The discount window at the Federal Reserve allows banks to borrow money at an above-market rate in exchange for high-quality collateral. The facility is always available to use, but typically nobody does. Not only is the borrowing costlier, there's also a "stigma" associated with its usage, since the perception is that if you use it your institution might be in some kind of financial distress. So why has some entity (or multiple entities) been using it lately? On this episode of the podcast, we speak with Bill Nelson, chief economist at the Bank Policy Institute and a former employee of the Federal Reserve who helped design and manage the discount window for 10 years. We discuss what the program is, its history and how it's used today. This transcript has been lightly edited for clarity.
Key insights from the pod:
What is the discount window? — 4:34
Changes to the discount lending rate — 7:24
Why do banks use the discount window? — 9:08
Assets used by banks for collateral — 12:02
Why is anonymity important? — 13:45
Why are banks borrowing from the discount window now? — 15:43
Discount window versus standing repo — 21:21
How are discount window rates set? — 24:14
Will discount window borrowing go up from here? — 26:32
Why discount borrowing is part of QT — 26:32
Why the discount window is like Taco Bell — 29:54
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Tracy Alloway: (00:10)
Hello, and welcome to another episode of the Odd Lots podcast. I'm Tracy Alloway.
Joe Weisenthal: (00:15)
And I'm Joe Weisenthal.
Tracy: (00:17)
Joe, do you remember the discount window?
Joe: (00:20)
Yeah. The only thing I know about the discount window is that it's some way for the banks to borrow money from the Fed and that they always talk about the stigma of the discount window. And I don't even really know why, but I know it's banks have various ways of pledging money and borrowing collateral and borrowing. But something about the discount window, I doubt there's a real window, but there's a stigma attached to it, supposedly. That's all I know about the entire thing. That's it.
Tracy: (00:46)
I'm imagining banks going up to a window at the Fed and being like, ‘I'll have $1 billion worth of liquidity, please.’ No. Okay. So the discount window facility is an emergency lending facility from the Fed. And I think one of the reasons there's a stigma attached to it is we tend to see usage of it go up during crises. And most notably during the 2008 financial crisis and during March of 2020, we saw discount window use go up as well. And interestingly, even though we are not experiencing a financial crisis at the moment, we have seen the discount window balances go up. More recently, they reached $10 billion, I think in late November. Currently they've come down a little bit around like $4 billion. But it is kind of weird to see this happening at a time when there are still supposedly ample reserves in the financial system and still a lot of liquidity sloshing around.
Joe: (01:48)
Right. We have seen, you know, the market sold off and all that, but by and large, there's no sort of signs that there's some like real stress in the financial system. And as far as I know, this is one of those things [where] for some reason someone out there is using this facility, I don't think we know who. You know, the other thing I know about the discount window is I sort of associate it, every once in a while you see like a ZeroHedge tweet about it or something like that. It's like, ‘oh, there's little line that ticked up,’ so what does this mean?
Tracy: (02:20)
The apocalypse is coming, yeah.
Joe: (02:22)
That’s the other thing that I sort of associate with, with the discount window. But yeah, that is sort of this, it's an interesting question, like what's going on there,
Tracy: (02:31)
Right. So it is a little bit of a mystery at the moment. There's some speculation that maybe it has to do with some losses in the crypto industry. Recently we have seen SilverGate, for instance, under pressure, some other banks potentially as well, maybe some smaller banks that have experienced a lot of losses on their bond portfolios as interest rates go up. There are all these theories floating around. So I thought we really need to stop and just talk generally about what the discount window is and how it came into being and what it means, maybe, that use is going up now. Maybe it tells us something more broad about where we're heading.
Joe: (03:07)
You know, what's weird to me is you think like, okay, emergency borrowing, you have to pay a premium for that, but like discount window, I assume that's even cheaper money. So everything about it is a mystery to me.
Tracy: (03:18)
Totally. And if you think back to, you know, one of the fundamental tenants of central banking is lend freely against good collateral. So why is it a big deal if banks are using the discount window? The Fed has made it clear in recent years that it wants banks to use the discount window when they have to. But anyway, we could keep talking about this or we could bring on our guest.
Joe: (03:39)
Bring in an expert.
Tracy: (03:40)
Yeah, bring in an expert who really is the perfect person to discuss this. We're going to be speaking with Bill Nelson, he's Executive Vice President and Chief Economist at the Bank Policy Institute, which is a trade group slash think tank for banks. But previously he spent 24 years at the Fed, including I think about a decade actually overseeing the discount window. So
Joe: (04:06)
So the actual perfect guest, here's someone spending 10 years running the discount window, I think the actual perfect guest.
Tracy: (04:14)
Yeah, exactly. So Bill, thank you so much for coming on Odd Lots.
Bill Nelson: (04:17)
Well, thank you for having me. I really enjoy your show, and thank you. It's fantastic to be here.
Tracy: (04:22)
Oh, thank you so much. Maybe just to begin with, you know, should we start sounding the, the ZeroHedge alarms, is this like the beginning of a new financial crisis that discount use is going up?
Bill: (04:34)
No, actually just to take you back a touch. It's really not even the case that the discount window is generally an emergency lending facility. So when people think about the Fed lending, you know, of course they think about the global financial crisis and lending to AIG and panics and alphabet soups of facilities. Those are all emergency lending that's done to non-banks. The discount window is something that's been there since the beginning of the Fed. It's a vehicle for lending to depository institutions. So banks, thrifts, credit unions, it really was a window and they really did discount things. So the reason why it's called the discount window is not because the credit was extended at a a subsidized rate, although it was for 40 years. And that's kind of an interesting story in and of itself. But I'll skip over that, but because the way the credit was extended was by discounting customer notes.
So the bank would bring in a commercial loan that maybe, let's say it paid off a thousand dollars in a month, and the Fed would give them $990 for it. And then when the month was over, the Fed would get the thousand dollars as the repayment on the loan. So that's where the name comes from.
Related to this discussion we're having right now, the Fed has always had sort of a ‘come hither, stay away’ approach to the discount window , where they want people to be willing to use it, but at the same time, they don't want people to use it too much. So if you go back and we'll, I'm sure talk more about stigma, but if you go back and look at changes that the Fed has made to the window over time, they've kind of alternated between changes that were made to try to encourage people to borrow and changes that were made to discourage people from borrowing.
And the most recent set of changes, one that I was very involved in was in 2003. And in 2003, the Fed went from extending credit at a subsidized rate, which required a lot of rules, to extending credit at an above market rate. And the idea was to get rid of all those rules and just let the rate itself determine how much credit people wanted, but they really wanted people to use it as a backup. So there's actually three types of discount window credit. There's primary credit, secondary credit, and seasonal credit. And these loans go on all the time. There's loans every day in relatively small amounts, particularly seasonal credit, but it's a perfectly ordinary thing, although it is a tool that the Fed uses in response to a financial crisis too.
Joe: (07:00)
So that's really interesting, this idea that it's like, okay, well, why is there a stigma? Well, if you're going to be borrowing at above market rate, presumably you don't want to do that. Can you talk a little bit about why there was a period in which it was subsidized lending? What was the purpose? Why have a special window for subsidized lending where maybe the borrowing is at a below market rate?
Bill: (07:24)
Right. So generally throughout most of the Fed's history, the discount rate was at or a bit above market rates. In the mid 1960s, the Fed was under a lot of pressure from the Johnson administration and from Congress to not tighten monetary policy. The Great Society was beginning, the Vietnam War was going on. They didn't want the Fed to choke that off by tightening monetary policy. But back then, the Fed was very concerned about inflation. So they were determined to tighten monetary policy. Oh, and back then, what people paid attention to was the discount rate as the measure of the stance of policy. So in the second half of the sixties the Fed kept the discount rate constant, but they tightened reserve conditions and raised the Federal funds rate like you would see now.
So the Federal funds rate went from generally being at or below the discount rate to being about 50 basis points above the discount rate as they tightened policy. And then it just stayed there for about 40 years. And it really wasn't until [Fed] Governor Lyle [Gramley] made a concerted effort to say, that doesn't make sense. You want your lending rate to be above market rates so that it's a backstop to overcome the sort of the cost of making the shift that there was a concerted effort then, to change the way it was done.
Tracy: (08:45)
Hmm. So you talked about changes made over time to the discount window. Can you maybe talk about those through the frame of why banks make the decision to use it? Like what would be a bank's rationale for using it in say, the 1960s versus maybe the early 2000s, and 2008, versus, I guess, now?
Bill: (09:08)
So generally the discount window, discount lending, so this is in fact primary credit lending, which is what everyone calls discount rate, discount lending, serves two purposes. So one purpose is a monetary policy function. The other purpose is a financial stability function. And so, it was more important as a monetary policy tool back when the Fed was conducting policy the way it did before the global financial crisis. So every day they would leave a certain amount of reserves out there with the expectation that markets would clear at the rate that they were targeting. But some days they would leave too much and rates would fall to zero. Some days they might not leave enough, rates would jump up, and the discount window was a tool for putting a ceiling on those upward spikes. So the idea was if rates rose up above the discount rate, why pay more in the Fed funds market when you could just turn to the discount window and borrow at that rate? And it was a somewhat effective ceiling, but it wasn't.
Joe: (10:08)
Which years are we talking about again here?
Bill: (10:10)
Honestly, I would say, you know, at least back to the seventies, all the way up to 2008. But it wasn't the best ceiling because of stigma, which we can come back to the other function that the discount window serves is that it's a backup source of funding. It's a funding that you always know will be there. Banks pre-positioned collateral at the window, banks have about a one and a half trillion dollars of collateral that just sits there at the window. It's mostly loans. Then the Fed applies a conservative haircut to it. And so that collateral's there, and if at the end of the day you come up short, either because market conditions are tight for one reason or another, or there's some problem in the market that that collateral is there and you can borrow, and most importantly because you know it's there, then you ideally don't get the pernicious dynamic that turns a liquidity strains into a liquidity crisis.
So what happens when there's liquidity strains, everybody gets worried about their liquidity situation. They don't want to come up short because that's really costly. So they pull back from lending to each other, they pull back from lending at term. But if you know that the discount rate window is there, at the end of the day, you're less likely to do that. So both of those functions have really been a function of its purpose all along. And they're all sort of stymied if people don't want to borrow,
Joe: (11:26)
This is sort of a conceptual idea in monetary policy that asserts itself over and over again, that we see, which is that the existence of some sort of entity. And it could be a window, it could be a borrowing facility, it could be a promise to cap yields somewhere, makes it so that in theory the entity doesn't have to be used. And it feels like that is a recurring theme throughout monetary policy. Now, what is discount window eligible? What type of collateral? And, in a given bank's portfolio, are all their assets discount eligible? What are the rules around that?
Bill: (12:02)
The Fed's objective is that all bankable assets are eligible, for which they can get a a good legal claim to. And what that basically amounts to is performing loans and investment-grade securities. And even some securities that are booked abroad, although that takes some extra work to get the appropriate legal claim to the collateral.
Banks tend to bring in their loans rather than the securities, because the securities are useful sources of liquidity in other circumstances. But if they have a book of business loans that are just sitting there, you know, then they can't get liquidity out of them. So they bring them into the Federal Reserve bank, their Federal Reserve Bank, the Federal Reserve Bank applies a lendable value to each of those loans. And that adds up to the stock of lendable value of collateral that each bank has at the Reserve Bank ready to go if the bank needs it. It's also that collateral is also used to collateralize daylight overdrafts.
Tracy: (13:15)
So one thing we haven't really spoken about or made explicit is this is all done anonymously, so we don't know which bank is borrowing from the Fed. And one thing I've always wondered, I mean, presumably when you were supervising the discount window usage, you had some idea of who was using discount lending. How does it actually work? Do you know who's using it and why, at any given time? And, you know, are Fed officials sworn to secrecy? How does it work exactly?
Bill: (13:45)
So you're right. Keeping borrowers’ identity secret has always been seen as an important way to make borrowers willing to use the window. After all, and it is a backup source of funding in a lot of circumstances, and nobody wants the market to see that you're using your backup source of funding.
So identifying borrowers, you know, has always been seen as as a, something that could contribute to stigma. After the global financial crisis, one of the reasons why stigma is so bad now, it's as bad as it's ever been, is because during the global financial crisis, borrowing at the discount window kind of got lumped together with TARP capital injections. And was seen as a bailout for the banks.
But in fact, you know, again, most discount window lending is perfectly ordinary. It was provided at an above market rate and all of the discount window loans that were made by the Fed during the crisis, and also all the emergency loans were repaid on time with interest. So they weren't a bailout, but they were seen that way. And that has made banks even more reluctant to use the window. But consequently, because, you know, the Fed agreed, or well, Congress instructed the Fed to start identifying borrowers with a two-year lag. So now you can go in, you can look on the Fed's website and see who borrowed two years ago.
Joe: (15:05)
So, okay. So fast forward to today. We have seen this little uptick. We will know in two years who these banks are?
Bill: (15:13)
Yes, absolutely. So I don't really find the uptick to be necessarily that extraordinary, because banks are meant to view the window as something that they can use and, and it's known.
Joe: (15:25)
Well, so why don't you give an example, and not identifying banks because you wouldn't know, but what would be the type of circumstances that today in 2023, a bank might see fit to pay this slightly above market rate to get liquidity for their collateral?
Bill: (15:43)
So when we designed the current discount window arrangement in 2003, we spent a lot of time thinking, well, what's the right rate that we need to charge to make the rate alone something that will encourage banks to just use it as a backstop. But we had to pick one rate for all 30,000 Dis [depository institutions], including every tiny credit union. And that's quite a wide range of alternative source of funding costs. But you can't charge smaller banks more than larger banks. That would be impossible. Okay. So right now the discount rate is at the top end of the target range. It's much lower relative to the Fed funds rate than it was when we designed it this way. So it's about 15 to 18 basis points.
So when you look at the gamut of smaller institutions, there's a lot of them where that's not such an unattractive rate. They might come in and borrow from the window for a while. Maybe they lost a municipal deposit and need funding for a little while. Or actually, it's so close to the Fed funds rate that under some circumstances, Federal Home Loan Bank, it's less expensive than certain types of Federal Home Loan Bank borrowing.
So there's a pretty good reason to think that there's just a lot of smaller institutions [that] are finding the rate relatively attractive. One of the things that was noticeable is that the r borrowing went up quite a bit at in advance of each FOMC meeting. So there seemed to be some kind of a dynamic between the expected rate jumping up and the relative attractiveness of the discount rate. Haven't really completely figured that out.
Tracy: (17:16)
Maybe they're just trying to give the Fed what it wants, you know, they're saying like, ‘look, we're using the discount window. Look at us before your meeting,’ every time.
Bill: (17:24)
Well, in some sense, you could be right. It becomes, especially important for the Fed, that everybody sees the discount window as a viable source of short-term funding when the Fed is shrinking, when they're reducing the size of the balance sheet. And so I'm not aware of any direct communication to this effect, but it would be sensible that they would be out there saying, because as you guys know, as the Fed shrinks its assets, it's also shrinking its liabilities, including, in particular, reserve balances -- the deposits of banks at the window.
So for the Fed to get as small as it wants to be, banks have to reduce their demand for those deposits at the Fed. And one way to do that is make them comfortable with the idea that, well, if you really need money at the end of the day, and you happen to, you know, surprisingly come up short, you can always use the discount window.
It's kind of like if you have a checking account that has overdraft protection versus one that doesn't. You're probably going to be happy running a lower balance on the one with the overdraft protection. But on the other hand, if using that overdraft protection hurts your credit rating, then you won't be willing to do it. And that's where the problem of stigma comes in.
Stigma is kind of like, well, there's sort of an implicit penalty out there, maybe on the part of examiners, maybe on the part of management, that imposes a cost of using it. So if you can reduce that stigma, then you can get banks to be happy to hold smaller levels of reserve balances, and the Fed can continue QT longer than it would be able to otherwise.
Tracy: (18:57)
Do banks actually sort of talk behind each other's backs, I guess, for lack of a better expression, about who they think might be using the discount window? Is the stigma that strong in the sense that maybe, you know, if you think someone's in trouble and they're using it, you might be reticent to deal with them or extend financing to them? Is there like a real world cost of that kind of speculation?
Bill: (19:19)
There can be. I really don't think that the lending that's going on now is, is meaningful enough. But if you go back, say, before the global financial crisis and before this change, one of the rules that the Fed had when it was extending credit at a subsidy rate was you have to go out there and try to get the money at a market rate before you come to us. So if somebody was out in the market bidding for funds, and then they didn't end the day actually getting those funds in the marketplace, people would speculate, well, they went to the discount window, and that would be something that market participants would be concerned about. But it is speculation. It's not made public.
Joe: (19:54)
What does the job of the discount window manager entail?
Bill: (19:58)
Accept collateral, value collateral and extend the credit when the credit is requested.
Joe: (20:03)
But like, on a day-to-day [basis]? I mean, you ran it for 10 years. What is it like on a day-to-day basis, what does it look like, that role?
Bill: (20:13)
So I was at the board, so my job was sort of designing policy, making sure that policies were followed at the Reserve Banks. But, you know, so at each Reserve Bank there's a discount officer, and they would determine how much seasonal credit a bank could get based on their seasonal needs. They would determine whether a bank was eligible for primary credit, because to get primary credit, you have to be financially sound, otherwise you get secondary credit. And they would manage the provision, the extension of credit in the collateral, make sure the Fed has the right legal claim to the collateral so that somebody else doesn't come and get it. And then managing requests.
Tracy: (20:49)
So you touched on this briefly already, but I think it's important so I'd love to hear more. Can you sort of place the discount window in the ecosystem or constellation of borrowing facilities available to banks right now? Because as we've been discussing, these things have changed over time, and nowadays you have a whole bunch of alternatives, even more than we had post-2008 financial crisis. You have things like the standing repo facility, the reverse repo facility. How does the discount window fit in with all these other things coming from the Fed?
Bill: (21:21)
There's two relevant facilities. So there's primary credit, the discount window, and then there's the standing repo facility, which was created a couple years ago by the Fed. And actually what the standing repo facility does is it only accepts Treasuries and Agency MBS collateral, what's called open market operations collateral, OMO collateral. And each day it stands ready to conduct repos with the banks that are a participant at the facility, at the SRF rate or the discount rate against those securities. So really, it looks a lot like a discount lender loan. It's a collateralized loan at the discount rate. There's a few things that are different because it's authorized under the Fed's open market legal authority. It's not limited to commercial banks, and in particular primary dealers. The broker dealers that do business with the Fed regularly, they're automatically eligible for the standing repo facility. And then other banks have signed up, but banks have been relatively slow to sign up for a couple reasons. But right now, only large banks, GIBs and some US branches of foreign banks are signed up.
The standing repo facility was designed for two reasons. One was just to provide participants in the repo market [with] a backstop, and it was kind of targeted towards the repo volatility that took place in September, 2019. So they wanted banks and broker dealers to know that if they extend credit when markets are tight, that if push comes to shove, they can always get funding at the end of the day at the standing repo facility.
But the other objective was to create something that basically served the same function as the discount window, but didn't have the same look and feel as the discount window. It was extended under different authority. It was a repo, not a loan. It was meant to, because open market operations, there's no stigma associated with open market operations. So they were trying to get some of that positive energy from the open market operations. And so far, it's not completely clear that it's actually working,
Joe: (23:28)
But I guess it's like one of those things where, okay, the, the facility exists even if there's not that much uptake or sign up. So theoretically, that might still have some stabilizing effect, knowing that there could be more usage of it.
Bill: (23:43)
It could, but you have to sign up and that that takes some time. But it works for primary dealers, for example.
Joe: (24:03)
I want to go back to something you said. You said the spread, the current discount window rate is fairly narrow right now. Can you remind again, like how is that number set?
Bill: (24:14)
So that's actually more complicated than you would think that it would be. So the discount rate is set by the Reserve Banks with the advice and determination of the board. And so if you ask somebody on the board, they'd say the board sets the discount rate. And if you ask people at the Reserve Banks, they'd say the Reserve Banks set the discount rate, and actually there's 12 discount rates, one for each Reserve Bank. But what happens is board of directors of each Reserve Bank requests a discount rate, and then that sits there at the board. And when the FOMC changes the target for the federal funds rate, they accept whatever requests are sitting there that conform with the change in the target for the federal funds rate. And the other reserve banks scramble to get in conforming requests.
And so maybe over the next day, or even that afternoon, the other requests come in. But actually looking at discount window minutes, which are published by the Fed, can be an interesting way to learn about dissent on the part of the Reserve Banks about what the FOMC did that otherwise you wouldn't know about. Because if the Reserve Banks have requested a 75 basis point increase and the FOMC just increases 50 basis points, you'll never know that unless you actually read the minutes.
Joe: (25:24)
I don't think I've ever, I didn't even know there were discount window minutes. I gotta start reading those.
Bill: (25:26)
There are.
Tracy: (25:30)
Some light bedtime reading for you, Joe. So maybe just to sum it all up, you know, we're seeing discount window usage go up. Would you expect that discount lending to continue increasing going forward given that the Fed is ostensibly shrinking its balance sheet and tightening monetary policy? And then secondly, I guess this is the thing I don't really get, because you described discount lending as maybe the rate makes sense, particularly for some smaller banks given all these moving parts in monetary policy right now. But at the same time, reserves are still pretty ample. I can't remember if the Fed had like a particular level in mind, but I think we just dipped below like $3 trillion and probably closer to $2 trillion might be that the threshold for ample, but it would seem like there's enough liquidity out there such that banks don't need to use the discount window. And yet that is exactly what we're seeing.
Bill: (26:32)
So I think that, you know, we're all used to thinking about banks in terms of the big banks. Those are the ones that we're used to thinking about -- their activity and money markets. But again, there's thousands of banks out there of all sizes. And so in an environment where deposits are running off, loan growth is strong, the discount rate is very close to the target for federal funds rate to money market rates. It isn't surprising to me that there are a lot of smaller banks out there coming in and using the window. And it could have been that that troubles in the FinTech industry contributed to some uptick in borrowing over the recent months. And as you mentioned, you know, that borrowing has come down.
I would expect the borrowing to continue at a modest level going forward. It's actually pretty interesting, the Bank of England plans on using that as their way to figure out how small they can get. So it's quite different. So the Fed's policy is, we're going to shrink. We don't know how small we can get, but we're going to shrink until we're about $300 billion above that level. So that's kind of a tricky act to execute. What the Bank of England has done is they've said, we're going to make our lending rate and our borrowing rate equal. And we also opened a new standing repo facility. Unlike the Fed, we've advertised that we want people to use it. We've gone out to our examiners and told them that it's okay to use it. And what we plan on doing is we plan on shrinking until we see borrowing at that facility pick up.
And then not only will that mean that they'll really know how small they can get, but it will create a positive dynamic that will get them smaller, because market rates will be a bit above the rate that the Bank of England pays on the reserves. And that will give banks and bank examiners incentive to get used to banks getting smaller and smaller in the usage of reserves.
The Fed's plan has the reverse effect. We're going to stop with a lot of extra reserves out there. The market rates will remain below the rate that we pay on reserve balances because there's an abundance of reserve balances out there. That will never create that incentive for banks to economize on reserve balances. So it doesn't really create that same incentive for the central bank to get smaller over time.
Joe: (28:49)
Just one last question from me, and I guess I'm just still trying to wrap my head around this and, you know, Tracy asked, ‘well, like, why would anyone use it?’ And you mentioned it's probably the smaller banks. What is the circumstances of some of these tiny banks? And you mentioned maybe not even the FinTech [banks], that would push them, as opposed to the big banks, into having some impulse to use this?
Bill: (29:14)
So they use it because they need funding for some reason or another. And in some circumstances it's actually less expensive funding than the Federal Home Loan Banks, which banks borrow a lot from the Federal Home Loan Banks. It's sort of a very normal thing. They're widely used as sort of the contingent backup source of funding or regular source of funding. And with the Fed raising rates so rapidly, and with the rates so close, it actually in some circumstances can be more attractive. But also for a few basis points here and there, that really doesn't necessarily determine these decisions. So if it's convenient to use the discount window…
Joe: (29:54)
What does that mean, like ‘convenient,’ because I know there's not an actual window, I assume it's all just mouse clicks, right? What does that actually mean? Like when we were talking about convenience and you're like, okay, the collateral's right there at the window ready to be used. What are we actually talking about when we talk about convenience?
Bill: (30:09)
So you just call up your discount officer. The discount window is open until the very end of the day. It's open past anything else. Fedwire closes, you can still get a discount window loan.
Joe: (30:17)
What time does Fedwire close?
Bill: (30:18)
I don't remember anymore. I used to know that, but it's been too long since I've been gone from the Fed. And so you can always get it there. Your collateral is there, it's just, you know, you just call up and request it. It used to be that loans were extended just on an overnight basis, so you'd have to roll them. But starting in the global financial crisis and as a means to encourage banks to use the window, they extended the the initial maturity to 90 days renewable on your request. So you could always keep it out there.
Joe: (30:46)
So it really is easy.
Bill: (30:46)
It really is easy. And they never changed it back from 90-days to overnight.
Tracy: (30:52)
I like the idea of the discount window as the Taco Bell of liquidity facilities, it's open at all hours, but you might feel bad after using it.
Bill: (31:01)
Exactly. Too much Taco Bell is still probably not the way to go.
Joe: (31:04)
Right. You know, I was down in Texas recently, and it's like, why would you eat a Taco Bell when there's TexMex. It's like, well, you know, it's open, it's there, it's around.
Tracy: (31:12)
You know what you're getting.
Joe: (31:13)
You know what you're getting. Maybe there's a little stigma attached to it, you know, eating a Taco Bell when you're in Texas, but I guess, you know…
Bill: (31:24)
So there's actually, right now, more stigma than there has ever been. Let me give you a few anecdotes on why that is. So Betsy Duke was a governor at the Federal Reserve system. She had been a CEO at a regional bank before that. And she, so go, go back before the global financial crisis, she described borrowing from the discount window as like borrowing money from your parents. You'll do it if you have to, but nobody really wants to. And you feel kind of bad about it. Now, after the global financial crisis with all of this you know, sort of recriminations about receiving a bailout and public flogging of the people that use the window and bank management really not wanting to go through that again, the stigma just jumped exponentially.
And I was told by a treasurer at the US branch of a foreign bank that when he got his job, he was told, well, if you ever do borrow from the discount window, there's going to be two phone calls. There's going to be a phone call from the president of the New York Fed to our CEO to ask why you borrowed, and there's going to be a phone call from human resources to you, to tell you to clean out your desk. So, you know, under those circumstances.. And so, I mean, one of the issues that complicates stigma is that you get a very different message, I'm told this from by the bankers that I work with, from the discount officers and from the supervisors. So the discount officers kind of understand, they encourage you to want to use it.
Supervisors on the other hand, really are uncomfortable with using the discount window. And in the end, this is the complication of having something that you want people to use, but it's still supposed to be a backup. When you tap your back up, it kind of says something went wrong. And when we designed the new discount window and it was no questions asked, I was talking to a bank out on the West coast and encouraging them, you know, to use the window. And they said, ‘our supervisor really doesn't want us to use the window.’ And I said, ‘oh, well tell them about these changes that we've made.’ And they said, ‘no, we told them about it and they still don't want us to use it.’
So I went back to DC and working with all the banking agencies, got the banking agencies to write what's called an SR letter. And this is still the rule of this, is still the law of the land. It's a letter to the bank examiners that says it's okay to use the discount window. So I went back to the bank, this West coast bank, they said, ‘yeah, we got our examiner to read the SR letter, but they still don't think it's a good idea to use the discount window.’ So that’s kind of entrenched. It can be hard to overcome.
Tracy: (33:47)
Yeah. Well Bill, I am so glad we were able to have this conversation that was really a fantastic overview of the discount window, and you really put it in context for us as well, the recent discount lending. So thank you so much for coming on Odd Lots!
Bill: (34:02)
You bet. Thank you for having me.
Joe: (34:03)
Yeah. I learned a lot. Thanks.
Tracy: (34:22)
So Joe, I thought that was really interesting and really great to hear about the discount window from someone, you know, who has that operational experience with it and who has been thinking about what it's there for, for a long time. And also I thought it was really interesting to hear about the changes from, you know, 1960s to today. And in some ways this idea that we're sort of going back to the 1960s where it's more about maybe adjusting to monetary policy than actual emergency lending like we saw in 2008.
Joe: (34:54)
Itis interesting, you know, and thinking back to some of these recent episodes that we've done with like Josh Younger and so forth, the degree to which some of these conflicts between one entity that wants tighter monetary policy, fight inflation versus other entities, political entities that don't, is super interesting. I thought the comparison to sort of like overdraft protection was very helpful in understanding it and this idea that if, you know, no one really wants to overdraft, but if you know that that protection is there, then you might be comfortable holding lower balances and so forth. That, I think, really helped me sort of wrap my head around what this facility is really for.
Tracy: (35:33)
It is still the case though, that we could be seeing some banks experiencing some liquidity strains, not out of the realms of possibility. And certainly we know that a lot of smaller banks probably have mark-to-market losses on their portfolios of bonds, you know, Treasuries or mortgage backed securities. And I think, I think the FHLBs are required to use tangible equity, which includes unrealized gains and losses -- I'm going to get this wrong -- on available for sale securities? I think so. It would mean, if you had marked down your bond portfolio quite a lot, you might be locked out of that [FHLB] borrowing and then that might lead you to go to the discount window.
Joe: (36:17)
Well, we'll find out in two years.
Tracy: (36:19)
I was going to say, I guess the good news is we only have to wait two years because, thanks to Dodd-Frank, we'll find out who's been using the discount window in what is it? It's 2023, so in 2025.
Joe: (36:31)
And then for all the stigma, they're like, ‘yeah, it was two years ago,’ so.
Tracy: (36:35)
They’ll be like, ‘we did what we were supposed to do.’ Well, we'll have to have Bill on.
Joe: (36:39)
Yeah, we'll go over, we’ll say what was going on with them.
Tracy: (36:44)
We'll officially solve the mystery of discount lending in 2022 and 2023. Alright. Shall we leave it there?
Joe: (36:51)
Let's leave it there.
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