Crypto isn’t the biggest worry in the Silvergate-Home Loan bank story

I want to start by saying that it is with great hesitation that I land on the subject of this column. editorializing on a reporter’s own story as it breaks is cheeky, but to editorialize on that the same history two weeks in a row borders on bad taste.

But a few things happened with the Silvergate-Home Loan story last week that make the topic worth repeating. One is that some of the nuances of what was important about the story have become more prominent and placed in valuable context. The other is that, upon further reflection, the cause for concern is not that cryptocurrencies will infiltrate the banking system, but rather that mortgage lending banks are a far more critical liquidity artery in the financial system than we may have realized. legislators can appreciate.

To recap: We wrote a story last week showing that Silvergate Bank, a crypto bank that saw roughly 70% of its deposits disappear as the FTX fiasco unfolded, had taken out $4.3 billion in Federal Home Loan advances. Bank of San Francisco. in the fourth quarter. Those advances came to represent the bulk of the bank’s liquid assets, even though the bank had only a vestigial tie to mortgages, home development, or anything else that might further the ostensible mission of the Federal Loan Bank System. for Housing. What’s more, because bank advances on home loans are repaid before federal deposit insurance claims in a settlement, the FDIC could take losses in the event of a bank failure.

Somewhere along the way, the final message of the story came through. flattened in “Home Loan Banks Bail Out Crypto,” and that’s not necessarily wrong in effect, even if it’s not necessarily right in implied intent.

Mortgage lending banks make advances to their members largely based on the value of their collateral, rather than the lines of business in which their members are involved. As president of the Federal Home Loan Bank of San Francisco, Teresa Bazemore said in a LinkedIn post Last week, mortgage lending banks “do not have any supervisory responsibility for the business operations of a member institution,” instead relying on those that do to flag an institution as unworthy of credit. So the fact that the Silvergate deposit run is linked to the cryptocurrency recession is interesting and certainly newsworthy, but not necessarily important in the San Francisco bank’s decision on whether to advance Silvergate cash in return. of government-backed securities.

It’s worth pausing here for a moment to note that, at this point in the thread, Silvergate may seem unstable, but it doesn’t seem to pose a systemic risk yet. The systemic risk angle of the story comes into play if Silvergate fails or, in a scenario that is more likely to actually pose a risk to the financial system, the failure of a number of banks similar to Silvergate that are similarly situated and indebted with the Banks of mortgage loans.

But even there, the risk seems somewhat remote. Home loan bank advances are secured by government-backed debt, which is very good collateral. So in the event of bankruptcy, the home lending banks have a senior lien that could leave the FDIC with the bag, but the collateral held on those advances would likely absorb a sizeable portion of that debt.

And when we look around the banking industry, there don’t seem to be another dozen Silvergates that could act as a force multiplier for that risk. Signature Bank, for example, has also aggressively expanded into banking crypto firms and has reported significant deposit liquidation and turned to home loan banks for liquidity. But one important difference in Signature’s case is that it has a strong multi-family housing business that makes its link to the Home Loan Bank System more obvious on the one hand, and its portfolio more diversified than Silvergate’s on the other. other.

Before we decide that the Silvergate-Home Loan story is more of a financial curiosity than imminent danger, let’s consider another piece of news that came late last week. the federal reserve published its Semi-Annual Survey of Senior Financial Officers on Friday night and found that 77% of respondents whose bank was owned by a home loan bank said they were “very likely” to use home loan banks to replenish lost liquidity, and another 14% said they were “likely” to take advantage of those advances if the need arose. By contrast, 78% of respondents said it was “not likely” that they would use the Fed’s discount window for liquidity, and 0 % said it was “likely” to do so.

That should give us pause. The Fed’s discount window is the lender of last resort, and its use sends a powerful signal to the market that it is out of options and therefore not worth further investment; that’s why banks don’t want to use it. But if a bank can get all the liquidity benefits of a discount window without the market taint, or, apparently, oversight, why wouldn’t a bank do that instead? In fact, many have and do, and the scope of those loans, as we learned from the Silvergate experience, probably goes well beyond housing and related markets.

Even here, there is no imminent threat to financial stability. The banks are well capitalized and the markets are buzzing right now, and no matter how volatile crypto can get, it’s not a big enough market to sink the economy.

For that to happen, a massive shock to the system and/or a massive devaluation of public debt would be required. Is there something on the horizon that could create those conditions?

i can think of something: the debt ceiling crisis.


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