The Federal Reserve chose to forge ahead with another rate hike in March in spite of the banking industry facing significant pressure related to rapid hikes. Wednesday, March 22, the Federal Open Market Committee opted to raise the bank overnight lending rate another 25 basis points to a range of 4.75% to 5%, its highest level since 2007.
“The U.S. banking system is sound and resilient,” the Fed said in a statement announcing the hike. “Recent developments are likely to result in tighter credit conditions for households and businesses and to weigh on economic activity, hiring, and inflation. The extent of these effects is uncertain. The Committee remains highly attentive to inflation risks.”
This is the Fed’s ninth rate hike since March 2022. The federal funds rate was brought down to near-zero at the COVID-19 pandemic onset and stayed that low until inflation started rising well above the Fed’s target. Annual consumer price inflation peaked at 9.1% in June 2022 and has steadily but slowly fallen since. In the latest reading for February, consumer prices are still charging ahead at a 6% annual rate, triple the 2% target rate. Meanwhile, the Fed’s preferred inflation gauge showed inflation rose from December to January in the latest available data, defying rate hikes meant to slow price increases.
What does the bank crisis have to do with rate hikes?
Silicon Valley Bank officially collapsed on March 10 after customers initiated a bank run, triggered by liquidity concerns. The California-based bank had too much customer money tied up in lower-interest government securities and when the bank signaled that it needed to raise capital and sell bonds at a loss, customers and investors panicked.
“They put massive amounts of long-term government bonds on the books and other deposits were short term, so they had a horrible interest-rate mismatch,” former FDIC Chair Bill Isaac explained.
When the Fed started rapidly increasing interest rates starting in March 2022, it put the bank’s securities underwater. Because interest rates had gone up, their lower-interest yielding bonds were worth less on the open market. On March 8, the bank announced it sold $21 billion worth of bonds at a $1.8 billion loss.
How has the Fed responded to the crisis?
Silicon Valley Bank is not the only institution to face a liquidity crisis over rapidly rising rates. To plug the hole exposed by the SVB failure and prevent more bank runs, the Fed announced it would be providing additional lending opportunities to banks that may be facing liquidity problems.
The Fed also made it easier for banks to borrow from its discount window and banks took advantage more than ever before in history. In one week, banks borrowed $152.85 billion, up from $4.58 billion the week before. It was way more than the previous record set during the 2008 financial crisis of $111 billion.