Why Banks Are Suddenly Borrowing From the Fed's Discount Window

Tracy Alloway (0:10)

Hello, and welcome to another episode of the Odd Lots Podcast. I'm Tracy Alloway.

Joe Weisenthal (0:15)

And I'm Joe Weisenthal.

Tracy Alloway (0:17)

Joe, do you remember the discount window?

Joe Weisenthal (0:20)

Yeah, the only thing I know about the discount window is that it's some way for the banks to borrow money from the Fed, and that they always talk about the stigma of the discount window. And I don't even really know why, but I know that it's like the banks have various ways of pledging collateral and borrowing, but something about the discount window, I doubt there's a real window for me. There's a stigma attached to it, supposedly. That's all I know about the entire thing. That's it, that's it.

Tracy Alloway (0:46)

I'm imagining banks going up to a window at the Fed and being like, I'll have one billion worth of liquidity, please. No, okay. So the discount window facility is an emergency lending facility from the Fed. And I think one of the reasons there's a stigma attached to it is we tend to see usage of it go up during crises, and most notably during the 2008 financial crisis. And during March of 2020, we saw discount window use go up as well.

And interestingly, even though we are not experiencing a financial crisis at the moment, we have seen the discount window balances go up more recently. They reached $10 billion, I think, in late November.

Currently, they've come down a little bit to around $4 billion, but it is kind of weird to see this happening at a time when there are still supposedly ample reserves in the financial system and still a lot of liquidity sloshing around.

Joe Weisenthal (1:48)

Right, we have seen the markets sold off and all that, but by and large, there's no sort of signs that there's some real stress in the financial system. And I don't, as far as I know, but this is one of those things, like for some reason, someone out there is using this facility. I don't think we know who, the other thing I know about the discount window is like, I sort of associated like, every once in a while you see like a zero hedge tweet about it or something like that. It's like, oh, there's a little line that ticked up.

So what does this mean?

Tracy Alloway (2:21)

The apocalypse is coming, yeah.

Joe Weisenthal (2:22)

That's the other thing that I sort of associate with the discount window. But yeah, that is sort of, it's an interesting question. Like what's going on there?

Tracy Alloway (2:31)

Right, so it is a little bit of a mystery at the moment. There's some speculation that maybe it has to do with some losses in the crypto industry recently. We have seen Silvergate, for instance, under pressure, some other banks potentially as well, maybe some smaller banks that have experienced a lot of losses on their bond portfolios as interest rates go up. There's all these theories floating around. So I thought we really need to stop and just talk generally about what the discount window is and how it came into being and what it means maybe that use is going up now. Maybe it tells us something more broad about where we're heading.

Joe Weisenthal (3:07)

You know, what's weird to me is you think like, okay, emergency borrowing, you have to pay a premium for that. But like discount window, I assume that's even cheaper money. So everything about it is a mystery to me.

Tracy Alloway (3:18)

Totally. And if you think back to, you know, like one of the fundamental tenets of central banking is lend freely against good collateral. So why is it a big deal if banks are using the discount window? The Fed has made it clear in recent years that it wants banks to use the discount window when it has to. But anyway, we could keep talking about this or we could bring on our guest.

Joe Weisenthal (3:39)

Bring in an expert.

Tracy Alloway (3:41)

Yeah, bring in an expert who really is the perfect person to discuss this. We're gonna be speaking with Bill Nelson. He's executive vice president and chief economist at the Bank Policy Institute, which is a trade group slash think tank for banks. But previously, he spent 24 years at the Fed, including, I think, about a decade, actually overseeing the discount window.

Joe Weisenthal (4:06)

The actual perfect guest. When you're like, okay, here's someone spending 10 years running the discount window, I think the actual perfect guest.

Tracy Alloway (4:14)

Yeah, exactly. So Bill, thank you so much for coming on Odd Lots.