The Fed, Part 3: Factoring Loans & Time Value of Money
Reviewing the Silicon Valley Bank crisis and Fed disinformation
Remember the Silicon Valley Bank crisis? Remember the Fed’s BTFP program that was purportedly “printing” $300 billion, and the hysteria that ensued? Balaji said bitcoin would go to $1M within 90 days? Everyone lost their minds. I remember.
I posted this and this back in March and April 2023, during the peak of the SVB-led, Fed-induced delirium, saying the histrionics of Arthur Hayes, Balaji, and every macro pundit was misled. What they were promoting was misinformation (unintentionally, but still) about what the Fed does and what “money printing” actually means. The thoughts and commentary you’re about to read here were shared in the midst of the panic, this isn’t a ‘hindsight is 2020’ thing. You can check the receipts in the links. It aged well.
This post is not a victory lap, it’s intended to document and reinforce how Fed worship is consistently wrong, yet always en vogue. When the Chicken Littles keep promoting the wrong things it needs to be noticed. I don’t know how else I’m going to drive this Fed stuff home.
Nearly one year has passed since then. Inflation has continued to trend down. There was no crisis or huge flush of “liquidity” into markets.
Emphasis: every single bank alive is structurally insolvent. You could crush JP Morgan right now if everyone asked for their money back. None of these banking issues are new. This structural insolvency is integral to the very nature of banking. This is why Held To Maturity accounts exist. It’s because every time rates go up, banks are wiped out on paper. What’s surprising… is this was surprising.
The Fed is designed to be a backstop for banking stuff like this. In fact it’s one of the few useful things it does!
SVB Backstory
Dollars (deposits) are given to banks. This is USD that already exists. Banks invest this money into bonds and other instruments. Because rates rose (due to inflation, it had nothing to do with the Fed, you can read The Fed Part 5 and Part 4 for a thorough deconstruction of this) those investments lost mark-to-market value. So the bank could not fulfill depositor requests to withdraw. This is how any bank run works.
Now that money isn’t necessarily gone, it’s simply trapped. Trapped until the bonds the banks invested in reach maturity, because even though the mark-to-market bond prices are down, when they come to term and are repaid by the US government, they’ll return the full principal. So the money is not gone, it’s in purgatory. I referred to them as “purgatory dollars” back in March 2023.
The Fed, through BTFP, provided loans against those bonds at par so banks could access dollars for customer withdrawals. The BTFP loans (they are not a gift, they are a loan with interest) last up to a year and then are repaid by the bank.
That’s what the Fed’s BTFP is (Bank Term Funding Program). It is nothing more than factoring loans for dollars that already existed. At the time it was for around $300B.
Reframing
The reasonable way to understand this program wasn’t to convulse like this 1-year BTFP loan is "money printing mania" like everyone did online. However, it is reasonable to say that the BTFP did avert a deflationary event; this is not at all the same thing as creating an inflationary one.
By providing the banks loans, it’s not unreasonable to think that there was some form of money creation happening through the ‘time value of money’ (TVM) concept.
Let’s review what happened like calm, rational actors. Was there any new money actually willed into existence from this program?
Purgatory Dollars
To review what happened:
Depositors give money to SVB.
SVB invests these deposits in government bonds (Treasurys).
Those bonds fell in price because interest rates rose.
When depositors tried to withdraw their money they couldn’t, because the bank had invested it into bonds that lost value.
If SVB dumped their bonds to try and fulfill depositor requests, it would have caused a market panic.
However, if people were patient, those bonds they invested in will return their full principal at maturity.
So those dollars are effectively trapped until the bonds come to term. But people want their money now. Thus, the problem.
The Fed gave SVB and other banks loans against those bonds at par, meaning loans at the price of their principal amount of the bond, even though their market value was lower.
However, no matter what the market price of the Treasurys are, they are worth the full par amount at maturity.
Because bonds lose value as rates rise, the deposits that were given to them are in purgatory until the bonds they hold mature and return their principal. The Fed just gave the banks a loan and used the bonds as collateral. That’s literally all the BTFP is.
However…
Those bonds were never meant to be sold or valued MTM. Held-to-maturity accounting exists because banking could not exist valuing everything real time. This is not new. This is not surprising.
The Fed provided deposit access for stability, and the NET amount of dollars in existence is the SAME as the amount that existed at the original deposit dates.
That’s why it’s fair to say the BTFP avoided a deflationary event. But that is dramatically different than saying this is causing an inflationary wave, dumping liquidity everywhere, and “printing money”.
Unfortunately reasonable framing doesn’t get the clicks.
Factoring Loans and the BTFP
Think of the Treasurys (I’m using bonds and Treasurys interchangeably) the banks own as an accounts receivable from the US government. The bank lent the US government money, and this bond which we’re understanding as an accounts-receivable (it’s functionally identical) are paid back to the bank when the Treasury expires.
So we're dealing with the concept of time as it relates to the bonds and their worth, not the concept of existence.
Providing a loan against incoming future money is called a factoring loan in the business world, and it’s done all the time. Businesses do this by borrowing against their accounts receivables, invoices, or money they’re owed but haven't been paid yet.
A factoring loan is done when a business knows it has dollars coming in the future but they need cash now, so they borrow against this future money, pay interest on it, then when the accounts receivable is paid, they pay off the loan.
See the BTFP similarities? How many panic over accounts-receivable loans?
Time Value Of Money
Time value of money (TVM) is the backbone for how basically all financial assets are valued.
“Money printing” would suggest these BTFP dollars are new and additive to the total dollar supply, and don't have to be paid back. That is not what happened. The USD deposits SVB had already existed. But then the bonds lost value, so the dollars couldn’t be accessed. The Fed just let banks access money that was trapped in those bonds, it was not net new dollar creation.
However it let depositors access their money much sooner than they otherwise would have. This does have time value of money implications.
What is the ‘time value of money’:
Money now is worth more than money later, because when it’s in your hands you can do productive things with it right away that allows you to generate more money from that money.
So the further out in the future you have to wait to be paid, the less valuable those dollars become in present terms, as you are missing out on the utility that money could be bringing you today. That’s what “discounting” means in finance parlance; dollars in the future are worth less than dollars today, so you discount the value of those future dollars to present terms.
A common way to calculate what that discount should be is via the ‘risk-free rate’ (RFR), which is typically the US 10-year Treasury rate. AKA the discount rate. For this exercise, the TVM calculation I’ve made assumes everyone takes their BTFP loans, invests in the 10-year UST, and compounds (a generous assumption).
The BTFP loans are only for up to one year, but I’ll do you one further and pretend like they may be for eight years. Let’s pretend the BTFP is 8x longer than advertised and see what that means for actual dollar creation! Surely this will be juicy.
So let’s see how much more money this $300B BTFP factoring loan will generate. The 10-year yield was about 3.5% when I originally wrote this. If you think the discount rate should be different you can just tweak the 'r' value.
So at the end of year one, the TVM additive amount of USD in the world is $10.5B more. It takes a year to create that extra capital. Two years from now we’re looking at $21.4B more USD, etc.
And now let’s pretend we were wantonly lied to and these loans are allowed to remain outstanding for eight years…
If the BTFP loans were for eight years it would have resulted in around $95B more dollars created. That’s after eight years!
$95B over that long is peanuts. And I want to reiterate, I’m going waaaay out of my way here to try and create a bigger number, because these were one-year loans.
BTFP loans only lasted one year then were repaid. So if we’re being sober, undramatic people whose entire financial personality isn’t what Jerome Powell ate for breakfast that day, that means the one-year TVM calculation is what applies… which means around $10.5B in new dollars were “printed” by around Q1 2024 from the BTFP.
Oh by the way, the banks owe interest on those BTFP loans! I’m not even factoring this in! So it’s actually less than this. I’m intentionally trying to be generous here to drive home a point. It’s just not that much new money, and it sure as hell isn’t $300 billion.
But that’s not exciting. Worshiping at the altar of the Fed is far more exhilarating.
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Great series. FWIW I agree that the Fed does not control the interest rates.
On the subject of QE. Here is the latest from Arthur Hayes: https://substack.com/@cryptohayes/p-182012894. There he explains how the QE reserves created from the thin air enter the real economy. What says you?