In a recent video, renowned investor and educator George Gammon issued a warning about an impending second wave of the banking crisis. He delved into the data, revealing the signs that suggest the crisis is just beginning.
The Mysterious Second Central Bank
Gammon began by introducing the Federal Home Loan Bank System (FHLB), a lesser-known entity that he refers to as the “second Central Bank of the United States.” Established by the government in 1932 to promote homeownership, the FHLB has grown massively over the last 90 years, serving the interests of large financial institutions more than homeowners.
The FHLB is a lender of “second to last resort,” where banks go when they’re in trouble before approaching the Federal Reserve. While it was initially set up to help small and community banks extend mortgages, it has evolved into a stealth bailout system for big banks to plug holes in their balance sheets.
The Risk Waterfall
Gammon explained the concept of a “risk waterfall,” a sequence of options that troubled banks go through when they need liquidity. The first option is the marketplace, such as the repo market. If the marketplace refuses to lend due to the bank’s risky position, the bank’s next option is the FHLB. However, borrowing from the FHLB can be expensive and comes with stringent terms.
If a bank is so troubled that even the FHLB refuses to lend to it, the bank’s last resort is the Federal Reserve, through facilities such as the Bank Term Funding Program (BTFP). However, borrowing from the Federal Reserve carries a stigma, signaling to the market that the bank is in dire straits. The ultimate stigma is borrowing from the Federal Reserve’s discount window, which Gammon describes as “banking suicide.”
Predicting the Next Wave of the Banking Crisis
By examining the advances from the FHLB and the overflow into facilities like the BTFP on the Federal Reserve’s balance sheet, Gammon suggests that we can determine the level of stress in the banking system and the likelihood of the banking crisis continuing.
He points out that the advances from the FHLB have been increasing, similar to the trend seen in 2007 before the Global Financial Crisis (GFC). Furthermore, the BTFP has also seen a significant increase, indicating that banks are unable to access liquidity from the market or the FHLB.
However, borrowing from the discount window has decreased, suggesting that the worst of the crisis may not have hit yet. Gammon warns that when borrowing from the discount window shoots up, it’s likely that more banks will go bust, potentially leading to a crisis similar to or worse than the GFC.