How America accidentally made a free-money machine for banks

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ruin and riches. Less than a year ago rising rates caused Silicon Valley Bank (SVB) and then First Republic to fail, the largest bank collapses since 2008. Yet on January 12th JPMorgan Chase reported its seventh consecutive quarter of record net-interest income.

One reason the crisis did not spread in 2023 is that the Federal Reserve contained it with a new—and generous—loan programme. Unfortunately, that has come at a cost that the Fed should have foreseen. Thanks to another turn in the interest-rate outlook, its intervention has mutated into a free-money machine for any bank brazen enough to exploit it.

The bank term funding programme (BTFP) offers banks loans secured against the face value of Treasury bonds. The idea was to stop wobbly banks having to sell Treasuries to raise cash if depositors fled. At SVB, a fire sale induced by a bank run crystallised losses, because higher rates had reduced the prices of long-term bonds far below their face value.

But the BTFP lends the face value, rather than the market value, of the securities against which its loans are secured and, sure enough, its generosity succeeded in shoring up the system and stopping what could have become a severe crisis. Today, however, the BTFP is itself causing trouble. The interest rate that banks must pay to borrow reflects, with a small premium, the one-year interest rate set in financial markets.

That is in turn based on predictions of the average Fed policy rate over the next year. Because investors are betting the central bank will cut rates significantly, the cost of borrowing today is only 4.8%. Yet because those rate cuts have not yet happened, the Fed still pays banks 5.4% on their cash balances.