Lender of Last Resort: Issues with the Fed Discount Window and Emergency Lending (February 15, 2024)
Summary
Transcript of the hearing Lender of Last Resort: Issues with the Fed Discount Window and Emergency Lending, before the Subcommittee on Financial Institutions and Monetary Policy of the Committee on Financial Services, U.S. House of Representatives, on February 15, 2024 (Serial No. 118–75). Opening statements are listed for Chairman Andy Barr and Ranking Member Bill Foster, with a statement by Hon. Maxine Waters. Witnesses were Professor Hal Scott of Harvard University, Mr. William Nelson of the Bank Policy Institute and Professor Simon Johnson of the MIT Sloan School of Management. The appendix includes material from the American Bankers Association and the Council of Federal Home Loan Banks, and the subcommittee adjourned at 11:56 a.m.
Summary drafted by a model from the document's text below and checked by script against that text before publication. It is a navigation aid, not a reading of what the document proves. Where AI is used
Cite this document
“Lender of Last Resort: Issues with the Fed Discount Window and Emergency Lending (February 15, 2024).”
Original at www.govinfo.gov. Archived at Pandemic Darlings, https://pandemicdarlings.com/source-documents/chrg-118hhrg56280-be33380fa7/
, SHA-256 b27845389f01da8a0c7e348c989d27ab0434292ced873d719313927a9d3e191a.Full text
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
(
www.govinfo.gov
U.S. GOVERNMENT PUBLISHING OFFICE
56–280 PDF WASHINGTON : 2026
HOUSE COMMITTEE ON FINANCIAL SERVICES
PATRICK MCHENRY, North Carolina, Chairman
FRENCH HILL, Arkansas, Vice Chairman MAXINE WATERS, California, Ranking
FRANK D. LUCAS, Oklahoma Member
PETE SESSIONS, Texas SYLVIA R. GARCIA, Texas, Vice Ranking
BILL POSEY, Florida Member
BLAINE LUETKEMEYER, Missouri NYDIA M. VELÁZQUEZ, New York
BILL HUIZENGA, Michigan BRAD SHERMAN, California
ANN WAGNER, Missouri GREGORY W. MEEKS, New York
ANDY BARR, Kentucky DAVID SCOTT, Georgia
ROGER WILLIAMS, Texas STEPHEN F. LYNCH, Massachusetts
TOM EMMER, Minnesota AL GREEN, Texas
BARRY LOUDERMILK, Georgia EMANUEL CLEAVER, Missouri
ALEXANDER X. MOONEY, West Virginia JAMES A. HIMES, Connecticut
WARREN DAVIDSON, Ohio BILL FOSTER, Illinois
JOHN W. ROSE, Tennessee JOYCE BEATTY, Ohio
BRYAN STEIL, Wisconsin JUAN VARGAS, California
WILLIAM R. TIMMONS, IV, South Carolina JOSH GOTTHEIMER, New Jersey
RALPH NORMAN, South Carolina VICENTE GONZALEZ, Texas
DANIEL MEUSER, Pennsylvania SEAN CASTEN, Illinois
SCOTT FITZGERALD, Wisconsin AYANNA PRESSLEY, Massachusetts
ANDREW R. GARBARINO, New York STEVEN HORSFORD, Nevada
YOUNG KIM, California RASHIDA TLAIB, Michigan
BYRON DONALDS, Florida RITCHIE TORRES, New York
MIKE FLOOD, Nebraska NIKEMA WILLIAMS, Georgia
MICHAEL LAWLER, New York WILEY NICKEL, North Carolina
ZACHARY NUNN, Iowa BRITTANY PETTERSEN, Colorado
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 Member
Chairman AYANNA PRESSLEY, Massachusetts, Vice
BILL POSEY, Florida Ranking Member
BLAINE LUETKEMEYER, Missouri NYDIA M. VELÁZQUEZ, New York
ROGER WILLIAMS, Texas BRAD SHERMAN, California,
JOHN W. ROSE, Tennessee GREGORY W. MEEKS, New York
WILLIAM R. TIMMONS, IV, South 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
(II)
C O N T E N T S
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 Institu-
tions and Monetary Policy, a U.S. Representative from Illinois ...................... 3
STATEMENTS
Hon. Maxine Waters, Ranking Member of the Committee on Financial Serv-
ices, 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 Entrepreneur-
ship, 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
(III)
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, Fos-
ter, Sherman, Scott of Georgia, Green, Beatty, Vargas, and Casten.
Chairman BARR. The committee will come to order. Without ob-
jection, 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 with-
in which to submit extraneous materials to the chair for inclusion
in the record.
I now recognize myself for 5 minutes to give an opening state-
ment.
OPENING STATEMENT OF HON. ANDY BARR, CHAIRMAN OF
THE SUBCOMMITTEE ON FINANCIAL INSTITUTIONS AND
MONETARY POLICY, A U.S. REPRESENTATIVE FROM KEN-
TUCKY
In performing lender of last resort functions, central banks have
long been told to abide by recommendations memorialized by Brit-
ish 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 lend-
ing freely also means that the Federal Reserve (Fed) should be pre-
pared 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 bor-
rowers. Another is by using lending authority in Section 13(3) of
(1)
2
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 stig-
ma 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 com-
panies 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 indi-
vidual 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 li-
quidity requirements, more transparency in Fed emergency lend-
ing, 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 perma-
nent.
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 oper-
ations 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 dis-
cuss today, though I am skeptical that Home Loan Banks were in-
tegral to the Fed’s emergency lending clunkiness last March.
As the Fed reexamines its operations, an open question is wheth-
er legislation may be needed to address some of the problems in
the Fed’s liquidity provision present last March. Meanwhile, Fed-
eral 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 bet-
ter at analyzing such things than it did with its under-analyzed re-
cent 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 Sub-
committee On Financial Institutions And Monetary Policy, the gen-
tleman from Illinois, Dr. Foster, for 4 minutes for an opening state-
ment.
3
OPENING STATEMENT OF HON. BILL FOSTER, RANKING MEM-
BER OF THE SUBCOMMITTEE ON FINANCIAL INSTITUTIONS
AND MONETARY POLICY, A U.S. REPRESENTATIVE FROM IL-
LINOIS
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 institu-
tions of different sizes bidding for their business. That will not hap-
pen 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 over-
look.
In this hearing, we are going to be discussing how the Fed’s dis-
count window and other emergency lending authorities have per-
formed 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 ex-
acerbating shifts in market behavior.
I am afraid we are soon going to be living in a world where indi-
viduals’ 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.
4
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 every-
one has their financial advisers automated or at least enough peo-
ple to really put banks at risk.
Then there is the whole separate issue of short sellers and delib-
erate attacks on a bank when banks depend so much on their rep-
utation. 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 com-
mittee, 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. REP-
RESENTATIVE FROM CALIFORNIA
Ms. WATERS. Thank you very much. It has been nearly a year
since we faced the sudden failures of Silicon Valley Bank, Signa-
ture Bank, and First Republic Bank. I was pleased Treasury Sec-
retary Yellen, the Federal Reserve, and the Federal Deposit Insur-
ance Corporation (FDIC) took swift action to stabilize the situation.
Going forward, I support efforts by Biden’s regulators to encour-
age the use of the Fed’s discount window by banks that need li-
quidity. 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 pan-
demic.
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
5
Johnson. Mr. Johnson is the Ronald A. Kurtz Professor of Entre-
preneurship 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 PRO-
FESSOR OF INTERNATIONAL FINANCIAL SYSTEMS, EMER-
ITUS, 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 mem-
bers.
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 satis-
faction. After Silicon Valley Bank (SVB) failed, the Fed established
the Bank Term Funding Program under Section 13(3) of the Fed-
eral Reserve Act and valued hold-to-maturity government securi-
ties at par rather than at market, as they had done under the dis-
count 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 in-
stantly 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 knowl-
edge, 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
6
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 in-
surance 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 al-
ready 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 can-
not be managed to the current $250,000 limit, such as business
payments.
Sixth, under—and I stress this—appropriate circumstances, exec-
utive 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 les-
son from the coronavirus disease (COVID)—should be limited to li-
quidity 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 de-
signed.
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:]
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
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 di-
rector 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 ad-
vances under the authority granted under Section 10(b) of the Fed-
eral 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 re-
serves.
Smaller banks borrowed to address short-term funding needs,
such as might be caused by losing a large municipal deposit, for ex-
ample. To be sure, the discount window is also and has always
been the Fed’s first line of defense against broader financial tur-
moil.
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 contin-
gency funding inevitably suggests something has gone wrong.
Stigma got much, much worse in the aftermath of the global fi-
nancial 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 dis-
count window and prepositioned collateral as a source of liquidity.
Banks are not allowed to assume that they borrow from the dis-
count window in either their liquidity coverage ratio or their inter-
nal liquidity stress tests.
24
Not only do these restrictions depart from reality, a bank pre-
pared 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 win-
dow ring hollow if banks are told that contemplating such bor-
rowing 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 man-
agement 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 de-
posits 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 dis-
count 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 dis-
count 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:]
25
26
27
28
29
30
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, sub-
mitted 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 ex-
ception 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 dis-
cuss 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 reg-
ular 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.
31
Having those advisers speed up the bank runs will be coming for
sure.
So in addition to dealing with the clunkiness and removing or at-
tempting to address the stigma, I do urge consideration of revis-
iting the Transaction Account Guarantee Program, which pre-
viously 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 con-
gressional approval. There is specifically a fast track process for ap-
proval of the Transaction Account Guarantee (TAG) through the
Senate but not through the House, and I have not yet found some-
one 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 abil-
ity 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 trans-
action, 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:]
32
33
34
35
36
37
38
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 substan-
tial 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 sub-
stantial 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 oper-
ations 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 gen-
erally 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 re-
vised Regulation A, and move the discount window to an above-
market rate so that it could let the rate itself govern a bank’s deci-
sion 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
39
Regulation (SR) letter written by the supervisory agencies, recog-
nizing that the discount window is an important tool for liquidity
risk management.
So I think that the Fed needs to redouble—and that was work-
ing. 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, edu-
cating Congress about the importance of the discount window
would be a critical change.
Chairman BARR. Yes. I am very intrigued by your recommenda-
tion, when you say banks are not allowed to assume that they bor-
row 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 exac-
erbating 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 recog-
nized.
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?
40
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 govern-
ment.
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 bor-
rowing 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 ex-
actly—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
41
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 con-
sider. One is that it does take time and work to set up the arrange-
ment, 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 actu-
ally 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 intel-
ligence 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 reputa-
tion go up there and say, I have a hundred banks that are in trou-
ble. 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
42
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 be-
fore 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 re-
acting 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 Pro-
gram 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 talk-
ing about today with the discount window, but it would be a com-
plement 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 every-
thing.
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 situa-
tion 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 time-
frame. 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 in-
stantaneous 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.
43
Mr. Scott, with regards to the term funding, the short-term fund-
ing 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 prob-
lems, 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 anniver-
sary 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 ex-
ception to protect uninsured depositors, and the Fed used its emer-
gency 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 Sec-
retary 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 Guar-
antee Program was not available on short notice because of the
terms of Dodd-Frank, I think the measures that they took, both in-
dividual measures and the packaging ways they put them together,
were entirely responsible and saved us from a much more severe
financial crisis.
44
Ms. WATERS. Thank you.
Professor Johnson, you also raised how important it is for bank-
ing regulators to finalize the Basel III end game proposal to
strengthen bank capital requirements. I agree with you, but we re-
ceived 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 com-
promised of various Republican, Democratic, and international Eu-
ropean 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 eco-
nomic exceptional difficulty. In fact, our view is that well-capital-
ized banks are more likely to be robust lenders throughout the
business credit cycle; therefore, strengthens economic growth pros-
pects 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 abso-
lutely intertwined with issues of liquidity pressure in many finan-
cial 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 Val-
ley 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, Congress-
woman, 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 impor-
tant.
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.
45
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 pos-
ing 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 condi-
tions?
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 dis-
count 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 fi-
nancial crisis. The answer was in some cases, well, why is that nec-
essary? 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 ex-
actly 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 bene-
ficial to extend the operating hours of the discount window?
Mr. NELSON. I do. I think the critical question is actually the op-
erating 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.
46
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 re-
duce the reliance on special credit facilities during periods of insta-
bility?
Mr. NELSON. I think it would—not necessarily, because the insti-
tutions 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 West-
ern 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 pre-
vent the misuse of 13(3) facilities.
How is this safeguard applied in practice under truly exigent cir-
cumstances?
Mr. NELSON. Each time the facility is used or created, the Fed
looks at and determines that similar credit is not available else-
where.
Mr. LOUDERMILK. Okay. Last March, the Fed set up the Bank
Term Funding Program facility, a 13(3) facility. The BTFP lets bor-
rowers 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 in-
stitutions 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, be-
cause 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 dis-
count 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
47
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 re-
quirement 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 avail-
able to other parts of the economy.
So I think actually making that secret again would be problem-
atic, 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 reserva-
tions 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
48
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 impor-
tant means by which smaller and regional size banks conduct reg-
ular asset liability management when they need funding, and that
is an important role and one—but at the same time there is a sig-
nificant 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 guaran-
teed by the government, and that is a recipe for systemic risk.
Addressing that problem would require a lot of careful consider-
ation, 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 re-
serves, 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 Fos-
ter 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 im-
pact 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 instanta-
neously. 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 rapid-
ity of these things probably increase, not decrease, as we go for-
ward. Certainly, the ability to communicate concern in the market-
49
place 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 re-
spond to these runs quicker and quicker?
Mr. SCOTT. Well, I am not a techie, so I cannot give you the de-
tails, 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 deci-
sions?
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 op-
erating 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 institu-
tions that depositors were worried about and enabled them to po-
tentially 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 dis-
count 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 ar-
bitrage to borrow from the program and simply deposit the money
50
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 cri-
sis, 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 rank-
ing 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 appre-
ciate 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 hap-
pening all the time now. I say this because now insurance compa-
nies are starting to leave areas of the country or not renewing poli-
cies 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 poten-
tial 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 insur-
ance 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 finan-
cial 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 ap-
proach to regulation in the EU, the U.K., and the U.S. That is tre-
mendously important for insurance and other parts of the financial
51
sector, and that is something that Systemic Risk Council has writ-
ten about, thinks a lot about, that consistency.
With regard to the climate change impact, I am sure you are ab-
solutely 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 al-
lowed 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, Pro-
fessor—or
Mr. NELSON. Climate change is a serious problem, and it is ap-
propriate that the regulatory agencies that are responsible for reg-
ulating 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 rea-
sons 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?
52
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 en-
tirely legitimate business purposes and making sense on an indi-
vidual 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 some-
thing stupid or irresponsible. It is the way that those risks would
aggregate data through legitimate AI. That is a very serious possi-
bility.
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 Re-
serve 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 mort-
gage-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 as-
sets 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 Fed-
53
eral 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 Fed-
eral 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 pro-
grams, credit unions have access to a central liquidity facility, a
Federal function maintained by the National Credit Union Admin-
istration. It is essential that Congress ensures that the central li-
quidity facility is up-to-date and ready to provide efficient and ade-
quate 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 imple-
menting that policy with appropriated money or appropriated guar-
antees.
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 corpora-
tions 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 institu-
54
tion by its crazy bets in the one entity that they had that was not
regulated by State insurance commissioners. In spite of that man-
agement, that management was not able to bankrupt any of the
regulated insurance companies.
I think this was the most impressive show of effective State regu-
lation 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 real-
ize 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.
55
Bill may want to comment on that.
Mr. SHERMAN. It is clear from the statute, the Competitive Eq-
uity 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 gen-
tleman 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, liquid-
ity, 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-ma-
turity 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-matu-
rity 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.
56
Ms. KIM. Okay, Mr. Scott, let me move on.
There is a stigma associated with borrowing from the Fed’s dis-
count 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 uti-
lize the discount window?
Mr. NELSON. Making those changes, particularly the internal li-
quidity stress test, which is not something subject to an inter-
national agreement or international standard, would send a mes-
sage to banks that being prepared to borrow from the discount win-
dow 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 incen-
tive.
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, in-
stitutions are encouraged to be planning on using U.K. facilities.
The U.K., the Bank of England has made repeated public an-
nouncements 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 coun-
tries, and on the other, the effect of the Basel III Endgame pro-
posal to increase capital requirements.
Mr. Nelson, can you talk about how the lending for small busi-
nesses 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 busi-
nesses 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.
57
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 deposi-
tors, I cannot speak to that.
Mr. GREEN. Well, all right, let us make it deposits.
Mr. JOHNSON. Absolutely. A very large share of uninsured depos-
its.
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 ex-
tent that it was?
Mr. JOHNSON. There would be no—there is no run. Insured de-
positors do not run on American banks. That is not something that
happens.
Mr. GREEN. If they do not run when you have your deposit in-
sured, 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 ques-
tion 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 percent-
age 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—
58
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 pen-
alty 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 at-
tractive.
Mr. GREEN. I am asking because smaller banks, as you know, es-
pecially 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 re-
minding 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 own-
ership, 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 un-
able 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 in-
crease 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 quick-
59
ly 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 dis-
count 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 collat-
eral. That agreement is complicated by the fact that the Federal
Home Loan Banks are secured by a blanket lien on all of the bor-
rowing 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 Re-
serve 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 li-
quidity from the Fed’s discount window because SVB has never ac-
tually 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
60
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 Fed-
eral 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 pos-
sible.
Mr. TIMMONS. Who has the authority to expand the Fedwire win-
dow?
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 tre-
mendous 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
61
those actions have increased the need of the Federal Reserve to in-
termediate 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 foot-
print 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 ex-
pect, among the market participants, that the Fed will intervene
to rescue markets and businesses, increase the potential for sys-
tematic 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 al-
leviate the moral hazard when the Fed acts this way, is under—
and I stress this, and I put this in my testimony. Under appro-
priate circumstances, we should make those people at the bank
who are responsible for triggering this government support respon-
sible 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 some-
body 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 some-
what 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 sys-
tem, you are increasing the likelihood that people will come to ex-
pect 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.
62
Mr. Nelson, under 13(3) there is authorization for the Fed to lend
to bank and nonbank institutions under unusual and exigent cir-
cumstances 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 account-
ing 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 liquid-
ity 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 cov-
ered 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?
63
Mr. NELSON. There is a pretty robust debate in the academic lit-
erature 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 haz-
ard even more than receiving a similar loan from a financial insti-
tution 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 bil-
lion, 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 dis-
count 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 cri-
sis 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 sys-
tem needs a lender of last resort is because we have various regu-
latory frameworks in our economy that can inhibit economic expan-
sion or economic stability?
64
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 ir-
rational.
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 econo-
mists 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 sys-
tem 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 un-
derwriter 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 institu-
tion 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 ana-
lyze 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 al-
most 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 in-
creasing 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.
65
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 with-
in which to submit additional written requests for the witnesses to
the chair, which will be forwarded to the witnesses for their re-
sponse. 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.]
APPENDIX
February 15, 2024
(67)
68
69
70
71
72
73
74
75
76
77
78
79
80
81
82
Æ
File and source
- File
- CHRG-118hhrg56280.pdf
- Size
- 7,386,491 bytes
- SHA-256
- b27845389f01da8a0c7e348c989d27ab0434292ced873d719313927a9d3e191a
- Our copy
- CHRG-118hhrg56280.pdf
- Original
- www.govinfo.gov