The banking crisis of 2023 appears to be just the beginning, with the third-largest bank failure in US history having taken place and more predicted to follow.
To understand why this is happening, we should look at the second central bank of the United States that very few people are aware of, the Federal Home Loan Bank System.
This system was set up by the government in 1932 to promote homeownership and, over the past 90 years, has grown tremendously and has now become a lender of second-to-last resort, serving the interests of giant financial institutions more than homeowners.
The advances that go out to the marketplace from the Federal Home Loan Bank go by the name of ‘advances.' These advances began to go parabolic in 2007, which was prior to the bankruptcy of Lehman Brothers and Bear Stearns, indicating that the GFC tsunami was on its way.
During Covid, advances dropped significantly, but in 2022, it went straight back up. The banks poised to go bust borrow from this system, pretending to obtain cash for mortgages while plugging large holes in their balance sheets.
These troubled banks' first option is always the marketplace, but when it denies their loan applications, they opt to go to the Federal Home Loan Bank System, which is very expensive.
However, there is still a stigma attached to borrowing from the Federal Reserve, the ultimate lender of last resort, which is the equivalent of going to the discount window. If we observe that this lending is going up and hasn't come down, we know that there are banks that cannot access market liquidity or Federal Home Loan Bank System loans.
Once we understand the risk waterfall, we can determine how much stress the banking system is under and what the probability is that this banking crisis will continue into the future. We can even predict the crisis's timing to some degree by combining charts of the advances of the Federal Home Loan Bank, the balance on the Federal Reserve's Bank Term Funding Program (BT FP), and the discount window.
Once the latter goes up, we know that the crisis's next wave is imminent, possibly taking us into an environment very similar to or worse than the Great Financial Crisis.
In summary, the banking crisis of 2023 is just the beginning, with a second central bank, from which giant financial institutions are borrowing, becoming the lender of second-to-last resort.
The marketplace is the first go-to place for these troubled banks, but when rejected, they borrow from the Federal Home Loan Bank, which is costly. The stigma attached to borrowing from the Federal Reserve is akin to having a dropped credit score.
By analyzing charts from these institutions, we can predict the timing and severity of the crisis's next wave.