I disagree. I worry that this structure may effectively tie Powell's hands and prevent him from raising rates further.
As you describe it, banks can post collateral with a market value of $75 in return for $100 of loans from the Fed. This is not a panacea. There is a reason why this is not normally done.
The problem arises when this loan has to be repaid. At that point, the bank will have to repay $100 to recover $75 worth of collateral. There is a gap between what the bank must repay and the value of the collateral it gets back. This means that, at that point, banks may find that they are insolvent and unable to repay the loans. This is the banking version of "jingle mail", sending the bank's keys to the Fed instead of repaying the loan.
The higher the rates, the lower the value of the collateral, the greater the gap, and the more likely the banks are to default on their loans when they come due ...
... silly me, of course not ... at that point the banks will expect the Fed to bail them out again and cover the gap through some "repurchase" voodoo where the banks can "repurchase" their collateral at market value and have their loans forgiven.
> The problem arises when this loan has to be repaid. At that point, the bank will have to repay $100 to recover $75 worth of collateral.
This is not much of a problem if the Fed allows the loan to be rolled until the bond matures. Then, at maturity, the loan's principle is paid by face value of the bond.
The only issue is that, in the meantime, the bank does have to pay interest to the Fed on the loan. This is a tightening; it's just not as tight.
The face valve of the bond cancels the principle, the bond's coupon cancels some portion of the loan interest, and the only thing left at the end is a cashflow from the bank to the Fed representing the remaining interest. Heck, the Fed could make this cancellation explicit, create a bond representing this cash flow, and sell it to somebody else.
This also doesn't prevent Powell from raising rates further. If anything, it eliminates a reason why he couldn't.
Banks generally do well in higher interest rate environments. It's in a ZIRP climate that banks struggle. By kicking the can down the road banks can use the profit they're making from the business they do today to pay off the dumb debt they acquired in the past couple of years.
In the US alone banks are underwater to the tune of 650bn (that we know of). It will take a while to pay off.
The banks might get an outright bailout -- it wouldn't be the first time -- but nobody wants that. Not Powell, not Yellen, not Biden, and certainly not you or me.
> Banks generally do well in higher interest rate environments.
It’s not about a high vs low interest rate environment. It’s about a falling versus rising interest environment. In a rising interest rate environment, a banks bond holdings is continually losing value.
> The problem arises when this loan has to be repaid. At that point, the bank will have to repay $100 to recover $75 worth of collateral.
Assuming an absence of default, and the Fed being able to wait being paid back until the bond matures, then the collateral will be worth its par value (ie. $100).
As you describe it, banks can post collateral with a market value of $75 in return for $100 of loans from the Fed. This is not a panacea. There is a reason why this is not normally done.
The problem arises when this loan has to be repaid. At that point, the bank will have to repay $100 to recover $75 worth of collateral. There is a gap between what the bank must repay and the value of the collateral it gets back. This means that, at that point, banks may find that they are insolvent and unable to repay the loans. This is the banking version of "jingle mail", sending the bank's keys to the Fed instead of repaying the loan.
The higher the rates, the lower the value of the collateral, the greater the gap, and the more likely the banks are to default on their loans when they come due ...
... silly me, of course not ... at that point the banks will expect the Fed to bail them out again and cover the gap through some "repurchase" voodoo where the banks can "repurchase" their collateral at market value and have their loans forgiven.