No matter who the next U.S. president is, the Federal Reserve will be forced to "backstop"!

As two U.S. presidential candidates plan to further increase the deficit by trillions of dollars, the Federal Reserve faces the risk of exceeding its role as a lender of last resort or becoming a pillar that the market relies on even in normal times.

The concept of a lender of last resort was first theorized by 19th-century economist Walter Bagehot, who believed it was necessary to prevent bank runs.

Since the 2008 financial crisis, with the expansion of the Federal Reserve's balance sheet and the establishment of new tools to support the market, its role in the market has significantly increased. This corresponds with the rapid growth of the U.S. Treasury market, which has more than doubled in the past decade.

On September 30, the so-called Standing Repo Facility (SRF) saw a withdrawal of $2.6 billion, marking the latest panic since the establishment of this tool in 2021.

This tool allows certain lending institutions to borrow against collateral such as Treasury securities, aimed at alleviating cash shortages in the market that could lead to sudden spikes in short-term interest rates, threatening financial stability. However, two anonymous banking sources and a market expert indicated that there were no liquidity issues that day, and financial pressure indicators were below normal levels.

These individuals stated that the withdrawal of funds highlights a serious structural issue: the size of the U.S. Treasury market has become too large, reaching approximately $28 trillion.

This is a problem that could become more severe. The U.S. fiscal deficit is growing. Earlier this month, a budget-focused think tank estimated that Trump's tax and spending plan would increase the deficit by $7.5 trillion over the next decade, while Harris's plan would add $3.5 trillion to the deficit.

Currently, the Federal Reserve and market participants are proposing various ideas, which will further deepen the Federal Reserve's involvement in the market.

While the smooth operation of the U.S. Treasury market is crucial for global financial stability, the Federal Reserve's increasing participation may have unintended consequences, such as crowding out other investors and creating asset bubbles, similar to what occurred during the COVID-19 pandemic.

Darrell Duffie, a market expert and finance professor at Stanford University, said, “This is a serious problem. We need to redesign the financial system and regulatory framework so that the market can absorb liquidity demands under stress, and we are not there yet.”

The Federal Reserve faces a series of poor choices, cornered by the decisions of fiscal authorities. Former Reserve Bank of India Deputy Governor Viral Acharya stated that this issue is beginning to resemble conditions in emerging markets, “because the deficit is soaring, the borrowing schedule is too aggressive, and there are mismatches—but importantly, there are frictions between private supply and demand for liquidity.”

Acharya, now an economics professor at NYU Stern School of Business, said, “Therefore, the Federal Reserve must simultaneously put out three or four fires.”