditions?
Mr. Nelson. I think that there is inevitability that once
you start using it, you start to use it more. I think that
there is a sense of general trend.
When I used to go out and talk to people about using the
discount window back before the global financial crisis, at
times I would be asked, well, would the Fed ever use 13(3)? My
answer was always, no, absolutely not. They have not used it
since the 1930.
Of course, the global financial crisis hit and they used
it, and I was very involved in that, as appropriate. Then COVID
came around. They immediately rolled out all the same
facilities again.
So it is clear now that in response to troubles, opening a
broad-based facility for nonbanks under 13(3) is on the table
and that has moral hazard consequences. I remember talking to
money market mutual funds about the effort to reform them after
the global financial crisis. The answer was in some cases,
well, why is that necessary? If there is trouble again, the Fed
will just open up a new lending--a lending facility for us
again. As COVID hit, that is exactly what happened.
So--and the risk is that the institutions that receive
13(3) loans generally tend to be ones that are not as
stringently regulated as commercial banks. They do not have the
same controls to control the moral hazard.
Mr. Loudermilk. Instead of an option of last resort per se
as maybe it was intended, this has become the default go-to?
Mr. Nelson. I think that is probably going too far. I do
not think it has become a default. Nevertheless, I am sure on
everyone's mind is now that if sufficient trouble happens, the
Fed will be able to open a 13(3) facility.
Mr. Loudermilk. The safety net is always there.
Mr. Nelson. The safety net is expanded.
Mr. Loudermilk. All right. With the Fed's progress toward
real-time 24/7 services in other areas, do you believe it would
be beneficial to extend the operating hours of the discount
window?
Mr. Nelson. I do. I think the critical question is actually
the operating hours of Fedwire and the National Book Entry
System for securities. You could make a discount window loan in
the middle of the night, but you could not book it to the
institution's account, because Fedwire is closed.
So the Fed is studying and has expressed a desire to extend
Fedwire to 24/7, and that would make a lot of things a lot
simpler, but I do not know how difficult it is.
Mr. Loudermilk. Do you think if they did do this, would it
reduce the reliance on special credit facilities during periods
of instability?
Mr. Nelson. I think it would--not necessarily, because the
institutions that would have access to those 24/7 facilities
would all be commercial banks, ones with accounts at the Fed.
So----
Mr. Loudermilk. Are there any technical or logistical
obstacles that might prevent the Fed from doing this?
Mr. Nelson. I do not know. I am sorry.
Mr. Loudermilk. Can you explain how services like Fedwire
might have played a role in preventing Silicon Valley or
Signature Bank from accessing liquidity through the Fed's
discount window?
Mr. Nelson. As Professor Scott mentioned and as was
reported in the press during the efforts to keep Silicon Valley
open, they had trouble getting securities from their
correspondent bank in New York into their account so that they
could lend against them.
The facilities close at 7 p.m., which is a normal time for
things like that to close, but that is Eastern Time and so 4
o'clock Western Time, and extending the hours would have
helped.
Mr. Loudermilk. Okay, thank you.
One of the requirements to use 13(3) authorities is to
affirm that the participants cannot secure credit
accommodations from any other institution. In theory, this is
an important safeguard to prevent the misuse of 13(3)
facilities.
How is this safeguard applied in practice under truly
exigent circumstances?
Mr. Nelson. Each time the facility is used or created, the
Fed looks at and determines that similar credit is not
available elsewhere.
Mr. Loudermilk. Okay. Last March, the Fed set up the Bank
Term Funding Program facility, a 13(3) facility. The BTFP lets
borrowers pledge securities and get a loan at par value, not
market value. Since then, the program's credit extensions have
reached around $165 billion and is slated to expire in March of
this year.
Do you believe that the program achieved its intended
purpose?
Mr. Nelson. I do. I mean, viewed from the outside, it
appeared that what happened was the Fed that SVB weekend looked
around and looked at the uninsured deposits that were out there
that could run and the amount of collateral that was pledged by
the institutions subject to those runs, and they have judged
that to be a necessary response.
It was one that allowed them to move collateral very
quickly, because book entry securities can be moved immediately
and in large amounts. I think it entailed a lot of risk,
though.
Mr. Loudermilk. Thank you. I yield back.
Chairman Barr. The gentleman yields.
The gentleman from Georgia, Mr. Scott, is now recognized.
Mr. Scott of Georgia. Thank you, Chairman.
Mr. Johnson, welcome. Now, I truly believe that the Fed's
discount window can be very helpful, but we got a problem. Our
banks are scared to use it because they fear it is going to
hurt them with their investors and depositors. That is even if
we are waiting 2 years before we even tell anybody that they
are using it.
So what can we do? What else can we do to really deal with
this problem?
Mr. Johnson. Well, Dr. Nelson has proposed to remove the
requirement to disclose who borrows from the discount window. I
think the problem with that is, Congressman, that there is
already a great deal of concern that the deal that banks have
with regard to the Federal Reserve is actually a pretty good
deal and not available to other parts of the economy.
So I think actually making that secret again would be
problematic, including given, as I mentioned, the governance
structure of the regional Feds, where banks sit on the boards
of these Feds which would then be giving them advantageous
loans in secret. That is very difficult, I think, to make that
work politically with the country.
I think, Congressman, that the Transaction Account
Guarantee Program that we previously discussed would be very
helpful to achieving your goals and the goals of this
committee, because the point is that if that program is
available, there can be losses for one entity.
Let us say Silicon Valley uninsured depositors might have
lost five cents on the dollar. That is one reasonable estimate
and they would have gotten a lot of their cash back, by the
way, within a couple days. That is the way the FDIC operates.
The TAG would have been applied to all other banks
throughout the system--small, medium, and large--on a temporary
basis. That would have prevented the panic and the fear that
was going to drive other depositors, other insured depositors
to the mega banks in the following days.
So I think, as a belt-and-suspenders approach, as a
backdrop to the discount window, for which I really do not
think we are going to get past the stigma completely ever, I
think you need the TAG program.
Mr. Scott of Georgia. If we are not going to be able to get
rid of it ever, in your estimation, do you think that we will
have more Silicon Valleys, more banks disruption, more hurt to
our economy? Are you saying that this is something we are going
to have to live with or can we solve it?
Mr. Johnson. I think we live in a very unpredictable world.
As Dr. Nelson said, we have had four major--three major
disruptions, three needs to use the 13(3) powers over the past
15 years. I do not think the world is going to become more
stable, Congressman.
I think 13(3) is available. I understand Professor Scott's
reservations about it, but it is available precisely when
nonbanks are in trouble, so not member banks, or when you need
to provide some support to banks and break through that stigma
barrier.
The 13(3) powers, as we saw in the case of Silicon Valley
Bank and Signature Bank, are not sufficient. That is why they
did the systemic exception.
Mr. Scott of Georgia. Yes. You mentioned, Dr. Nelson--let
me ask you. The Federal Home Loan Bank system is a source of
collateralized borrowing that some banks tend to turn to when
they need liquidity. How do you feel about that? Is that a way
out of this?
Mr. Nelson. The Federal Home Loan Bank system is an
important means by which smaller and regional size banks
conduct regular asset liability management when they need
funding, and that is an important role and one--but at the same
time there is a significant moral hazard and a problem with the
Federal Home Loan Bank system in that the securities that it
issues to fund itself are viewed as guaranteed by the
government, but they are not guaranteed by the government, and
that is a recipe for systemic risk.
Addressing that problem would require a lot of careful
consideration, because of their role in the banking system.
That said, one role that they are not suited for is to be
lender of last resort, and that is for three reasons.
The first is that, as I mentioned, the Federal Reserve, as
we have discussed, the discount window is open till the end of
the day. It is the last mover. The second reason is that at
times being lender of last resort requires lending vast amounts
of money, and that money is not--the Federal Home Loan Bank
system does not have that. They have to borrow it. That takes
time and it can add to the stress in the financial system. The
third reason is that when the Federal Reserve--sometimes being
a lender of last resort requires adding reserves to the banking
system. When the Federal Reserve makes a loan, that expands
their balance sheet and it creates reserves, but not for
Federal Home Loan Bank loans.
Mr. Scott of Georgia. Well, thank you. I think we can find
a way out of this.
Chairman Barr. The gentleman's time has expired.
Mr. Scott of Georgia. I really do.
Chairman Barr. Thank you. The gentleman's time has expired.
The gentleman from Tennessee, Mr. Rose, is now recognized.
Mr. Rose. Thank you, Chairman Barr and Ranking Member
Foster for holding the hearing. Thank you to our witnesses for
being here with us today and sharing your time and expertise.
Dr. Scott, in your testimony, you discussed how the
development of transfer speeds has resulted in bank runs that
have gone from taking 10 days down to, effectively, 1 day,
maybe hours. What impact do instant transfers have on the
ability of the Federal Reserve to respond to bank runs?
Mr. Scott. Well, for one thing, I think SVB teaches us that
they have to be responding quickly because the runs are
happening quickly, and their operations need to be set up to
permit that. As I think we have discussed with Fedwire where
they were not, they have to be improved.
I would like to see more operational improvements so people
could transfer collateral to the Fed and receive funds
instantaneously. Technically, this should be possible in the
modern world. I think those are clear operational improvements
that the Federal Reserve should make.
Mr. Rose. As we think about technology, Dr. Scott,
obviously, we will continue to advance, and we will see the
quickness, the rapidity of these things probably increase, not
decrease, as we go forward. Certainly, the ability to
communicate concern in the marketplace is almost instantaneous
at this point, and the ability to move funds is very quickly
becoming instantaneous.
What does the Federal Reserve, besides the things that you
have said, what changes in technology do they need to implement
to respond to these runs quicker and quicker?
Mr. Scott. Well, I am not a techie, so I cannot give you
the details, but I think if we have a world with AI, we can
sort of figure out how to move funds fast and get collateral to
the Fed. I am sure the technical people can figure that out
pretty quickly and set up a system to do it.
Mr. Rose. Is the Fed and the other regulatory
establishment, are they equipped from a policy perspective to
make such quick decisions?
Mr. Scott. Well, I think they learned a lesson here. By the
way, the next day, when they were dealing on Friday with
signature, they left Fedwire open until the end of the day. In
terms of the operating hours issue, they learned a lesson.
I would like a lot of improvement here just from the
movement of the collateral to the Fed instantaneously.
So, again, I cannot give you the technical way to do it,
but I am sure that others can.
Mr. Rose. Thank you.
Dr. Nelson, in March of last year, the Fed set up its Bank
Term Lending Program to let eligible borrowers pledge eligible
securities and get a loan to value equal to the par value of
those securities, as opposed to the current market value.
Currently, credit extensions in the bank term funding
program are about 165 billion, and the program is scheduled to
expire in March of this year. Do you believe that the program
was successful and was it useful?
Mr. Nelson. I believe it was successful. I think it is too
bad that it was necessary, but I do think that it was
successful in that it allowed the Fed to quickly gather a lot
of collateral from institutions that depositors were worried
about and enabled them to potentially meet runs.
The fact that the Fed was lending in a partially
uncollateralized way at a low rate for long terms are largely
inconsistent with standard lender of last resort practice.
A better approach and one--so it is great that we are
having this hearing today--is that banks be prepared to borrow
from the discount window, preposition large amounts of
collateral in advance.
Mr. Rose. Should the facility be maintained in its current
form?
Mr. Nelson. No, Congressman. It should be ended.
Mr. Rose. So thinking about that, the risks of this
program, such as moral hazard that may be associated with it,
comment on those.
Mr. Nelson. I would say that in general, the Federal
Reserve should not be--I do not think it has ever happened
before, to my knowledge, that the Federal Reserve has lent in a
partially uncollateralized way, and so, that is--and
particularly at a rate that is below market rate.
Once market shifted to expecting a decline in rates, the
way the rate was calculated, as Professor Scott mentioned, it
became an arbitrage to borrow from the program and simply
deposit the money at the Fed. Both of those are unattractive
features of a central bank lending program.
Mr. Rose. Are there any market implications from the
program being terminated?
Mr. Nelson. I do not think so.
Mr. Rose. All right.
Dr. Scott, you are aware during the 2023 Silicon Valley
Bank crisis, the Federal Reserve stepped in and backstopped the
deposits of investors that were uninsured. You have advised
that Congress should restore the ability to increase deposit
insurance in a crisis.
What would be benefits and harms of doing so, Dr. Scott?
I see my time has expired, so if you could answer that for
the record, I would appreciate it.
Mr. Chairman, I yield back.
Mr. Loudermilk [presiding]. The gentleman yields.
The gentleman from California, Mr. Vargas, is now
recognized for 5 minutes.
Mr. Vargas. Thank you very much, Mr. Chairman and the
ranking member. I appreciate the opportunity to speak here.
I especially appreciate the witnesses today. I think you
have been tremendous in what you have said so far, and I also
appreciate your service. I appreciate it very, very much.
I will have three areas I want to cover, climate change,
insurance companies in the industry, and AI.
First of all, do you believe in climate change?
All three of you? That is refreshing because sometimes we
hear that we do not.
I do think that the world has changed, and I think it is
dramatic. We saw in San Diego recently a thousand-year flood
that is happening all the time now. I say this because now
insurance companies are starting to leave areas of the country
or not renewing policies because of climate change and now the
risks that they see.
We have been talking mostly about banking, the last resort
of banks to loan, from the Fed, but also AIG was brought up
earlier. I do want you to comment a little bit about that,
about the potential for insurance companies here because I do
think that we are going to run into some problems that some
insurance companies are going to become insolvent because they
are not appropriately reserving.
Could you comment on that? Because it is a very different
type of collateral. It is a very different issue when you have
an insurance company versus a bank.
Mr. Johnson. Perhaps I will go first on that, Congressman.
Mr. Vargas. Yes.
Mr. Johnson. First of all, the AIG failed because the AIG
financial products, which was an offshore London-based quasi
hedge fund----
Mr. Vargas. Hedge fund, sure.
Mr. Johnson [continuing]. took on massive exposures and
that was an absolutely crazy idea.
That is one reason that Basel III, for example, emphasizes
the need to have consistent--it is part of a package of
consistent approach to regulation in the EU, the U.K., and the
U.S. That is tremendously important for insurance and other
parts of the financial sector, and that is something that
Systemic Risk Council has written about, thinks a lot about,
that consistency.
With regard to the climate change impact, I am sure you are
absolutely right that particularly extreme weather events in
some parts of the United States pose major risks to everyone,
including homeowners, including insurance companies.
I think the bigger risk you are going to see there,
Congressman, is exactly the reports from Florida, for example,
where insurance companies pull out because they cannot raise
rates or are not allowed to raise rates or do not want to raise
rates to match the risks.
So then who is left holding those risks? Is it the
homeowners? Is it the States? Who else is it? I do not think we
have seen that come through into banks. I think banks have
other issues right now, including commercial real estate that
are absolutely worthy of discussion, but I am not sure we have
seen exactly that impact yet on the banks.
To the previous discussion, I think future financial crisis
may come to us from many directions and having it come to us
through climate change and extreme weather events is entirely
possible.
Mr. Vargas. Would anybody else like to comment? Yes,
Professor--or
Mr. Nelson. Climate change is a serious problem, and it is
appropriate that the regulatory agencies that are responsible
for regulating carbon risk do so.
I think we can also agree, though, that bank supervisors
should be focused on safety and soundness and financial
stability risk. Study after study after study, including two by
the New York Fed and one by the FDIC have failed to see or find
any relationship, any negative impacts, material negative
impacts on the banking system by climate events.
Moreover, if banks are required to devote resources to
climate risk, that means those resources are coming from
somewhere else.
I do think that, we need--I just remain concerned that the
reasons why the banking agencies are focusing on climate risk
is a well-intentioned desire to do something about it, as
opposed to a carefully considered assessment that imposes
potential instability or safety and soundness risk.
Mr. Vargas. Well, I do not know that I would agree with you
fully on that because you do see that banks loan--and,
obviously, we are talking about the collateral and the business
loans that they have and homeowner loans. A lot of these loans,
of course, are the very expensive homes along the coast. So
when you do have issues of climate change, obviously, that
could affect those loans that are used for collateral.
So I am not sure that I fully agree with you, but if you
would like to comment on that. No? Okay.
Well, I do want to go on to, for the last few seconds that
I have here, AI. A scenario was given to you by Mr. Luetkemeyer
about AI fraud, but what about AI that is not fraud? I mean, it
seems that now we have a real issue here with AI that is not
fraud that could cause some real problems for the banks.
Could you comment on that very quickly?
Mr. Johnson. Yes. So I recommend everyone to read Gary
Gensler's paper. It was written before he joined the SEC,
which, actually, it models--and I will not say exactly that,
but completely legit AI adopted by banks and other financial
institutions for entirely legitimate business purposes and
making sense on an individual basis the way those AIs can
interact, particularly if they are very similar to each other,
could exacerbate run risk and create systemic risk.
That would not be because any individual firm was doing
something stupid or irresponsible. It is the way that those
risks would aggregate data through legitimate AI. That is a
very serious possibility.
Mr. Loudermilk. The gentleman's time has expired.
Mr. Vargas. Thank you.
Mr. Loudermilk. The gentleman from Wisconsin, Mr.
Fitzgerald, is recognized for 5 minutes.
Mr. Fitzgerald. Thank you, Mr. Chairman.
Mr. Nelson, you note in your testimony that before a
Federal Reserve bank can lend to a commercial bank, it must
work out the subordination agreement with any Federal Home Loan
Bank that has collateral pledged to them by that commercial
bank. Obviously, this is because both Federal Reserve banks and
the Federal Home Loan Banks are required to perfect their
security interest in any collateral that they attempt.
My understanding is the home loan bank usually will take
mortgage-related collateral while the Federal Reserve bank will
take consumer, commercial, credit card, and other non-real
estate loans as collateral.
I know that the Federal Home Loan Bank (FHLB) in Chicago
provides regular quarterly reports to prudential regulators of
its bank members about their boring.
Mr. Nelson, I will ask you first, what has your experience
been with the communication and coordination between home loan
banks and the reserve banks in times of crisis? Are there ways
that you can think of that we could improve the coordination
between the two entities?
Mr. Nelson. As you know, Congressman, for every Federal
home loan bank member, commercial bank, the corresponding
reserve bank and Federal home loan bank work out an agreement
between them about what collateral will be pledged to the
window because, as you know, the Federal Home Loan Banks are
secured not just by individual assets but by a blanket lien on
all of the assets of the institution.
Consequently, the Fed cannot get a perfected interest in
the assets of that institution. So what happens is the two get
together, and they identify categories of loans that can be
pledged to the Federal Reserve, and the Federal Home Loan Banks
subrogates its interest to the Federal Reserve for those
categories.
Those tend to be ones that the Federal Home Loan Banks do
not give lending value to for non-real estate assets, consumer
loans and business loans. Now, obviously, that takes time and
effort, and so it cannot be done in a crisis.
One change that could be considered would be to--it seems
to me that a better arrangement, more appropriate to the role
of the Federal Reserve as lender of last resort and the Federal
Home Loan Banks as providing regular asset liability management
lending would be to flip the situation and provide the blanket
lien to the Fed and take it away from the Federal Home Loan
Banks.
Mr. Fitzgerald. Very good.
As we take a comprehensive look at contingent liquidity and
Federal emergency lending issues, I would ask that we also
consider the credit unions and their importance of having
strong backstops in place for those institutions.
In addition to FHLB advances and access to various Fed
programs, credit unions have access to a central liquidity
facility, a Federal function maintained by the National Credit
Union Administration. It is essential that Congress ensures
that the central liquidity facility is up-to-date and ready to
provide efficient and adequate contingency liquidity to the
credit union system in the event of liquidity stress or some
type of distress.
Professor Scott, what is the most important reform that we
could make to the lender of last resort function?
Mr. Scott. If I have to pick one, I would go back to my
point about COVID.
Mr. Loudermilk. Could the gentleman turn your microphone
on.
Mr. Scott. I am sorry.
If I had to pick one, I would go back to my point on COVID.
The Fed should not be getting into situations where it is doing
fiscal policy as it did with the main street lending facility
during COVID. This should be a government role. It should be
Treasury implementing that policy with appropriated money or
appropriated guarantees.
So I think we need to get the Fed out of fiscal policy.
That was the COVID lesson. It was not SVB but let us remember
the Fed played a huge role in lending to main street, lending
to corporations generally, providing credit. I do not think
that is the way it will fit.
Mr. Fitzgerald. Very good. Interesting.
A recent report on 2023 banking crisis by a group of
thirty, the Group of Thirty, proposed a requirement that banks
preposition enough collateral with the Fed to support loan loss
revenue, loans sufficient to cover all banks' runnable
liabilities.
In recent remarks, Acting Comptroller of the Currency, Hsu,
called serious consideration of a new liquidity requirement
that would involve the prepositioning of collateral at the Fed.
Professor Scott, can I ask you, do you think such a
prepositioning requirement is a necessary reform?
Mr. Scott. I do not object to prepositioning if the banks
want to use it. They should be able to preposition collateral.
Mr. Fitzgerald. Thank you.
Mr. Scott. Where I draw a line is a requirement----
Mr. Loudermilk. The gentleman's time has expired.
Mr. Fitzgerald. Thank you, Mr. Scott.
I yield back.
Mr. Loudermilk. The gentleman from California, Mr. Sherman,
is recognized for 5 minutes.
Mr. Sherman. Earlier we discussed AIG. I would point out
that you had a management capable of bankrupting the whole
institution by its crazy bets in the one entity that they had
that was not regulated by State insurance commissioners. In
spite of that management, that management was not able to
bankrupt any of the regulated insurance companies.
I think this was the most impressive show of effective
State regulation of insurance companies. It also shows that
credit default swaps are basically insurance.
We could structure my fire insurance policy that if my
house burns down, they do not write me a check. I just trade my
deed for a short-term treasury bill. I guess you would say,
well, then it is not an insurance policy. It is just a--no,
this is--we need to realize that many things we call
derivatives are actually insurance. At least we are regulating
them better as derivatives.
The other thing I would point out is that there seems to be
a tendency among bank regulators to undercount the importance
of interest rate risk. A million dollar treasury bond issued
25, 30 years ago is worth $600,000 today.
Let me just ask Mr. Scott. Would the Fed discount window
lend more than $600,000 on a million dollar treasury note that
had a fair market value of $600,000? Would they lend more than
current fair market value?
Mr. Scott. Well, not only would they, they did from the
bank term facility program. Once they put this program in
place, they valued securities not at their market value but at
their par value. So . . .
Mr. Sherman. Wow.
Mr. Scott. Yep.
Mr. Sherman. This is kind of an unauthorized,
uncongressionally authorized bailout when a bank can go to the
government and say I have an asset that everybody in economics
understands is worth $600,000, and you are going to loan me a
million dollars against it.
I remember Troubled Asset Relief Program (TARP). We had to
authorize that here in Congress.
So the Fed does lend money on assets based on the myth that
it is worth more than you can sell it for. Do I have that
right?
Mr. Scott. They do that, Congressman.
Under the discount window, which was not the BTFP facility,
that was 13(3), the Fed is not required to have collateral. It
is not required. They only need to have collateral to their
satisfaction.
Mr. Sherman. Got you.----
Mr. Scott. So, and I think----
Mr. Sherman. I need to spend the rest of my time focusing
on the Federal Home Loan Bank. There is this attitude that
somehow it is a red flag. Although, in our area, we have seen
JP Morgan, Wells Fargo, Bank of America be general--be major
borrowers.
Is it a red flag for an institution? Does it symbolize that
they are not solvent to borrow from the Federal Home Loan
Banks, Mr. Scott?
Mr. Scott. No. I think they are borrowing from the home
loan banks, as Bill Nelson said, to manage their assets and
liabilities on an ongoing basis. I do not think, their
borrowing from the Federal Home Loan Banks is actually as much
seen as a stigma as they would be borrowing from the discount
window.
Bill may want to comment on that.
Mr. Sherman. It is clear from the statute, the Competitive
Equity Banking Act of 1987, that the Federal Home Loan Banks
are a lender, not the lender, a lender of last resort. I ask
unanimous consent to put in the record the conference report
from that Act. I ask unanimous consent to----
Mr. Loudermilk. Without objection.
[The information referred to can be found in the appendix.]
Mr. Sherman. The Federal Home Loan Banks continue to serve
an important source of liquidity for small community banks in
the aftermath of the Silicon Valley. It took the Federal
Reserve 3 weeks to establish a bank term funding program.
Dr. Nelson, had it not been for the Federal Home Loan Banks
Act acting as a lender of last resort during those weeks, would
we have had some bad consequences in the main street economy?
Mr. Loudermilk. The gentleman's time has expired. If the
gentleman would answer for the record.
The gentlewoman from California, Ms. Kim, is now recognized
for 5 minutes.
Ms. Kim. Thank you, Chairman.
I want to thank the witnesses for joining us today.
My home State of California saw firsthand some of the
biggest bank failures in history with SVB, the First Republic
Bank. In the case of SVB, we know that its failure was due to
the perfect storm of the bank mismanagement, financial
regulatory failures, liquidity, and social media panic.
Mr. Scott, in your written testimony, you mentioned that
the Fed, in quotes, was operationally unprepared for the
unprecedented speed of the run, end quote, of SVB.
Can you elaborate on why the Fed was so unprepared and can
you point to any changes that the Fed has implemented since the
bank failures to be better prepared?
Mr. Scott. Well, I cannot say why they were unprepared. I
do not know, but I think I said a few times today that they
were not prepared to extend the operating hours of Fedwire.
They were not prepared to facilitate the transfer of collateral
from the Bank of New York Mellon, which was holding collateral
for SVB to the Fed. They were not prepared for that.
Why were they unprepared? I do not know.
Ms. Kim. Well, in your testimony, you also indicated that
SVB possessed hold-to-maturity government securities that could
have been pledged as collateral to cover the run on deposits.
Can you elaborate on that, why SVB did not pledge this
collateral to borrow from the Fed's discount window?
Mr. Scott. They could not get it there. The next day, when
the Fed created this other facility, they agreed to value the
hold-to-maturity assets at par. That they had a lot of value
anyway, even a market value, and they could not transfer those
assets over to the Fed.
My calculations, actually, even if you looked at the hold-
to-maturity assets at market value we are talking $70 billion,
something like that. So they had tremendous borrowing capacity
from just those assets at market value, which they could not
get to the Fed to borrow.
Ms. Kim. Okay, Mr. Scott, let me move on.
There is a stigma associated with borrowing from the Fed's
discount window. Furthermore, current law also disincentivize
banks from utilizing the Fed's discount window when there is a
liquidity crisis.
Mr. Nelson, Chairman Barr touched on this earlier, and I
would like to follow up on that. How could allowing banks to
assume that they borrow from the discount window in the
liquidity coverage ratio or internal liquidity stress test
incentivize more banks to utilize the discount window?
Mr. Nelson. Making those changes, particularly the internal
liquidity stress test, which is not something subject to an
international agreement or international standard, would send a
message to banks that being prepared to borrow from the
discount window is something that we see as a tool that you
should be using for your liquidity risk management and would
create an incentive for banks to do so.
In fact, SVB was looking at the possibility of signing up
for the standing repo facility and being prepared to use it,
but when it learned that--but it learned that would not have
actually helped them in the internal liquidity stress test and
took away that incentive.
So it was a real missed opportunity.
Ms. Kim. Can you quickly tell us how EU countries, the U.K.
or Canada treat their own discount windows in liquidity stress
test?
Mr. Nelson. It is quite different. In the U.K., which has
much less of a stigma problem, for example, institutions are--
they cannot change the LCR but in their own internal liquidity
assessments, institutions are encouraged to be planning on
using U.K. facilities.
The U.K., the Bank of England has made repeated public
announcements that this should be seen as a business decision
on the part of banks. They ran tabletop exercises to get the
supervisors and the banks together to practice using the window
when it was appropriate to do so. So lots can be done.
Ms. Kim. Thank you. Thank you.
I am concerned that some proposals to change requirements
in the preposition in collateral of banks at the Fed could tie
up capital that could be used for lending to small businesses
and families. On the one hand you could have had this proposal
by the G30 countries, and on the other, the effect of the Basel
III Endgame proposal to increase capital requirements.
Mr. Nelson, can you talk about how the lending for small
businesses and families would be impacted by the combination of
these two proposals?
Mr. Nelson. It is quite the opposite. It would actually
encourage such lending because banks, instead of holding
reserve balances or treasuries, which are, effectively, loans
to the government as their source of liquidity, they could be
making more loans to small businesses and pledging those to the
discount window to get borrowing capacity.
Mr. Loudermilk. The gentlewoman's time has expired.
The chair recognizes the gentleman from Texas, Mr. Green,
for 5 minutes.
Mr. Green. Thank you, Mr. Chairman. I thank the ranking
member as well, and, of course, I thank the witnesses for
appearing today.
Is it true that a large number of the depositors at Silicon
Valley exceeded the $250,000 FDIC guarantee? Is it true? If so,
if you think so, raise your hand, please. Only one person? Only
two?
Mr. Johnson. I am sorry. Say the last statement.
Mr. Green. The depositors at Silicon Valley, is it true
that a large number of them exceeded the FDIC $250,000
guarantee?
Mr. Nelson. So 95 percent of their deposits were uninsured.
Mr. Green. Ninety-five percent.
Mr. Johnson, do you agree that it was a large number?
Mr. Johnson. It was a large share of deposits. Number of
depositors, I cannot speak to that.
Mr. Green. Well, all right, let us make it deposits.
Mr. Johnson. Absolutely. A very large share of uninsured
deposits.
Mr. Green. Do you agree that if all of them had been at or
under $250,000, the run would not have been precipitated to the
same extent that it was?
Mr. Johnson. There would be no--there is no run. Insured
depositors do not run on American banks. That is not something
that happens.
Mr. Green. If they do not run when you have your deposit
insured, why would you? Your money is going to be accorded you
from the FDIC. If you are not concerned about the run, then the
question becomes this: Who was responsible for this large
amount of people or depositors or deposits being above
$250,000?
The bank itself is the first line of defense to make sure
that you do not have this large--this excess of depositors for
over $250,000. Without the bank's help, you find yourself where
we were.
I am not sure that we can blame the regulators for this.
Maybe we can find a way to get to them, but that bank had a
duty to put itself in a position such that if you have a run,
you will be prepared to take care of your deposits.
Mr. Johnson, your thoughts on this?
Mr. Johnson. Yes. I think, Congressman, you put it very
well. I think this was a massive failure of risk management.
The question is, as we have been discussing, how responsible
management should prepare for the eventuality of a run by
uninsured deposits?
So, for example, you might require, the regulators might
require, as Dr. Nelson has been saying, that you pledge enough
collateral so you can meet all of the runnable--all of the run
risks. That is one possibility.
Yes, I agree. The onus here and the questions here are in
the first instance and have been in the first instance been
directed at bank management. What were they thinking?
Mr. Green. Yes, and they should suffer consequences.
Let us go on to something else.
What percentage of banks at $1 billion and under, what
percentage of them use the discount window?
Mr. Nelson. I am sorry. I do not know, and that information
is only available with a 2-year lag. I would say the same
roughly--I mean, I would say roughly the same percentage as
large banks, which is it is very rarely used these days.
Mr. Green. Because there is a penalty associated with it,
it is more likely that it would have--it would penalize them
greater than it would the big banks because a small bank, you
are a billion or under. You do not have a lot of margin for
error.
It is not working? Pass him another microphone, please.
Thank you, sir. Just be patient.
Mr. Chair, would you give me an additional 30 seconds?
Mr. Loudermilk. No problem.
Mr. Green. All right.
If you would, sir, let us hear your thoughts.
Mr. Nelson. When calibrating the size of the appropriate
penalty in 2003, for example, where the goal of the Federal
Reserve was to let the interest rate alone be the means by
which banks chose on their own to only use the discount window
as a backup source of funding, it was really the smaller banks
that determined where that rate needed to be because larger
banks have access to money market funds that are generally at a
much lower rate.
So the opportunity cost of the other banks is actually
higher for smaller banks. For them, the discount window might
be more attractive.
Mr. Green. I am asking because smaller banks, as you know,
especially those that are owned by African Americans, and there
are very few, they have great difficulty accessing capital from
any source, great difficulty. I would like to see the Fed find
a way to assist these smaller banks.
Now, if you can, in writing, submit me your thoughts.
Thank you, Mr. Chairman.
Mr. Loudermilk. The gentleman's time has expired.
The gentleman from South Carolina, Mr. Timmons, is
recognized for 5 minutes.
Mr. Timmons. Thank you, Mr. Chairman.
Before we get into today's topic, I cannot help but begin
by reminding everyone that we would not be here without the
reckless spending habits of my colleagues across the aisle led
by President Biden. Their unbridled $7 trillion spending spree
led to the highest inflation we have seen in my lifetime, which
resulted in increased interest rates.
This caused millions of Americans to be priced out of home
ownership, grocery bills to nearly double, and, ultimately,
these banks to fail. Whether it is the southern border, the
economy, or chaos on the world stage, the policies of this
administration are hurting not only American citizens but the
entire world.
Now the topic at hand.
In March 2023, we witnessed the three largest bank failures
since 2008 when SVB, First Republic, and Signature all were
unable to stave off bank runs and ultimately shut their doors
due to poor risk management, concentrated client bases, and in
some cases rapid expansion, all of which were exacerbated by
the increase interest rate environment, these banks all tried
to work with the Federal Reserve to access emergency forms of
capital.
However, there were instances where failing banks were met
with barriers to emergency funds that they really needed as
quickly as possible. For instance, Signature Bank attempted to
pledge collateral to the discount window, but some of the
collateral was encumbered by a Federal Home Loan Bank's super
lien, leading to a delay in the bank being able to secure their
loan through the discount window.
Trying to transfer collateral that had been pledged to an
FHLB bank but not tapped for a loan over to the Fed's discount
window seems to have been clunky and created lags in getting
liquidity when time was really of the essence.
Dr. Nelson, what can and should the Fed and FHLB do on a
more permanent basis to avoid this problem happening again?
Mr. Nelson. As I discussed, the Federal Reserve and the
Federal Home Loan Banks, for each Federal home loan bank member
bank, they work out an agreement in advance of who gets which
collateral. That agreement is complicated by the fact that the
Federal Home Loan Banks are secured by a blanket lien on all of
the borrowing banks' collateral. That makes it challenging for
the Federal Reserve to get a perfected interest and why that
bank-by-bank agreement is necessary.
So what they do is they pick some type of bank loans,
customer loans, business loans. They pledge those and the
Federal Home Loan Banks subrogate their interest to the Federal
Home Loan Banks.
Now, I think a preferable approach may be that the Federal
Reserve has a blanket lien and the Federal Home Loan Banks do
not, which seems more appropriate for the position of being a
lender of last resort for the Federal Reserve. Whereas, a more
normal asset liability management lending on the part of the
Federal Home Loan Banks.
Mr. Timmons. How would that policy change be put into
effect?
Mr. Nelson. It would require a change in the law.
Mr. Timmons. Okay. Thank you.
There have been reports that SVB was hit with a bank run
and needed liquidity quickly. There may have been lags in
obtaining liquidity from the Fed's discount window because SVB
has never actually tapped into the discount window and had to
navigate the process.
Dr. Nelson, again, should the regional Fed bank not, in
this case the Federal Reserve Bank of San Francisco, be able to
provide emergency assistance to a bank like SVB to quickly show
them how to access the discount window?
Mr. Nelson. They could and I am sure that they would have
been trying to help the institution. I think the challenges
were that the institution did not have collateral pledged to
the window and that took some time.
As Professor Scott has mentioned, some of that had to do
with not keeping Fedwire open later, but I do not know the
details of what went into that decision.
Mr. Timmons. My next question is actually on Fedwire. Can
you explain what Fedwire is and whether the operations of
Fedwire played a role in the reported clunky attempts of SVB or
Signature Bank to get liquidity from the discount window?
Mr. Nelson. The Federal Reserve--so Fedwire is basically--
each bank has a deposit at the Fed, and when money is
transferred from one bank to the other, the receiving bank's
deposit is increased. The providing bank's deposit is reduced,
and it is at the core of the entire U.S. payment system.
In addition, there is a similar system that transfers book
entry securities, treasury securities, agency mortgage-backed
securities (MBS) from one bank to another that is also operated
by the Federal Reserve. It was necessary to keep those open
later in order for the correspondent bank of SVB to get
collateral in.
That wire is normally kept open until 7 P.M. Eastern time,
which is standard. Nevertheless, 24/7 would be better if it is
possible.
Mr. Timmons. Who has the authority to expand the Fedwire
window?
Mr. Nelson. The Federal Reserve.
Mr. Timmons. They can do that without law, just a policy
change?
Mr. Nelson. As far as I understand, yes.
Mr. Timmons. Okay, thank you.
There seems to be a legitimate need for tweaks or reforms
to the Fed liquidity tools, especially the discount window.
I have a couple more questions, but I will send them to you
in writing.
Thank you so much. I yield back.
Mr. Loudermilk. The gentleman has yielded.
The gentlewoman from Texas, Ms. De La Cruz is now
recognized for 5 minutes.
Ms. De La Cruz. Thank you, Mr. Chairman, for holding this
hearing. Thank you to the witnesses for being here and
appearing before us.
Mr. Scott and Mr. Nelson, I have a few questions for the
two of you mainly focused on moral hazard. My first question
is: Why are we in a situation where the Federal Reserve has to
undertake tremendous interventions in our economy?
Mr. Scott. This problem of supporting the financial system
and the presence of moral hazard have been with us from the
time of Alexander Hamilton's establishment of the First
National Bank. There is a tradeoff here. The more support that
you get from the Fed as a lender of last resort to avoid
contagion, which can destroy the economy, the more the
potential moral hazard.
So we have to strike a balance between those two things.
Ms. De La Cruz. Would you like to weigh in?
Mr. Nelson. I would just add that to some extent, the
Federal Reserve has taken actions that have reduced financial
market intermediation. In particular, I would point to the
leverage ratio capital requirement, which treats all assets
equally and, therefore, imposes a high capital requirement on
things like treasuries and the tools needed to intermediate in
treasury markets.
The Federal Reserve fixed that temporarily during COVID and
that helped tremendously. Once that stopped, the Federal
Reserve had to, because of its giant balance sheet, once again,
increase its reach throughout the financial system.
Moreover, the capacity of primary dealers to intermediate
has barely changed as the treasury debt has grown
substantially. Meaning that the ratio has fallen by a quarter
over the years. So those actions have increased the need of the
Federal Reserve to intermediate when there are very large
flows, say, into the treasury market.
Ms. De La Cruz. Well, my concern is really that if the
Fed's footprint in our economy grows, market actors will come
to expect the Fed to step in and bail them out when actors act
badly. Do you expect, among the market participants, that the
Fed will intervene to rescue markets and businesses, increase
the potential for systematic financial instability?
Mr. Scott. I think we are dealing with the same problem
here. One thing I think we should explore, it is politically
difficult to alleviate the moral hazard when the Fed acts this
way, is under--and I stress this, and I put this in my
testimony. Under appropriate circumstances, we should make
those people at the bank who are responsible for triggering
this government support responsible in some way as to a
clawback of executive comp.
Now, I underline under appropriate circumstances because a
bank can fail through no fault of an executive or through the
fault of executive A and not executive B.
So the bill that is out there really does not, in sort of
dealing with this, does not get into how do we determine
whether somebody should be responsible for this.
One way to alleviate moral hazard is to make those
responsible for the failure of a bank that triggers government
response somewhat responsible.
Mr. Nelson. If I could add to that?
Ms. De La Cruz. Yes. Yes, sir.
Mr. Nelson. Another thing that has happened since the
global financial crisis is that the Fed went from having assets
that were 5 percent of Gross Domestic Product (GDP) to now they
are about 26 percent of GDP, and they seem to be staying there.
That is largely because the Fed has changed the way it conducts
monetary policy.
It used to conduct policy by just providing the amount of
reserve balances that banks needed. Now it vastly oversupplies
that amount, and as it does that, that need gets bigger and
bigger and bigger so that the Fed, whereas before it had a very
small footprint in the financial system, now it has a vast
footprint in the financial system.
At times, for example, in recent years, half of the assets
of money market mutual funds, of government money market mutual
funds were loans to the Federal Reserve system. By
institutionalizing that bigger involvement of the Federal
Reserve in the financial system, you are increasing the
likelihood that people will come to expect them to solve all
problems with their balance sheet.
Ms. De La Cruz. Thank you. I yield back.
Mr. Loudermilk. The gentlewoman has yielded.
The gentleman from Tennessee, Mr. Ogles, is now recognized
for 5 minutes.
Mr. Ogles. Thank you, Mr. Chairman. Thank you, witnesses,
for being here. I had an opportunity to meet each of you prior
to--I think what we have seen over the last few years is an
increasing role of government and, perhaps, the regulatory
burden, depending on the agency, across the banking and
economic sector.
Mr. Nelson, under 13(3) there is authorization for the Fed
to lend to bank and nonbank institutions under unusual and
exigent circumstances as determined by the Board of Governors.
Is unusual and exigent circumstances legally defined?
Mr. Nelson. No, not that I know of. It does require the
Secretary of Treasury's approval as well.
Mr. Ogles. Mr. Scott, the Fed used section 13(3) to
establish its bank term funding program in response to the bank
failure earlier this year. While you question the rationale,
the Fed claims that this was partly so it could value assets at
par rather than market value. Is that correct?
Mr. Scott. That is what the Fed said.
Mr. Ogles. Well, accounting rules allow banks to value
their long-term assets at par on their balance sheets. This is
an accounting treatment. It is unlikely, in the event the Fed
had to take these assets as collateral, that they would be
worth that amount to the Fed. Is that correct?
Mr. Scott. Yes.
Mr. Ogles. The Fed cannot sell these assets at par, can
they?
Mr. Scott. They could not sell them at the market at par,
but we should remember that these were hold-to-maturity assets.
Under standard accounting, the banks should and did value them
at par because they did not intend them to sell them at par. If
they held them to maturity, they would be worth par.
Mr. Ogles. Right. Seeing how they had to sell them early,
then there was a reduction in said value, correct?
Mr. Scott. If they had sold them earlier, they actually,
under our accounting rules, would have been marked down to
market. This is why they did not want to sell them to cover the
deposit withdrawal. Better to pledge them to the Fed and get
the money from the Fed.
Mr. Ogles. If the bank is solvent, it can assess sufficient
liquidity without relying on valuations at par. It makes me
wonder if this program, the purpose of this program is their
true value in how it is currently structured.
What recommendations or tweaks would you make as concern to
valuation understanding that they may have to be held or they
may have to be departed early?
Mr. Scott. Congressman, my first point--I am sorry. I am
just a little bit hard of hearing.
Mr. Ogles. Yes, sir.
Mr. Scott. My first point on this facility is I do not
think it should have been used at all. I think the borrowing
should have been to the banking system through the discount
window, not through this new facility.
I do think this new facility, which valued collateral at
par, which was for a year of borrowing, which had a very low
price to borrow, should be terminated, as is the plan, I think,
in March.
Mr. Ogles. Switching gears, Mr. Nelson.
When the FDIC was established in 1933, deposit insurance
covered up to about 56,000 in today's dollars. Over time the
threshold has increased, market discipline has eroded, and
moral hazard has gradually taken hold over the banking system.
Does lender of last resort increase moral hazard?
Mr. Nelson. There is a pretty robust debate in the academic
literature among economists about whether or not it does.
Lending on a secured basis, at a penalty rate, when you are
extending a very safe loan and charging a high rate for it need
not create moral hazard even more than receiving a similar loan
from a financial institution would.
At the same time, if you are able to count on receiving
that loan when you are in trouble, potentially then that can
lead to taking activity that is not appropriately--in which you
take on more risk, and there is moral hazard.
Mr. Ogles. Well, understanding there is a difference
between the small borrower and someone that has assets over $10
billion. You take one company in particular that had, you
know--worth 13 billion, had 486 in deposits at SVB, I mean,
they have an obligation to, essentially, look at management
practices. Would that not be fair?
Mr. Nelson. Absolutely.
Mr. Ogles. Mr. Chairman, I am almost out of time. I will
yield back.
Mr. Loudermilk. The gentleman yields back.
The gentleman from Florida, Mr. Donalds, is now recognized
for 5 minutes.
Mr. Donalds. Thank you, Mr. Chairman.
Gentlemen, thanks for coming in.
Professor Scott, what concerns do you have about the recent
push for the Federal Government to increase the use of the
Fed's discount window more often?
Mr. Scott. Am I concerned with that? Is that the question?
Mr. Donalds. Yes. Are you concerned and would you
elaborate?
Mr. Scott. No, I am not concerned because I think that the
availability--this goes back to Hamilton again. The
availability of the discount window and the Fed's ability to
lend in a financial crisis to avoid contagion is crucial to our
economy because an unstemmed contagious run could destroy the
financial system and then destroy the economy.
So that is why you invented the Fed, to deal with this. I
think the lender of last resort function is essential to the
health of the U.S. economy. Every other major country has a
central bank that play a similar function.
On the other hand, we have to be cognizant of the problems
of having this, which is moral hazard. We have to figure out a
way to minimize that and strike the appropriate balance.
I think the Fed has done a good job generally in the crisis
of using this facility to stem crises. I think if they had not
done it here, we would have had a lot more hearings on why the
economy was in depression, why we were in recession, why the
Fed did not avoid it.
So I am not criticizing the Fed at all for exercising this
power.
Mr. Donalds. Let me ask you, as a follow up question,
Professor Scott. Do you think that, in part, the reason why our
financial system needs a lender of last resort is because we
have various regulatory frameworks in our economy that can
inhibit economic expansion or economic stability?
Mr. Scott. No. I think what happens, you have to--and I
read a book on this, a connectedness and contagion
advertisement.
Mr. Donalds. Right.
Mr. Scott. Contagious runs on the financial system are
often irrational.
Mr. Donalds. I would argue, Professor Scott, human beings
tend to do that as well.
Mr. Scott. If somebody gets--nothing that the bank did, but
a bank failed and said, oh, my God, if this bank fails, every
bank is going to fail. I am getting my money out.
This kind of--you know, noble prizes have been won by
economists talking about this kind of thing.
So I think this is not an expansion of the economy that
creates this. It is the fear that people have who are
depositors and banks that once a bank fails or a bad situation
develops, the financial system is going to fail, they try to
get their money out.
Mr. Donalds. Real quick, Professor Scott. Let us expound on
this thought. Let us go back to 2008. Full disclosure, I was a
credit manager, credit officer in banking prior to 2008. I was
watching home mortgage underwriting become a flat-out joke as a
credit underwriter as far as back as 2004, 2005, 2006, and
2007.
Is the cause of the financial crisis of 2008 more about
terrible credit quality that was the contagion in lending or
the issue that bank policy at-large was unable to be in the
normal deposit taking and lending function?
Mr. Scott. Those poor credit policies were probably
responsible for the failure of Lehman. Once Lehman failed, a
lot of other people who have perfectly good credit policies
were experiencing runs on their institutions because people
said, well, if Lehman could fail, our bank could fail, or our
nonbank could fail. I am getting my money out.
So the contagion part, or run really was irrational. Their
institution might have been fine. They did not want to take the
chance. Get my money out. That is why we need lender of last
resort.
Mr. Donalds. Okay.
Look, I think one of the things that I think we should try
to analyze and really take hold of, especially from the 2008
crisis moving forward is the initial creation of the Federal
Reserve. Obviously, there are people who have agreements and
disagreements on that, and that is a discussion that is had a
lot.
Post 2008, the Federal Reserve, none of us can deny, has
taken on a much larger portion of our economy. That, in my
view, is not healthy for a stabilized, growing, organic
economic system. It is almost as if we are trying to make sure
no problems exist, but then problems exist nonetheless.
Do you think that is a fair characterization?
Mr. Scott. My colleague, Bill Nelson, has talked about the
increasing role of the Federal Reserve and our economy. I think
that raises a lot of problems that we could have another
hearing about.
I think the focus here is in terms of playing this role of
lender of last resort in a financial crisis, I think they play
an appropriate role. Whether the Fed should have the
involvement in the economy as a whole that they have I think is
a totally different and separate question.
Mr. Loudermilk. The gentleman's time has expired.
Mr. Donalds. Thank you, Chairman.
Mr. Loudermilk. I would like to thank our witnesses for
their testimony today.
Without objection, all members will have 5 legislative days
within which to submit additional written requests for the
witnesses to the chair, which will be forwarded to the
witnesses for their response. I ask our witnesses to please
respond as promptly as you are able.
The hearing is adjourned.
[Whereupon, at 11:56 a.m., the subcommittee was adjourned.]
A P P E N D I X
February 15, 2024
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