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Banking in uncertain times (bitsaboutmoney.com)
386 points by tiniuclx 11 months ago | hide | past | favorite | 366 comments



As a former trading desk guy I struggle to see how the system allows things to be marked-to-cost. Or rather, why is it that we allow a bank to not mark-to-market a security for which there is a liquid market?

Allowing the bank to pretend it has more assets than it actually has seems to be an invitation to hide risk. If they had to MTM their underwater bonds, they would would have been pushed to raise capital earlier, or they would have cut their losses earlier.

It should be straight up "I have these deposit liabilities, I have this book of assets, oops, my assets are down a bit, lets do something about it". Instead of "I'm gonna run the gauntlet and hope the business survives until these bonds come in".


There are liquidity, jurisdiction and tax considerations that go into bond accounting. Under both US GAAP and IFRS you can't flip between held to maturity, available for sale and m2m asset classification advantageously. I think this is ok -- it's impractical and misleading for a bank to value every liability and asset by rebaselining value constantly. How would you determine fair value for a bespoke security anyway? No matter what you did it would be largely guesswork anyway. This change would make banks more difficult to value and increase volatility since performance would be even more heavily driven by market conditions. In my opinion, accounting statements aren't really the right place for the kind of disclosure you're looking for.

The Basel accords are supposed to establish a risk-oriented way of measuring and controlling capital risk limits across asset classes. SVB and other regional banks fought heavily against being subject to this kind of oversight. I think it makes more sense to rework Basel 4 based on this failure rather than change the accounting standards.


Many types of institutions have to mark to market on a ~constant basis, so it's not impossible. Yes there are certain asset classes (private companies, for example) that don't have easy or reliable marks (but people still do it anyway!). But at least for SVB the issue was not determining the market value, but that the market value was bad.


> why is it that we allow a bank to not mark-to-market a security for which there is a liquid market?

Because at maturity, the bank gets back its money. So it is perfectly valid to say "in ten years, this $100m bond is worth $100m...and I intend to hold it for ten years, so it's worth $100m [equivalent] today". The "I intend to hold it" is the relevant part of the valuation, though.


> The "I intend to hold it" is the relevant part of the valuation, though.

Yup, and definitely anticipate there will be major new regulations in this area. A huge part of SVB's book of bonds were categorized as "Hold to Maturity". And, legally, if you mark bonds as HTM, you are not allowed to hedge against their interest rate risk. Basically, the regulations say that if you're hedging against interest rate risk, you don't really intend to hold to maturity, so you need to put them in the "Available for Sale" category.

The fact that SVB had such a huge book of bonds at paltry rates with no/minimal hedging is just awful risk management.


> And, legally, if you mark bonds as HTM, you are not allowed to hedge against their interest rate risk. Basically, the regulations say that if you're hedging against interest rate risk, you don't really intend to hold to maturity, so you need to put them in the "Available for Sale" category.

This seems like an important point that I haven’t seen mentioned elsewhere. Lots of folks have been like “these people are morons they didn’t hedge their crappy bonds.” Can you write more about this?


Well, "these people are morons they didn’t hedge their crappy bonds" is pretty much correct. Here's a good explainer on the topic: https://corporatefinanceinstitute.com/resources/accounting/h... .

But it's not just that they didn't hedge their interest rate risk, it's also that they assumed that their deposit base would continue to stay the same or grow. The problem is that their highly correlated deposit base of tech startups actually all needed to take their money out at the same time when they couldn't get additional funding.

Thus, it's important to understand that banks themselves make the choice of whether a bond goes into the "held to maturity" or "available for sale" bucket. I'm not a bank compliance officer so I don't know the rules about how much they're allowed to put in each bucket, but one problem was that SVB incorrectly estimated how much liquidity they would need because they didn't plan for the risk of their deposits all needing to be drawn down simultaneously.


They went overweight in long duration bonds to get a little more yield. Terrible timing when interest rates were at 1000-year lows, but it kept the bonuses flowing and the stock compensation in the green.


> Yup, and definitely anticipate there will be major new regulations in this area.

It already happened. The new regulation is that the Fed now has a liquidity backstop for banks holding this asset class, using cash loans with a set maximum term against the par value.

Apparently the Fed decided “if we treat it this way for capital adequacy, and we provide liquidity backstops for banks for other asset classes based on how they are valued for capital adequacy, maybe we should do the same thing here, since otherwise adequate capital can easily and suddenly become inadequate.”


This backstop only applies to existing holdings. Banks can't go out today and load up on hold-to-maturity assets and expect the Fed to backstop them tomorrow with loans at par value. Presumably the next step is to regulate HTM holdings so that this won't be necessary again, or else you're creating a moral hazard.


>So it is perfectly valid to say "in ten years, this $100m bond is worth $100m...and I intend to hold it for ten years, so it's worth $100m [equivalent] today".

But that valuation model is not perfectly valid. It's only partially valid under limited scenarios.

As many comments have already pointed out, the issue is the bank has customers with demand deposits. The customers can demand withdrawal of their money anytime -- without advanced notice. In other words, SVB is not a hedge fund that has the customers' deposits contractually locked up for 10 years.

Therefore, the "10 year bond held to maturity" assumption becomes invalid if the bank has to sell them prematurely at distressed discount prices -- to meet liquidity requirements of demand deposits.

You can't use value securities as "mark-to-intended-optimal-future" as an alternative to "mark-to-market" for purposes of insolvency risk calculations.


> But that valuation model is not perfectly valid. It’s only partially valid under limited scenarios.

Its valid under the applicable regulations. However, it is one case where having adequate capital under those rules was not backstopped by available liquidity measures from the Fed.

One thing that seems to be generating less commentary is that, in the wake of the SVB collapse, and virtually simultaneously to the announcement of the systemic risk exception for SVB by the FDIC/Treasury/Fed, the Federal Reserve also announced a generally-available liquidity backstop program for this kind of hold-to-maturity assets.

> You can’t use value securities as “mark-to-intended-optimal-future” as an alternative to “mark-to-market” for purposes of insolvency risk calculations.

To the extent that refers to valuing the class of assets at issue at their par value, and to the extent that that was true last week, its not now.


Exactly. If you have a portfolio of 100% HTM bonds, your income schedule is completely predictable, down to the cent at every moment in time.

But your deposit demand is unpredictable and must be modeled. I don’t think even Taleb would have the scenario of “on Friday, you’ll lose $40b of deposits.” The bank would have had to be sitting on billions of T-bills, which ain’t gonna happen.

It seems like every bank is a tweet away from destruction.


>You can't use value securities as "mark-to-intended-optimal-future" as an alternative to "mark-to-market" for purposes of insolvency risk calculations.

I think this is exactly correct, but I dont think that is the purpose and scenario reported on their financial statements. I think it is fine to report valuation in terms of "mark-to-solvent future", as long as the appropriate data is provided to enable insolvency risk calculations, and the "mark-to-solvent future" model is not presented or confused with a insolvency risk model.

If an investor does not understand how HTM assets are accounted per regulation, but they are accurately reported, confusing the models is an investor error, not a bank reporting error.

My understanding is that banks provide clear reporting, and are transparent with their HTM portfolio.

HTM securities are typically reported as separate noncurrent assets; they have an amortized cost on a company's financial statements.


Welcome to a non-zero interest rate environment. "$100m equivalent today" is not $100m -- the term to search for is "net present value". These considerations are precisely what marking to market captures


> the term to search for is "net present value"

I understand NPV. I'd edit my post to put "$100m equivalent [NPV] today" to makes it clearer what was meant by "equivalent", but it's too late, and that's precisely what I nodded to with "equivalent" -- no need for jargon to get the sense across.

> These considerations are precisely what marking to market captures.

Of course. And they are -- in theory -- exactly what GP seemed to be asking about. Valuing an instrument at its NPV (NOT MTM) is perfectly reasonable...as a starting point. GP was questioning that. As everyone has pointed out, and anyone who's bootstrapped a yield curve or traded bonds (I have) knows, there are a ton of nuance and caveats to this, but the GP was not dealing with those and they are not relevant to GP's primary point/question.


If those assets are in your hold to maturity portfolio, they are still worth $100m. This return is guaranteed unless the Federal Bank defaults on those treasuries.


You're saying that if a bank paid $100m for low-yielding bonds in 2021 which are now worth $80m, those bonds should be valued at $100m on the bank's balance sheet. What if a different bank pays $80m today for the same bonds? Should they be able to show an immediate $20m increase in their book value because those bonds are "worth $100m"?


This thread with NPV is confusing the liquidity issue with the profit of the bond investment. The issue for this bank was not if this was a good or bad investment in the long run (these bonds might very well turn out to be a good investment the day they are paid back on), the issue here is that the bank's customers wanted to withdraw their money and there was not enough liquidity/cash in the bank so they had to sell something and the best/only thing they could sell was the bonds which right now were worth only $80m and the customer wanted their $100m.


The problem is that they are worth $100m if held to maturity (you get your $100m back, ergo their value is $100m if held to maturity), but the current price is $80m, because who wants to buy a bond at 0% when you could get around 5% at the next Treasury auction.


They're worth $80m today, and then maybe $82m next year, $84m the year after, and so on until they're worth $100m at maturity. (Obviously these numbers depend on current and future interest rates, and you'd be earning some interest in the meantime).

As I was trying to point out to the parent commenter, conflating "$100m today" with "$100m at maturity" leads to clear contradictions, like saying that a bank could earn $20m on paper simply by buying bonds trading below par value. Or to put it another way – if bank A holds $100m face value of 10-year bonds yielding 4%, and bank B holds $100m face value of 10-year bonds yielding 2% (but worth, say, $80m at market price), how can you claim that those banks are on equally good footing?

Valuing liquid bonds at par value is pretty clearly a hack to reduce volatility and increase confidence in banks' balance sheets, even if some people in the comments seem to view it as a more logical way of accounting. (Although to be clear, I don't mind companies doing their own fuzzy math as long as they give investors enough information to do proper due diligence. It's similar to the non-GAAP earnings that a lot of tech companies report.)


>As I was trying to point out to the parent commenter, conflating "$100m today" with "$100m at maturity" leads to clear contradictions, like saying that a bank could earn $20m on paper simply by buying bonds trading below par value. Or to put it another way – if bank A holds $100m face value of 10-year bonds yielding 4%, and bank B holds $100m face value of 10-year bonds yielding 2% (but worth, say, $80m at market price), how can you claim that those banks are on equally good footing?

Equal assets should never be thought to mean equal footing. The banks will show the same number for assets locked up for 10 years, but the banks will also show that they have different returns listed on their finalcial statement for the HTM assets, and different revenue from capital!

You cant and shouldnt expect to bank comparison to be easily reduced to a single measure, or for that measure to tell you something that is captured elsewhere.

It is like expecting an athlete's height to tell you something about their speed or strength.

HTM assets tell you the nominal value of assets they are holding to maturity.

It is not intended to show how much they could raise if they had to liquidate it today. It is not intended to show what that yield is for their bonds.

There are separate line items for that.

If you change the valuation of the bonds to market value, then you lose sight of the mature value of those bonds.

Replacing athlete height with athlete BMI tells you something different.


Not only that, but the value could drop even more if an inflationary spiral happens... Bank prime loan rates have been higher than 20% in the past, which means a $100m bond 5 years out could go as low as $33m in value... a 67% haircut!

Clearly, US Treasuries carry risk that's not been accounted for.


> US Treasuries carry risk that's not been accounted for.

US treasury debt is approximately the safest. The risk was that SVB might need cash before the bonds matured. The regulations encouraged SBV to do this. Now the Fed put is re-imagined, and we shuffle on while mumbling 'nobody could have imagined'.


Yes and yes, if they are allocated for HTM.

If you put cash in a a CD with a 1 year lock in, do you list it at current value or subtract a withdraw penalty.

Do you subtract early withdrawal penalties when calculating the balance in your 401k?

At the end of the day, a list of your asset values is not the same as how much you could liquidate those assets for today.

That would be a list of liquidatable assets.

HTM assets are called out separately on the balance sheet specifically to highlight that they cannot be easily liquidated.


> If those assets are in your hold to maturity portfolio, they are still worth $100m.

They are still worth $100m at maturity. $100m in ten years is (usually) worth less than $100m now. Do you really want to pretend that a ten year bond you purchased when inflation and the interest rate were near zero, is worth the same when inflation and the interest rate go up to say 10%? What about inflation of 100%? In nominal terms you’ll get back your capital, but in real terms you will get back only one thousandth.

To correctly value them now you need to calculate the NPV.


In real terms, you will get back exactly a hundred million. In the npv at that date will be exactly 100 million.

$1 after inflation is still $1. It is just that the value of $1 is now different.

As long as you hold to maturity, the number of dollars does not change.

If you report your Holdings in terms of dollars, they are always accurate as long as you hold.

If someone tells you they have $100 maturing in 10 years, it is Trivial for you to do the npv calculation yourself with your speculative model of what inflation will look like over the next 10 years.


> In real terms, you will get back exactly a hundred million.

In nominal terms. In real terms you have to adjust for inflation. [1] is a starting point if you want to read more.

> As long as you hold to maturity, the number of dollars does not change.

A dollar now is not the same as a dollar 10 years from now. [2]

[1] https://en.wikipedia.org/wiki/Real_versus_nominal_value_(eco... [2] https://en.wikipedia.org/wiki/Time_preference


I think we are misaligned on the reference time for the real valuation.

If you buy a 10 year bond today, you will get $100m dollars in 2023.

In 2033, that $100m will have a real value of $100m 2033 dollars on your balance sheet.

HTM assets are reported in the nominal purchase price today, which is also the real dollar value if you calculated it on the day of maturity.

I agree that if you estimated the net present value of $100m 2033 dollars, it would be worth less in terms of 2023 dollars.

This brings us back to your earlier question

>Do you really want to pretend that a ten year bond you purchased when inflation and the interest rate were near zero, is worth the same when inflation and the interest rate go up to say 10%? What about inflation of 100%? In nominal terms you’ll get back your capital, but in real terms you will get back only one thousandth.

YES! This way the asset sheet is always correct in how much you will get for the asset. If you have a $100 nominal bond it is worth $100 dollars. That is true today, and that will be true on the day of maturity. It will be true every day in between. The dollar value of the asset remains constant at the time of reporting.

Why would you want to report the net present value of that asset at maturation - which sounds like what you are suggesting?

The point of listing your bonds on your balance sheet isn't to estimate profit or returns, it is to list your current asset allocation.

You have a separate line item for revenue coming from those bonds. You have a separate model entirely for calculating ROI and profitability.

If you made a spreadsheet of your current asset allocation today, how would you list money locked in a 10 yr CD. As the dollar amount in the account, the value if you were forced to pull it out and pay a penalty, or some time shifted valuation?


> In real terms, you will get back exactly a hundred million. In the npv at that date will be exactly 100 million.

you wrote 'real terms' when you meant 'nominal terms.'

> $1 after inflation is still $1. It is just that the value of $1 is now different.

That is why we distinguish between 'real value' and 'nominal value.'


>> $1 after inflation is still $1. It is just that the value of $1 is now different.

>That is why we distinguish between 'real value' and 'nominal value.'

What will the real value of a $1 bond be on your balance sheet the day it matures? exactly $1


> What will the real value of a $1 bond be on your balance sheet the day it matures? exactly $1

The real value in future-date dollars will be $1. In present-day dollars it is likely to be less, the ability to refer to which distinction is the purpose of the formal difference between nominal and real value.


I agree. The difference between the two converges to zero as your your comparison time frames go to zero.

Initial time for real dollar caluculation can be anything. You can ask what your real dollar salary is relative to 1950, or relative to 1951, or yesterday.

You can ask what was the real dollar salary in 1951 relative to 1950, or 2051 compared to 2050.

While I meant to write real dollars, I wish I wrote nominal, based on how much confusion it caused.

I still stand by the idea that it is silly, and not very useful to put a future return on investment on an asset list in to 2023 dollars using a 10 year inflation projection.

Then the reported asset would fluctuate based on your model, and you already know exactly where it will end on the maturation date.


> Initial time for real dollar caluculation can be anything. You can ask what your real dollar salary is relative to 1950, or relative to 1951, or yesterday.

Regardless of which day's dollars we use as a baseline for comparison, a bond issued under at a lower interest rate is discounted relative to the same bond issued later at a higher interest rate. Quibbling about how we express this valuation suggests you don't understand this difference, but this difference is important to understanding the current day banking crisis.

> While I meant to write real dollars, I wish I wrote nominal, based on how much confusion it caused.

You still seem unaware that these meanings and words are a very well understood convention that you violated. The only confusion was the confusion you had in the meanings you assigned to the words.

> I still stand by the idea that it is silly, and not very useful to put a future return on investment on an asset list in to 2023 dollars using a 10 year inflation projection.

The main thing is that these valuation rules exist for reasons and while we could debate which rules are good etc., understanding the basics of bond valuation and the common terminology we use to discuss them is a minimum prerequisite and I'm still working on getting you on board with the basic terminology every one else is using.

There isn't much discussion to be had without a common vocabulary.


Im fine with your terminology and reference. The current date (or that of reporting) can be the reference time for a real dollar valuation.

I fully understand how bond market prices are impacted by interest rates. What most people seem ignorant of is the fact that bonds are not simply market trades asset, but are also have a value at maturity. Most people don't seem to know that HTM assets are reported separate from securities available for sale, which ARE tracked at market value.

And then there's the even stupider idea that the value of long-term assets should be listed as the maturation date npv, as if you can just look up future inflation rates for the next 10 to 30 years.

It seems obvious to me that if you never intend to sell a bond, the maturity value is a measure of interest.

Do you have anything else to add to the discussion, or was that your only point?


> It seems obvious to me that if you never intend to sell a bond, the maturity value is a measure of interest.

The reason this matters is because in the case of a bank who needs the funds to operate then they very much might need to sell the bonds, or revalue them at NPV because of statutory requirements.

This entire discussion is because the NPV of HTM assets is now relevant.


That doesn't mean it is universally relevant, nor does it mean it is more relevant than the maturity value in the asset table.

Most importantly, Banks already DO report the unrealized losses and Fair market value on HTM securities. Just not in the assists section, but in a dedicated section on the HTM assets. It is not some big secret.

You can even look at it in silicon valley Banks filings if you want(1). They break down the HTM losses and fair market value plain as day starting on page 125.

At the time of filing, they reported a mature value of 91 billion, fair value of 76 million, and unrealized losses of 15 billion. They break it down by the duration of maturity and interest they earn on them. Everything someone could ask for is there.

It seems to me that this whole question of reporting fair market value instead of maturity in the asset table comes from people who have never read a 10-k filing and think there is some conspiracy.

SVBs HTM loss situation should have been no surprise to anyone looking. The real conspiracy is their HTM position was common knowledge.

https://www.sec.gov/Archives/edgar/data/719739/0000719739230...


You can’t calculate NPV. You can only estimate it.

You can value something at its current market value, if the asset is one that has such a thing. And fair market value will generally correspond to what you would estimate to be net present value, plus whatever risk premiums and holding costs and so on that the market is accounting for.


> You can’t calculate NPV. You can only estimate it.

According to Merrian-Webster [1]:

calculate: 1 b: to reckon by exercise of practical judgment : ESTIMATE

[1] https://www.merriam-webster.com/dictionary/calculate


Okay, weird bit of pedantry - pretty sure that if a math test asks you to ‘calculate the product of 127 and 954’ you wouldn’t get many marks for answering ‘about 100,000’, but feel free to staple a copy of the dictionary definition to your exam paper and see if that works for you.

But sure, let me clarify it to: you can’t calculate a precise NPV.

You can only estimate one.

Which, when we are trying to do things like ‘calculate the total assets a bank has’, makes the net present value of their assets a not very reliable number to use.


> Okay, weird bit of pedantry - pretty sure that if a math test asks you to ‘calculate the product of 127 and 954’ you wouldn’t get many marks for answering ‘about 100,000’, but feel free to staple a copy of the dictionary definition to your exam paper and see if that works for you.

I wasn't taking a math test. I was saying something about NPV using a common meaning of an English word. You chose to ascribe a different meaning to that word, and pedantically - and incorrectly - tried to correct me.


$100m future dollars, which are less valuable than present dollars.


$100m future dollars are still still $100m dollars. It is the value of the dollar that is changing, not the number of them that you hold.

The day you are paid, you will still get handed exactly $100m million.

Every day between now and then you will still have exactly $100m in bond holdings. How many cheeseburgers you can buy with that number of dollars may change from day to day, but the number of dollars will not.


You don't need to appeal to cheeseburgers to not want to value 100 future dollars at 100 current dollars, if you can buy 100 future dollars for 80 current dollars, which is essentially what happened when rates rose.

(Someone else is offering 100 future for 80 current because they have a forecast about cheeseburgers, sure. But you don't have to agree with that forecast to take their deal; the deal looks even better for you if you don't agree.)


The whole point of HTM as an asset class is that you dont plan to sell it.

Think of how you would report a non-transferable asset with maturation on your balance sheet?

How would you report savings in a CD with a steep early exit penalty?

Herein lies the difference between a list of assets, and a list of asset liquidation value.


That's hedging against inflation (which is definitely something they should have been doing for long term bonds). Interest rates directly affect the sale price of a bond, and it could have been hedged against, but it wasn't required. They won't do it unless it's required. Banks over 50 billion need to be regulated again (and they should lower it to 10 billion too).


But the entire point of computing current assets is to understand the effects of rapid withdrawals from the bank. If you are trying to predict the future value of the bank or how much money they will make then looking at the value at maturity makes sense. But the regulatory system doesn't (or shouldn't) care about that. The regulatory system should be concerned with estimating and mitigating the risk of sudden bank failure.


I believe this is what various "stress tests" are for. If your bank is a certain size you have to basically do scenario planning for situations like ”what if 25% of your deposits leave overnight and you have to sell securities that you didn't plan to sell?” As I understand the situation, SVB was just under the required size to submit to those stress tests.


There are smaller tests for liquidity, but the specific major stress test that SVB lobbied themselves out of is the DFAST (the Dodd Frank Act Stress Test) and it does not test liquidity. It takes the scenario of an adverse economic situation and comes up with a bunch of hypothetical numbers you might see for major economic variables - “the unemployment rate will be this, the default rate will be that, etc,” - and then banks have to run their books according to those hypothetical numbers and report back what their capital would look like in that situation. If it looks bad, they have to take action to make their capital more secure. Nowhere does it simulate a situation where depositors leave en masse.

There are liquidity tests and SVB was probably failing them (which is probably why the FDIC was paying close attention to them), but that specific test you’ve heard about is not related.


Domestic-focused banks with over $250B in assets need to comply with the Basel III inspired (I think?) LCR of enough high-quality liquid assets to cover 30 bad days of withdrawals. What is the requirement for banks under $250B? Another Q would be, did they sell their extension-risk suffering bond portfolio because those bonds didn't qualify as HQLA? I mean they'd seem to me to be liquid and high-quality just as they were, but any sales would harm their balance sheet right?


to my understanding, they themselves lobbied legislators to put them under that size (by increasing the ceiling).


The original asset threshold over which banks were subject to "enhanced prudential standards" in the 2010 Dodd-Frank bill was $50B. In 2018 the requirement was amended to >$250B in assets, or at the discretion of the Fed for banks over $100B. SVB was reportedly at $210B in assets.


And SVB were one of the banks lobbying for that amendment. At the time they were falling close to the $50B limit themselves.

So they certainly would have known at the time that being subject to the stricter regulations would have hurt their profitability.



Maybe both metrics would be useful. “If we had to sell today, this is our situation. If these bonds are held to maturity, this will be our situation.”

Seems like that would allow an investor to see the state of the bank more clearly.


Definitely. And SVB's financial reporting / balance sheet showed this problem beforehand, AIUI.


The problem, though, is that it's not necessarily 100% up to them whether they'll hold it to maturity, since withdrawals can force them to liquidate it. It seems like they should have a ruling forcing the use of some formula that factors in this possibility.


But why is that valid, if it's trading below par?

In the extreme - obviously you can't buy a call option and say 'I intend to hold this until it's $10 in the money, so it's actually worth (time-adjusted) $10'. What's the difference, besides probabilities of outcomes?


> The "I intend to hold it" is the relevant part of the valuation, though.

It’s really not, at least not mathematically. That intentions play a role is purely an artifact of regulations.


> > relevant

> not mathematically

Agreed. I don't think the GP was asking a mathematical question, so "relevant" meant "to explain why MTM accounting is not the only way".


Let's extend your example - I have a bond that costs $1 today, but is worth $1,000 at maturity - except that maturity is in 1,000 years.

So, can the bank claim it has $1,000 now?


Except the treasury desk is paying 5% to the person who gave you the $100m to buy the bond that is paying you and interest rate of 1%.


I'm surprised no one has already mentioned this series of events:

- Enron used "creative" accounting and mark to something style procedures to create fake valuations

- They go out of business.

- Regulators say, "Hey! Now you need to mark to market always!"

- 2008 happens. Markets for things like CDOs and CDSs dry up almost overnight. At the very least most of the liquidity is gone and spreads get VERY big

- B/c of the above coupled with rules of "you need to mark to market" and "if value falls X% you have to sell", lots of selling happens in low liquidity environments and therefore prices fall more, the downward cycle begins

- Post 2008, people realize that "mark to market, always!" maybe isn't the best idea.

- I would imagine, that's why the Govt is saying "Ok, we will pretend that your assets are worth par value". They don't want to trigger the downward spiral.

It's also interesting to note that the Govt made money on many of the assets they bought in 2008 at well below par value. The implication is that those assets were undervalued when they bought them. Again, I would imagine this is a selling point of the idea "the par value is probably not that bad price to pay for these things now".


> B/c of the above coupled with rules of "you need to mark to market" and "if value falls X% you have to sell", lots of selling happens in low liquidity environments and therefore prices fall more, the downward cycle begins

This is a _good_ thing. We don't want a house of cards that's so fragile as soon as it looks like it it's going to fall down, we pour glue all over it and prop it up with cardboard.

Assets need to fall in value so that the next guy can have a chance to thrive. Some bank collapsing is an opportunity for some of the younger folks to buy up a piece, or leave with a team and a book of customers.

We should have this happen regularly so that it isn't an earthquake each time.


It seems like there are limits, though. Do you really need to contribute to a flash crash [1], or is some longer time period okay?

Not getting triggered by a flash crash seems more robust, and getting triggered by it more fragile? Some of the time, anyway.

[1] https://en.wikipedia.org/wiki/2010_flash_crash


Flash crash came right back and nobody is suggesting settling intraday. But even if you had to check your books monthly, SVB would have had to recognize losses sooner and less catastrophically.


> At the very least most of the liquidity is gone and spreads get VERY big

Isn’t this just a way of saying “nobody wants to pay what I want to pay me?”. Unless it’s actually worthless, there’s a buyer, you just may not like the price.

The liquidity on my used socks is gone and spreads are very BIG. Why yes, I won’t sell for less than what I paid for them new, but it’s the market that’s failed, not my insane pricing demands.


House of cards is bad, but in the mean time consider such hypothetical situations - gov orders you, that you MUST sell a suburban house:

- within next 15 minutes

- within a year

Each time frame will definitely result in different price. All of them will be what market was willing to pay, but prices are somehow still different.

Forced sell does have an impact.


The basic job of a retail bank is to fund long-term loans with short-term deposits. A bank which is doing this optimally is still curiously vulnerable to bank runs. If all short-term deposits decide to redeem at once, that collective decision might render the bank insolvent and incapable of returning deposits at par, because not all long-term loans can be immediately redeemed/sold at par. In the normal course of business, nobody thinks too hard about this. Asking such an institution to MTM (which is intrinsically about immediate redemption/sale value) is asking everyone to document and consider a bank's inability to immediately redeem all depositors. We're doing more of that, which has pros and cons. (Recent MTM disclosures set off the SVB run in advance of a planned SVB equity fundraise.)

Finance is an imaginary staircase that only works until we look down and freak out. We don't document the robustness of the stairs because the stairs aren't real.


> basic job of a retail bank is to fund long-term loans with short-term deposits.

CDs are a thing. Unpopular because their rates sucked but that hasn’t always been the case.

Long-term loans become like short term loans closer to maturity. A mature bank should have a fair amount maturing every year, mortgages 24 or 23 or whatever years ago. Along with some early repayments or reissuances from people moving. Or 4 years ago for a vehicle, etc.


It seems to me (being uneducated in the matter) that if a bank is holding US government debt (treasuries) as "hold to maturity" that the US Government should have some ability to offer a line of credit against those assets for cases like this one was.

Or that the bank should be able to say "depositor X transferred $100 million to Chase, so we sent Chase a wire for $10 million and treasuries marked HTM worth $90 million" or something.


> It seems to me (being uneducated in the matter) that if a bank is holding US government debt (treasuries) as "hold to maturity" that the US Government should have some ability to offer a line of credit against those assets for cases like this one was.

Yes, the Fed basically did this.

See the recently (Sunday) announced "Bank Term Funding Program", which basically says if banks hold securities from the Federal government, the Federal Reserve will accept it as collateral for a loan, the collateral valued at par.

https://www.federalreserve.gov/newsevents/pressreleases/mone...


There is a world of difference between the FDIC offering loans to be paid with interest on securities and forcing other Banks to accept it in lieu of real currency.

The Proposal is closer to the idea that you should be able to pay your cash debt with stock valued at your purchase price, and not at the current market price.

It would mean that a bank that owes another bank $100 could instead pay with Bond currently valued at $50, and then go out on the market and buy two identical new bonds with the money they saved.


You don't even need the government to do it; the thing you're talking about is called repo. A bank agrees to sell high-quality collateral to another bank and then buy it back the next day for a little more (the level of interest paid gives us SOFR: the Secured Overnight Funding Rate).

The repo market is vast and generally massively liquid; trillions of dollars of funding per day.


>Or that the bank should be able to say "depositor X transferred $100 million to Chase, so we sent Chase a wire for $10 million and treasuries marked HTM worth $90 million" or something.

Why? HTM bonds are not cash so they are not interchangeable. This is like if you were forced to accept a 10 year IOU in place of cash from your employer.


Regulations that required banks (directly or indirectly) to buy government bonds should also require the banks to accept interchange of them when needed.

Banks exist at the whim of the gov't, it can require things for stability.


Sure, Governments can do anything they want. They can round people up and put them in gas Chambers. I'm just saying it's a bad idea and don't think the fact that the government can do it has any bearing on if it should do it.

With your proposition, I think it would be a terrible idea and reduce stability. I don't see how letting Banks unload bad assets on each other does anything to help the situation. The Bad Assets just follow the customer wherever they go and some unlucky Bank get stuck with them when the customer converts their cash to something like stocks or buys a cheeseburger.

At best, you have just turned bonds into the same thing as cash, defeating the purpose of bonds to begin with. You buy a bond and are paid interest because you can't use it as cash.

At worst it would be chaos. Everyone buys bonds and holds them when the value is good. When the value is bad, everyone forces each other to take over their bad Investments.


> US Government should have some ability to offer a line of credit against those assets

What is the difference between what you are saying and just buying back the bonds before maturity?

Anyway, governments do usually have all kinds of lines of credit against bonds. And when there is a difference, it's for the benefit of the government.


It would be some form of emergency credit or something similar to the interbank loans, basically doing what they've had to do with FDIC anyway.

Or the bank could have bought TIPS instead, I guess.


> basically doing what they've had to do with FDIC anyway

AFAIK, the thing the FDIC does is confiscate banks. Do they do anything else?


FDIC uses funds from the member banks and backstopped by the government to make depositors whole.

In this case, all depositors with no limit.


The interaction between the FDIC and a problematic bank is simply that the FDIC confiscates it. AFAIK, that's the only one they are allowed to have.

They don't lend money, don't put money in it, don't do anything else. They take the bank for themselves, and then proceed to pay the depositors.


That would fall over as soon as people decided to "Cash out" the United States. Which would be an interesting exercise tbqh. Probably catastrophic, but interesting. If the People went one way, and the Government another. We're most certainly entering Failed State territory at that point.


>Or rather, why is it that we allow a bank to not mark-to-market a security for which there is a liquid market?

I agree with your main point.

You'd have to be careful with regulation around this, because what you might end up with is banks preferentially seeking assets for which there is not a liquid market so they can pretend they are worth more. That's... not an obvious improvement.


As I understand it, banks have some assets that are marked-to-market, and others that are assumed to be held to maturity. Their classification is determined when they are purchased, but there are rules governing the mix.

To some degree this makes sense, because if the maturity timelines and classification are correct the bank is only losing opportunity cost and inflation-adjusted dollars. Not actual dollars.

Meanwhile, if they need money from the fed it is offered against collateral based on mark-to-market value.


> It should be straight up "I have these deposit liabilities, I have this book of assets, oops, my assets are down a bit, lets do something about it". Instead of "I'm gonna run the gauntlet and hope the business survives until these bonds come in".

Have a read of Matt Levine:

https://archive.is/l4nLU

The “let’s do something about it” could actually be business as usual. Look at the “deposit beta” in that article: when interest rates increase, mean rates banks pay on deposits increase less. So you can have a bank with a low mark-to-market value (assume all deposits liquidate at par and securities are sold at mid-market), but that ignores the value of the enterprise itself. Or you can project forward (to a specific time or times, not necessarily to the arbitrary maturity of each security), and you may well find that you end up with enough money at every point in the future to be quite comfortable, assuming your deposits stick around and continue to earn less than market interest.

Imagine you worked at a magic trading desk where you could issue a very special bond: you borrow money right now, and you pay a floating interest rate that is set at 1/2 the federal funds rate. This is a great deal, but it comes with a catch: the bond holder can call the debt at any time, which they will do on occasion at random but will do en masse if they don’t like you. Also, people can lend you money on these terms and you have to accept the deal. How would you make money on these? How would you account for them?

I agree that HTM accounting, done carelessly, can lead to wrong conclusions.


Isn't the short answer that if you made banks be flat interest rate delta, it would be impossible to make money as a bank - and therefore there would be no banks?

If a bank that makes a mortgage loan has to buy an interest rate swap that zeros out the interest rate risk on that loan, then the replicating portfolio is basically ... nothing ... right?

Banks have to be long duration risk to be useful.


Banks would charge fees for services.


> As a former trading desk guy I struggle to see how the system allows things to be marked-to-cost. Or rather, why is it that we allow a bank to not mark-to-market a security for which there is a liquid market?

Many of their assets aren't really fungible either. Mortgages are the canonical example: yes they can now be turned into MBS, but your local credit union just issues and holds them). The same is true of the commercial loan to the local stationary business. As far as I know those aren't bundleable into commercial paper securities. The debtors do the same: they don't treat their loan as having any market value at all beyond what it had when issued. House prices generally don't mark to market except in places with property tax assessment.


> your local credit union just issues and holds them [mortgages]

I was on BoD of a CU. About the only thing we didn't resell were loans which did not conform. The business was to originate, quickly resell, and do some more.


Thanks for this info!


There is a massive conflation of insolvency and illiquidity going on here, because the distinction requires more mathematical finesse than most people have.

A bank is illiquid if its holdings require time to sell at "market price". Selling things like mortgages requires time because the buyer has to perform due diligence. If i have to sell mortgages right now, I'm going to be getting an awful price for them.

OTOH, i can sell treasuries in a fraction of a second at the ask price minus epsilon. It's not a liquidity problem, its an assets < liabilities problem, (as you clearly state, I'm just frustrated by the discussion here).


So in a downturn all of the banks would just seem insolvent.

What is the alternative ? To have the banks trading on a millisecond basis so that the mark to market value of assets is positive ? What about the transaction fees ?


You just know that all the losing trades went from the hold-to-sell-for-a-profit book to the hold-to-maturity book.

In the olde days that was the bottom drawer where you would stuff the losing tickets at the end of the day and hope that they were in the money tomorrow.


The answer is simple of course, which is why no one does anything; the political and finance systems are in cahoots to enrich themselves and so such common sense policing to insure the stability of the system everyone relies on is not allowed.

Finance crimes are low tech and have not evolved much as they don’t need to; there’s no policing.

Have a go at it, elites scream communism and the like, and rile up the 2nd Amendment fan boys, only to throw the ones that go over the line in jail to keep up appearances.

I’ve been noting and watching this same social ebb and flow since the 80s. The kids/teens then who soaked that reality up live it still today. IMO memory is why we had a mini-Reagan in Trump grow so popular.

The reason such things you point out are allowed is they’ve always been allowed from the perspective of those benefiting from them. If the system was stable and accountable to the masses, the phony winners rich off mathematical inference but too inept to keep themselves alive would of course be subject to a terrible regime should elites be required to pull on their boot straps; a figurative identity of being coddled is all they know!


You know as well as I that the reason is that cash was able to sit in banks without losing money as a depositor. That gentleman's agreement is gone, due a set of actors' individualistic and uncooperative actions.


I highly recommend watching Mark Meldrums video from yesterday that answers your question.


Talking about the detail is wasting the effort when the problem is located at higher level, which is, the whole system is built in a socialism territory, started when Gold is by planning (major element of socialism), taken away from banking industry.


"This was complicated by some banks finding it surprisingly difficult to add numbers quickly… We have a report of Friday outflows, but it gets crunched by an ETL job which only finishes halfway through Saturday, and Cindy who understands all of this is on vacation, and… and eventually very serious people said Figure Addition The #*(%#( Out And Call Me Back Soonest"

As someone who has written ETL jobs for banks, this hits home.


I thought financial companies had regulations against bottlenecks like that? Something like, every employee has to have their access turned off for one uninterrupted week, to ensure they didn't leave something in that depends on them or they're controlling a (fraudulent) process no one else knows about?


Yes, the week (two weeks, IME) is a thing. As are contractor term limits. They reduce key man risk and keep knowledge internal. Still, it's possible to write a script to do something and then just not touch it for years. It keeps chugging away, and the mental model of how it works is lost to time or employee churn, and nothing goes wrong enough that anyone has to dig in and really understand it again.


Also doesn’t help when they never documented a thing and nobody cracked down on that because “it would slow down their unit’s productivity”.


Not gonna lie, I feel like I've been reading this like a Rudin book, going back and over each paragraph again.

This is probably the companion report to have on hand while reading:

https://www.fdic.gov/analysis/quarterly-banking-profile/inde...

In particular

* Chart 8. Number and Assets of Banks on the "Problem Bank List"

* (Chart 13.) Unrealized Gains (Losses) on Investment Securities

Sadly, "Results are published approximately 55 days after the end of each quarter (i.e., 55 days after March 31, June 30, September 30, and December 31)." So there's nothing super new. Bit it strikes me that Chart 13 is going bonkers on unrealized losses, but Chart 8 isn't quite matching the same (assets in problem banks, and # of problem banks is going down since rate hikes??).

Really wanna see that number for 2023Q1. But the quote

> about a quarter of all equity in the banking sector has been vaporized by one line item.

Struck me as pretty wild.


Read this all the way to the disclaimers at the bottom. It's just a fantastic piece of writing, digging deep into some of the unseen structures that underlie our society.

I'm not close enough to the banking system to judge the truth of it, but it was beautiful.

PS If you are on email lists, make sure to respond occasionally to the author. It's hard out there and they are shouting into the void. If a piece makes you smile/think/learn, tell them!


It seems to avoid discussing a rather basic issue, which is that as Fed interest rates rose, the interest rates on deposits (i.e. individual savings accounts) did not increase at all due to bank executives wanting to harvest more of that pie for themselves. Hence people seem to have an incentive to move money out of banks and into money market accounts that were giving much higher returns on those deposits.

The history here is illuminating: (Jan 1 2023)

> "During the 1980s, savings rates climbed as high as 8%. Deregulation caused deposit interest rates to stay higher than financial institutions could sustainably support, which contributed to banking failures during that decade. In the 1990s, savings account rates decreased significantly, typically sitting between 4% and 5%. The 2000s kicked off with a recession, and savings rates fell to between 1% and 2%. Following the financial crisis of 2008, savings account interest rates fell to historic lows—below 0.25%."

https://www.forbes.com/advisor/banking/savings/history-of-sa...

See also: https://twitter.com/biancoresearch


It's not discussed here, but banks probably couldn't increase their interest rates to be competitive with money market accounts etc because the whole root cause of the problem is that their deposits were backed up with long-term fixed interest rate bonds that paid substantially below the rate that someone could get by buying a bond now, and therefore below the return on money market accounts etc. How bad of a problem this is depends on how sensitive to interest rates the banks' customers actually are.


It avoids discussing it because neither SVB nor most other banks offered their customers interest rate increases.


“ as Fed interest rates rose, the interest rates on deposits (i.e. individual savings accounts) did not increase at all”

Very true

“due to bank executives wanting to harvest more of that pie for themselves.”

Eh, needlessly inflammatory and does not get at the real issue, although it is undoubtedly true that banks profited by not raising deposit interest rates. Banks could not safely raise deposit interest rates because large parts of those deposits were locked into investments in fixed-rate financial instruments.


First, the article is a great explanation of what's going on. "Maturity Transformation" explains the cause. "Trying to forestall a banking crisis" is a great discussion of the important next stage of the non-headline-grabbing solution.

Just wondering about this "desert" word, in context:

> I am very frustrated by political arguments about desert, which start with an enemies list and celebrate when the enemies suffer misfortune for their sins like using the banking system.

Anyone know what "desert" refers to?


A deserving; that which makes one deserving of reward or punishment; merit or demerit; good conferred, or evil inflicted, which merits an equivalent return: as, to reward or punish men according to their deserts.

"Just deserts" is a common phrase that uses it in the same way.


Oh wow. I (non-native) never realized it only had one s, I always assumed it was "just desserts", as in, you are getting the dessert you deserve, after the food (the evil you did) :D


If I was on Who Wants to be a Millionaire, I would've picked "just desserts" as my final answer without hesitation. TIL


I (native) also did not realize this.


Native English speaker here too.

TWL (Today We Learned)

I always assumed it was one one of those odd manglings that gained traction, like irregardless.


Apparently it's spelled "deserts" and pronounced "desserts"

https://www.merriam-webster.com/words-at-play/just-deserts-o...


Yes. That's why people think it's "desserts."


> > > > I am very frustrated by political arguments about desert

> > > What does "desert" mean here

> A deserving [...] merit

Thanks. As a native speaker aware of "desert"'s multiple meanings and "just deserts", I think "merit", "deservedness", "appropriateness" would have been much clearer choices here. Perhaps the jarring note alone (of "desert" in this context) should have clued me in that an unusual usage was in play. Thanks again for the clarification.


desert i don't think means deserving. It comes from the latin desertus which means to "make barren or empty/forsake". I think in this context it means to have something fail or be abandoned at a critical moment.


The person you’re replying to is correct - “desert” is in some contexts an old word that’s pronounced like “dessert” but spelled with one “s” that means “the punishment that one deserves”.

https://www.merriam-webster.com/words-at-play/just-deserts-o...


Also, "desert" as the present tense of "deserted". As in "All my friends have deserted me." Or, "The Sgt. Major punished the deserter."



Per Merriam-Webster, which for the benefit of international HNers I will mention is a well-known English dictionary: “the quality or fact of meriting reward or punishment”


This seems like a good opportunity to plug the American Heritage Dictionary, which in my experience is at least a couple notches better than Merriam-Webster despite their website being stuck in 1999 (maybe that's a good thing?)

https://ahdictionary.com/word/search.html?q=desert

de·sert (dĭ-zûrt)

n.

1. (often "deserts") Something that is deserved or merited, especially a punishment: They got their just deserts when the scheme was finally uncovered.

2. The state or fact of deserving reward or punishment.


Also a good opportunity to plug Webster's original English dictionary, which has a lot of very florid and evocative definitions that make it much more fun to open a dictionary https://webstersdictionary1828.com/Dictionary/desert

> DESERT, noun > > 1. A deserving; that which gives a right to reward or demands, or which renders liable to punishment; merit or demerit; that which entitles to a recompense of equal to the offense; good conferred, or evil done, which merits an equivalent return. A wise legislature will reward or punish men according to their deserts. > > 2. That which is deserved; reward or punishment merited. In a future life, every man will receive his desert

S/o to https://jsomers.net/blog/dictionary for opening my eyes here


I think it's interesting that their treatment of singular they is more thorough than Merriam-Webster's, manages to address people on the dissenting side with some empathy, and still recognizes that its widespread usage[0] means it would be silly to not include that usage.

https://ahdictionary.com/word/search.html?q=they

[0] To the point that even people complaining about it use singular they in their complaints without realizing it.


It should refer to "desert" as in "to deserve". Desert arguments typically ascribe a certain sort of moral responsibility on certain persons and them being liable to negative consequences in light of that ascription.


"desert" means something one deserves. You probably know it in the idiom "just deserts".


Ha! I just learnt something new. Always thought it was desserts with two S's, but seems that my version is a pun that is slipping into general usage: https://blog.oup.com/2007/07/eggcorn/


I knew the idiom, I just didn’t make the connection for some reason. Very interesting, the text is very close, but I didn’t get it.


I believe this is a British person saying “during dessert”?


Nope, guess not.


So, I'm a layman here, but I feel like he makes narrow banking (i.e. full-reserve or maturity-matched banking) sound more dangerous than it probably is, for instance:

> Take an exploding mortgage, the only way to finance homes in a dystopian alternate universe. It’s like the mortgages you are familiar with, except it is callable on demand by the bank. If you get the call and can’t repay the mortgage by the close of the day, you lose your house. What did you do wrong to make the mortgage explode? Literally nothing; exploding mortgages just explode sometimes. Keeps you on your toes.

It sounds to me like this could simply be solved with mortgage insurance. Granted, that insurance might be more expensive than it is now, but when a mortgage explodes you end up owning your house outright. Seems like not a bad deal. To reduce their risk (and consequently the cost of the insurance) the insurer would probably take on responsibility for finding alternate lending in the case of the loan being called, and the home owner would never hear about it until after the new lending was secured.

I'm sure there would be other problems, but it is not at all clear to me that those problems are worse than the ones we have now.


An exploding mortgage wrapped in mortgage insurance has exactly the same shape as a conventional mortgage from a fractional reserve bank. The insurer would be doing something like “fractional reserve insurance”, i.e. only holding some fraction of the total insurance payout it’s liable for, and you’d have the same problems. If you legislate that insurers can’t do fractional reserve insuring, the cost of insurance would go up so high that the only people who could afford insurance are people who could plausibly afford to buy the house outright.

The reason “fractional reserves” keep creeping back in whenever you try to offer mortgages to more than just rich people is because fractional reserves are a way to invent money out of thin air, and you have to invent money out of thin air because the not-rich people buying the houses do not have the money to afford the house (but they can make that money if they focus on it for 10 or 20 or 30 years).

You often see people demand to know why banks are allowed to do fractional reserve banking. And this is the reason: it lets banks offer mortgages and credit cards to most of the public. Most people don’t have much money, but do have a lot of future earnings. Giving people access today to large chunks of their future earnings is a big social good but it fundamentally requires money to be invented from thin air, and that invented money is then gradually filled in with real money over time as the earnings come in.

So somebody somewhere has to be inventing trillions of dollars. This is risky. The capitalist way is to have private entities who profit when they manage their risk well, since that provides the strongest incentives for competency. And the democratic-capitalist way is to heavily regulate those private entities, eating some portion of their profit to provide some extra value to the public.


You raise some interesting points. Let me see if I can address them.

> An exploding mortgage wrapped in mortgage insurance has exactly the same shape as a conventional mortgage from a fractional reserve bank. The insurer would be doing something like “fractional reserve insurance”, i.e. only holding some fraction of the total insurance payout it’s liable for, and you’d have the same problems.

They are similar in that in both cases we have an institution that may not be able to pay its obligations. Those kinds of risks will always be present in society. However, I do think that the shape of these risks are different in important ways.

First, in the full-reserve scenario, no money is being invented out of thin air. Insurance is a risk pooling scheme, that is it.

Second In a fractional-reserve system, bank runs are self-fulfilling prophesies, because the game-theoretic optimal move in the event of a bank run (or a reported bank run) is to run on the bank! Because no other conditions are necessary for a bank run (other than a widespread belief that one is happening) a bank run can literally be memed into existence. I believe that, to a certain extent, the functioning of a fractional reserve system relies on the general public being ignorant of how it actually works.

I don't think insurance acts like that. You can't make an insurance claim just because other people are doing it: you have to actually have a qualifying event. It also doesn't seem reasonable to assume that calling of the mortgage loans would start spreading just because of a rumor - there would have to be some other cause.

> You often see people demand to know why banks are allowed to do fractional reserve banking. And this is the reason: it lets banks offer mortgages and credit cards to most of the public. Most people don’t have much money, but do have a lot of future earnings. Giving people access today to large chunks of their future earnings is a big social good but it fundamentally requires money to be invented from thin air, and that invented money is then gradually filled in with real money over time as the earnings come in.

I think lending is an essential economic service, but I don't think the easy credit enabled by inventing money is a good thing. At a macro level, there are arguably all sorts of market distortions caused by too much money chasing too little "stuff" to invest in. At a micro-level, easy credit plus inflation incentivizes bad habits of spending money for instant gratification and discourages prudent saving and financial preparedness for most people.a instant gratification of spending more money noa instant gratification of spending more money no


> The losses banks have taken on their assets are real. They already happened. They are survivable if banks remain liquid.

But… they aren’t real yet? They haven’t been realized. If held to maturity they will be paid back in full.

Which I know the author is fully aware of. So I don’t understand this point.

> I would suggest one has at least one backup financial institution. If one hypothetically does not, I would observe that opening bank accounts rounds to free. Thousands of perfectly good financial institutions exist.

Some people have investment accounts with brokerages like Fidelity or Schwab. Many brokerages (including the two mentioned) offer cash management accounts. They offer deposit insurance similar to FDIC and will give you tools similar to checking accounts. Debit cards, checks, bill pay, etc.

They can be excellent backup accounts that don’t add the additional overhead (however small) of yet another company to deal with.


> > The losses banks have taken on their assets are real. They already happened. They are survivable if banks remain liquid.

> But… they aren’t real yet? [...] So I don’t understand this point.

If people withdraw their deposits, the bank will have to deliver the money somehow...by selling the assets that have lost money. So the point is that although, if nobody withdraws, the losses are survivable, if enough people withdraw, the losses are not survivable. As soon as depositors realise this situation, they will withdraw their money. So that's the problem.


Yes, if the bonds must be sold to cover withdrawals then the losses become realized (real) at that point. But not before.


From all the information I've gathered, there is an unstated aspect to this.

If any number of HTM bonds are sold to cover withdrawals, then all of them must be revalued and losses realised on the whole lot.


What. That’s insane. Essentially, if your deposit modeling is off just a little bit, you’re dead.


I'll turn that around: if as a bank your risk modeling does not account for outlier events, you're dead. Because the way banks and bank accounts are used these days (eg. payroll providers), the society is not willing to accept the second-order effects. As OP's example, a payroll provider was using SVB as their bank to hold funds in transit in order to make payments to third parties. Result?

    Every regulator sees the world through a lens that was painstakingly crafted over decades. The FDIC institutionally looks at this fact pattern and sees this as a single depositor over the insured deposit limit. It does not see 300,000 bounced paychecks.
But back to your point. Banks are over collateralised. Let's take an example from just this week. Credit Suisse is in trouble - their collateral has gone from ~170% to ~150% - they have the collateral to cover their total deposits, but they don't have nearly enough of them as liquid assets to cover the increased outflows.

Until last week I didn't know about HTM ("hold to maturity") and AFS ("available for sale") categories. I have since been educated.


> But… they aren’t real yet?

Barring something extremely abnormal happening, aren't low-yield bonds seeing real losses already due to inflation?

Like it doesn't have to be the spot price we're talking about, aren't many of them toxic already and others expected to track there?


> aren't low-yield bonds seeing real losses already due to inflation?

But bank deposits aren't in inflation adjusted dollars.


This is true, but there can be a lot of slight of hand when talking about dollars and future dollars.

Banks run on nominal dollars, and SVB would have remained capitalized if withdrawals hadn't overwhelmed their ability to get ready cash, which caused them to sell at a loss, which spooked everyone, causing a run.


Right, but if they're expected to be toxic you would mark them down nominally as well. It's not like the real losses aren't also nominal when realized.

And whether the metric you care about is the real losses or the expected nominal value at maturity depends on whether inflation continues to raise. As this also suggests interest rates increase, you get hammered on both sides.


No, because they still are with the same number of dollars, it it just that the dollar itself is worth less that it was.

If you say you have $100 worth of bonds, this is accurate at all points of time you hold it. What you can buy with $100 may be changing from year to year.


There is allot of financial illiteracy regarding the banking system. For example, heard an NPR reporter this morning talking about a bank not having money to loan because of depositors fleeing. These are vestiges of the Gold standard. There is no loanable funds market. That is, the funding for loans does not come from deposits. It comes from thin air. Banks create loans which then become deposits. So called "Bank Money" . In order to create loans and stay in the lending business, banks are required to have certain levels of capital.

* The Fed has control of quantity of money . No. The Fed controls the direction of interest rates via interest rate policy or simply put the Fed determines the price of money.


This is a very popular but false 'take the gist of it as true' misunderstanding.

Yes, banks do "create" money. No, it is not out of thin air. It absolutely does come from deposits.

An example of how banks "create" money, is person A has $100. A deposits it. The bank lends that $100 to B. Now B has $100, but A also still thinks they have $100, even though they just have a number on a piece of paper.

They system goes from acting as if $100 exists, to acting as if $200 exists, but really there is only $100, and an IOU for $100.

That is what bank money "creation" is. It is not from thin air.

People get confused because "money", as in fiat currency, is also a Government IOU. But the above principle is true for gold, bitcoin, or any asset, and they wouldn't get mixed up the same way thinking banks create gold out of thin air.

It is a starkly different thing than how the Government creates money.


There is not a dependency on deposits in order create loans. This is false. Banks can make loans to the extend of demand for loans at the banks terms. Deposits have nothing to do with it in terms of funding. The bank must be in compliance with capital requirements and reserve requirement in order to be in the federal reserve system . As Mosler says (founder of MMT) The loan guy does not call the deposit guy at the bank before making a loan.


I went in search of the capital requirements, just to get a feel for what limits do exist--since they're no longer directly connected to deposits. I found them: https://www.ecfr.gov/current/title-12/chapter-I/part-3/subpa...

But then my eyes glazed over and I remembered that I am not proficient in this language. Presumably the following requirements do place some limits on how much money they can have created?

> A common equity tier 1 capital ratio of 4.5 percent.

> A tier 1 capital ratio of 6 percent.

> A total capital ratio of 8 percent.

> A leverage ratio of 4 percent.


Every time a good loan is made. Thats an asset for the bank.


The loan guy absolutely does need to make sure the bank has the cash to make the loan. You can't loan more money than you have. What happens when B goes to withdraw it from the bank to buy a car or house if it isn't there?

If banks can loan more than they have by say borrowing the money at a lower rate than they lend it, that invalidates your basic premise of banks creating money. They wouldn't have created it, they would have borrowed it.


see my other reply on the balance sheet operations above.


There are many problems with your understanding, but the simplest total failure of your model is that if the bank did just get the money from somewhere else to lend, it is not creating it.

You are not describing the bank "creating" money, which they actually do as per how I described. You are describing the bank borrowing money.


I disagree . And language can get tricky here. You don't need deposit amounts in order to make loans. There is a bunch of gymnastics under the hood of the transaction I described but none of it requires consumer deposits.


You start a bank, I come to take out a loan and I want it in cash since I am buying a used car this afternoon. You have no cash since you said you don't need it, are just going to create it. Where does the cash come from? If you get it somewhere else, like the FED, you clearly aren't creating it, the FED is, right?

If you need to involve the FED (which you don't as per how I described) then the FED creates the money, not the banks. This invalidates your entire premise.


Moving the goal posts. Loans are contracts that create deposits. What you do with your deposit is a separate operation.


Additionally, if you take my example above and change bank B to bank A which is completely feasible in the real world, then it is thin air.


Weird, and I thought fractional reserve banking was a thing.

https://en.m.wikipedia.org/wiki/Fractional-reserve_banking


It is (was) a thing, the idea works exactly the same way. Person A deposits $100, bank lends $90 to B, $10 goes to reserve (if 10% reserve rate). System thinks there is $190 instead of $100, so money is "created".

As of 2020 in the US the reserve rate is 0%: https://www.federalreserve.gov/monetarypolicy/reservereq.htm


Person A does not need to make a deposit to fund load for Person B. If bank is in compliance they can make the loan.


> There is allot of financial illiteracy regarding the banking system.

And nor does the balance sheet become inexplicably unbalanced. It issues bills, a liability, which will cancel out as an asset unless it sells them, or takes a value from it's balance sheet capital, or gets interbank funding (which still balances, because that's another bank's asset).

You're not wrong a bank can fund it's lending, indeed there's that often cited BoE paper all about it, but that funding doesn't come from thin air.


The accounting is like this. Bank A is in compliance for the current period of time under examination (capital requirments and reserve requirements). Bank A makes a loan L1 to person B. This is a contract. Bank A has an asset in L1 on its balance sheet(this improves its capital ratio) and person B has L1 on her balance sheet as a liability. Person B makes a deposit of L1 amount into Bank B. Bank B has a liability of L1. Person B has an asset of L1 which is her deposit which she owns. Finally, Bank A makes a reserve payment to Bank B of L1. These reserves come out of the reserve account that each bank has at the Fed. The reserves maybe borrowed in the Federal Funds market on demand so long as the bank is in compliance.


I just don't get this about the system in the US.

If you keep creating money out of thin air — which as per my admittedly naive understanding is equivalent to just printing money without giving back anything in return — wouldn't it ultimately lead to a collapse or a hyper inflation? Like it did in Venezuela a few years ago (???).

Why is the US seemingly immune to this kind of thing?


Because:

1) taxation destroys money.

2) new money can be absorbed by economic growth. Imagine you have $100 in an economy and 100 apples. $100 is added, so there’s $200/100 apples. Inflation might occur. But if you make 100 more apples, so there’s $200/200 apples, the ratio of money to goods didn’t change, and you wouldn’t get inflation. That’s an extremely contrived example, but it gets the point across.

Considering both of those factors, I hope it’s understandable that printing money doesn’t necessarily cause inflation.


100% . Exactly and if "money" lands in the accounts of agents (people, businesses) who do not spend it, its not inflationary. If I have 10 trillion dollars in my account, but I do not use it. Its not inflationary. This is called a demand leakage. Savings is a demand leakage. Counterintuitive.


Even in this example where inflation doesn’t occur, consumers will never benefit from the productivity gains that allowed producers to make more apples. Something clearly changed that allowed more apples to be produced. Maybe a significant amount of capital was invested in more machines, or a new, faster growing cultivar of apple was developed. In any case, the entire benefit of the free market economy is that competition creates an arm race for better products at lower prices. When the central bank steps in and creates a bunch of new money, it destroys any benefit of increasing productivity, since apples with always be $1, regardless of whether 100 are produced or 1,000.


Sure, that's why no consumers have ever benefited from any productivity gains ever...

Central banks don't fix the price of apples. They simply make it possible/easier for cultivators of apples to obtain capital to invest in more machines or developing new cultivars of apples. The alternative is that cultivators have to try to find the capital by borrowing more expensively from a fixed supply of stored wealth. From the point of view of people holding the stored wealth, the arms race for better products at lower prices becomes a zero sum game where it's a winning move not to just hold onto the cash and let other people take the risks. Unsurprisingly, this does not benefit consumers, or the productive.


Yes, this is an important point: it matters how new money is created. $100 isn’t created and given to everyone. It’s created and given to the apple producers to make more apples. This is government spending.


Central Banks allow us to pay each other and regulate banks to operate in the best interest of the economy by making 'good' loans. You are describing a gold standard or fixed monetary system. These systems have lead to deflationary collapses time and again. Without getting off of the gold standard as it was defined we would have never funded WW2 which was the larges money printing event in US history equating to 22% of GDP in government deficits.


Hence the new budget designed to tax everyone to the gills. The fed and the government is coming to terms with the fact that they can't magically conjure up growth.


See WW2 for insight.


The money is mostly created as debt, with the obligation to repay more money. So it's not "not giving anything back in return".

A company wants some money to fund business expansion. So it borrows $1m with a promise to pay $1.06m back, which it can fund because it has customers. The bank in turn can fund this by borrowing $1m and promising to pay back $1.03m (when lending activity increases this money comes from the Fed, albeit normally indirectly via its bond market activity). It's not free money for the business: if they don't sell enough stuff they go bankrupt. It's not free money for the bank: if enough of it's customers don't pay they also get bankrupt. So the money created is based on market participants believing that the additional money will result in additional economic activity

Additionally, you've got the Fed actively intervening on a day-to-day basis to fix that base interest rate for borrowing and on a month-to-month basis to increase it if it thinks people are borrowing too much and prices are going up too fast


Banks in compliance can create loans on demand. They don't need to borrow the funds.


Yes in normal circumstances they won't need to immediately borrow the full outstanding amount of the loan to convert it to cash, but the fact they can borrow £1m in reserves at that rate to the extent capital weighting rules or withdrawal demands require it is critical to why the £1m credit they add in the borrower's account is treated as money by other banks and their customers. As is the detail that the bank's profit is only the difference between the interest rate paid by the business and the bank: the bit they create "from thin air" isn't their asset, it's a liability they may be required to borrow to pay some other bank or customer.


If the bank that creates the loan and subsequent deposit is the same bank, then its like creating money out of thin air, as they would be responsible for the reserve requirement imposed on them by that deposit. Reserve requirements can be zero and usually don't have to be met until the next accounting period. So there are not funding constraints on making loans.


I never argued there were funding constraints on making loans (there are capital constraints, but they're fuzzier). But the deposit is the bank's liability, not its asset (unlike, say, an organization having the ability to mint coins or cryptotokens for its own use from thin air; much more like Amazon's ability to create as many $10 vouchers as it wants, provided it's got a way of paying its vendors when people try to spend the vouchers). The only reason anybody else treats the increased number in the customer's bank account as "money" equivalent to cash is that the bank can borrow currency if and when it needs it (and remain solvent because eventually the customer will pay the bank back)


Yeah. Sounds good. The bank needs reserves, order federal money, base, or inside money(call it what you want) to meet deposit liabilities when they are called such as when the deposit owner writes a check to another bank or when funds are withdrawn for cash.


Makes sense. Thanks!


>Why is the US seemingly immune to this kind of thing?

See https://en.wikipedia.org/wiki/List_of_countries_by_military_...

Not trying to be a low-effort reply but any Economy 101 textbook will theorize that it's impossible. Practically, the world is too dependent on the USD in one way or another. If they try to break loose, they might get confronted with those military expenditures which is a good enough incentive to keep using USD as a global reserve currency.


No, really, this argument is even worse ignorance than the gold standard stuff, because it isn't true even as an oversimplification or historical detail.

The difference between Venezuela and any relatively stable country (the US is one of many, some of which have tiny armies and pacifist foreign policies) isn't military spending or reserve currency status, it's that the money in the country with the stable currency is created as a debt which the borrower and bank has to be repay in future (with the central bank also intervening if it thinks too many borrowers and banks are taking on debts) whereas the money in places like Venezuela is being created to pay off debts.


>which the borrower and bank has to be repay in future

And when do you expect this debt to be repaid back? If you cycle all the way back, at some point the money is created out of thin air backed by nothing but believe that the US will not default. It's not ignorance but reality that as long as you are the strongest arm in the room nobody is going to challenge you into paying back your debts. Yes, on paper it's all economically sound and "basic accounting" but the reality of the situation is that if America would not be able to defend its position as "stable country", nobody would accept their debt denoted in the currency they create themselves.


> And when do you expect this debt to be repaid back?

According to the terms of the loan or repo or maturity date of the bond. The money isn't "backed by nothing" it's backed by the productive capacity of an economy, and virtually all of it is created by market demand for credit, not the demand of the US government.

> It's not ignorance but reality that as long as you are the strongest arm in the room nobody is going to challenge you into paying back your debts.

It's absolutely ignorance to base your arguments about how a monetary system works on the assumption that the US is the only country in the world with a stable currency and modern central banking. The majority of the developed world is not "the strongest arm in the room" and people happily use those countries' currency and buy up their domestic-currency-denominated sovereign debt without any worries about hyperinflation or their military.

The military is of significance only to the extent that the dollar wouldn't be worth very much if the US was on the verge of being annexed by Mexico, but Venezuela has a military that prevents it from being annexed by Colombia too, and its military spending in excess of its productivity is still a cause of rather than a solution to its problems


There’s over-confidence espoused by economists, the idea that we can measure inflation with any kind of precision is challenging, never mind building on top of this shaky foundation that there are behaviours which regardless of circumstance will lead to a given outcome such as hyper inflation.

This is not to say that hyper inflation isnt a severe risk, it is. it’s to say that the mechanisms through which it’s created or avoided are not well understood nor proven.


In US the fed determines how much money is printed. The EU, UK, Japan, Switzerland, and China have similar central banks. Most countries do, but those are some major players (I left some out). Basically, if you print the right amount of money, it works. So they get smart Econ experts to guess how much money to print. And as long as they get close enough it doesn't cause hyperinflation.


This isn’t an accurate description of the mechanics of money printing in the US, the UK or the EU.


Interpreting "printing money" to replace the more technical "controlling the size of the monetary base[1]" seems reasonable. How is that incorrect?

Unless you're talking about literal printing press operations, "the fed tries to tweak the money supply to control inflation as one of its dual mandates" seems like an absolute correct, if simple, explanation of why we don't have hyperinflation.

(I know tone is hard to convey. I am serious about learning if I have a misunderstanding)

[1] https://www.stlouisfed.org/on-the-economy/2018/july/federal-...


>> Interpreting "printing money" to replace the more technical "controlling the size of the monetary base[1]"

These are different things.

Printed money is cash (or currency) and it represents a small amount of the total money in use, just under 3% in the UK. I don't have the figure to hand for the US but it's comparable, less than an order of magnitude difference. Printing money isn't a significant driver of the size of the monetary base, currency is (more or less) printed to replace the notes & coins that are guessed to have been lost or damaged. Talk about printing money, especially as a means to expand the monetary base, is usually misguided.

The monetary base consists of currency in circulation + reserve balances.

Reserve balances in the US, since March 2020 (Fed reserve requirements changed to 0%), refers only to the balance recorded in the account at the central bank for a given commerical bank (or other approved user of reserves). Reserves are money but they're a special kind of money that can't be spent in the economy. They're only usable by the central bank and institutions who are licenced to hold reserves at the central bank (predominantly commercial banks). They're not phyiscal (reserves used to include actual cash in the vault back when there were reserve requirements). Reserves, like most money today, just exist as rows in a DB on a computer.

There's an unlimited supply of reserves available to commercial banks (via the discount window), they are created on demand as needed from nothing by the central bank and charged at the discount rate in unlimited supply. A commercial bank today cannot run out of reserves.

>> the fed tries to tweak the money supply

The fed doesn't control much of the money supply, most of our money is created as commercial banks issue new loans. There's a common misunderstanding that commercial banks operate as intermediaries lending deposits, but they don't.


I am skipping the digression about whether "printing money" should taken literally to mean the actions of the actions of the Mint/Bureau of Engraving as opposed to the controlling the monetary base.

The Fed both controls the rate that commercial banks are charged (via the discount rate, or other rates based on it) to access the discount window and the rules for doing so. Infinite reserves[1] that charge interest when used aren't infinite. They explicitly have to be used to generate more value than the repayment with interest or the banks lose money and go broke.

If I am wrong, please explain how. But I interpreted most of your post a pedantic explanation about how their control of the money supply wasn't direct and instead through controlling other things that then controlled the money supply.

[1] Only, of course, capital requirements limit banks ability to lend.


>> I am skipping … controlling the monetary base

You can’t really do that and hope to have a handle on how money works. If you don’t have a grasp on the meaning of reserves, you’re sunk.

What are reserves, how are they created, how are they destroyed and why are they exchanged between banks? If you can answer these then you’re a solid third of the way to fully understanding this space.

You’ve talked about controlling the monetary base which makes me think you’ve fallen down the exogenous money hole. While you’re stuck in that alternate reality you won’t be able to accurately describe how banking works. Money, as we experience it today, is endogenous.

>> instead through controlling other things that then controlled the money supply.

They don’t control most of the money supply, commerical banks do. Capital requirements rein in commercial banks desire to “print” more money into the economy.


100% + I'd expand by saying the Fed uses its operations to control the price of money, which is interest rates, not the supply of money. The supply of money has many factors such as how many loans are created, etc. Taxes paid. etc beyond the Feds operational control.


That’s a rather pedantic interpretation. Yes the Fed doesn’t run the printing press, and it doesn’t set M1, but it controls the levers.

That’s like saying to the police officer: “I didn’t speed, I merely pressed on this pedal that’s connected to a rod that opened a valve providing more fuel to the engine that’s connected to the wheels”.


How does the fed control the levers?

Customer approaches commercial bank for a loan, bank assesses credit worthiness[1] and choses to make the loan. New money was “printed” into the economy.

What levers did the fed pull?

Also what function does the fed have in the tax part the GP mentioned?

[1] the bank has other depts looking at capitalisation constraints, another dept managing day to day operations of the reserve account, perhaps another dept managing funding sources etc. but the loan making function doesn’t consult them before creating new money to make the loan


The most obvious, direct lever is they set the reserve requirement ratio. The bank isn't going to make the loan if they don't have the reserve.

The next mechanism is setting the Fed funds rate and discount rate. That will very directly incentivize the bank to loan more or less money.

The third is the ability to buy whatever asset it deems necessary to support the economy. Quantitative easing almost directly impacts money supply.


>> they set the reserve requirement ratio

No that doesn't exist anymore: https://www.federalreserve.gov/monetarypolicy/reservereq.htm

>> The bank isn't going to make the loan if they don't have the reserve

The bank has unlimited reserves since the central bank will issue reserves via the discount window in unlimited quantities.

Loan making is capital constrained, not reserve (or deposit!) constrained.

>> That will very directly incentivize the bank to loan more or less money

No. This is ignoring what's happened over the past 14 years.

>> Quantitative easing almost directly impacts money supply

Again - this is a statement that isn't supported by what we've seen happen since the GFC.


Capital requirements (which is what Silvergate ran afoul of) have replaced reserve requirements. They function similarly, only instead of the amount of loans being determined by deposits they are determined by shareholder equity.


reserve requirements are based on deposits/liabilities. Capital requirements are what allows or disallows a bank from making loans.


The Fed logically cannot target both monetary aggregates and interest rate levels at the same time. Its impossible by definition. They operate interest rate policy by buying and selling assets (treasuries and Interest on reserve accounts) in order to hit a target. These operations affect monetary aggregates.


I’ll add that the reserve requirement is currently zero.

https://www.federalreserve.gov/monetarypolicy/reservereq.htm


It might be worth adding that regulatory capital requirements are not zero: https://www.federalreserve.gov/publications/large-bank-capit...


Banks do create money out of thin air, but depositors fleeing does in fact limit their ability to loan money. Here's how that works: every time a bank loans money, they create an asset (the repayment they're owed) and a matching liability (the actual money sitting in someone's account). So long as this stays within the bank or outflows match with inflows, everything works. However, if money starts flowing out of the bank overall for whatever reason then the trick no longer works - and that includes if the money is being transferred out by customers other than the ones being lent to, such as their employees or suppliers. The main consequences of this are usually that one bank can't be substantially more aggressive in lending or offer substantially different interest rates than everone else, which of course affects demand to borrow money from the bank.


I'll add that approximately 97% of US dollars are created in this way.

https://positivemoney.org/how-money-%20works/how-banks-%20cr...


Stating obvious, this is only true until debts exceed a leverage US government has to inject currency it magically creates or utilize other financial tools it has available. At the point they are unable to do so, that’s no longer the case, system reaches a critical point for which recovery will take real assets at fair market value on the global market.

Ironically, US’s down fall may be its own failure to believe itself.


If Banks make bad loans and those loans( or investments) are marked to market bringing the bank out of compliance with Capital requirements, then it gets shutdown.


That's the theory, but does anyone still believe it? In USA now, and for at least the last 15 years, those wealthy enough to hire lobbyists always get bailed out. This week was an opportunity to improve that situation, merely by allowing FDIC to operate in its normal lawful fashion. Small deposits protected entirely, large deposits receive their share of liquidated assets, shareholder equity disappears. Easy and lawful. Saule Omarova, had she been confirmed, would have pushed for this. (If better OCC regulation under her leadership hadn't avoided this situation entirely.) Suddenly it's obvious why she was not confirmed...


+1.

To add, the vast amount of money that's circulating is created by banks. As I keep harping, refer to this article by BoE for details.

https://www.bankofengland.co.uk/quarterly-bulletin/2014/q1/m...


"This is a temporary program; banks can only tap this liquidity for about a year. In the ordinary course, bank runs don’t last for a year; they either cause an institution to fail very quickly or peter out. But the other reason this is time-bounded is to defang the moral hazard, on behalf of both banks and their customers. (Moral hazard in insurance is when the existence of insurance makes it incentive-compatible for you to be imprudent in your own risk taking, expecting someone else to bear the consequences.)"

This is likely the most important part. FED, Treasury and administration bought some time, but what happens after one year is anyone's guess.


That was the Fed and treasuries way of telling all the owners of banks across the US, take the beating or else.

If the banks listen and take the beating, invest more equity and re-adjust their banking practices to handle interest rate risk, nothing exciting happens.

If the banks don't heed the klaxon call, they will likely get wiped to zero and cease to be owners of banks anymore(because the FDIC will take the bank over and say enough). Depositors/customers of the banks will probably be just fine though. The FDIC will either find a new set of owners or dissolve it and move customers to new banks that did take the beating.

I imagine some idiots will try and call the bluff, get wiped to zero and hopefully learn something in the process, if only to not be a bank owner anymore.


I will admit that I did not think about it in those terms, but that is why I like to come here ; you are exposed to different perspectives.

Do you think this is a way for FED to raise the rates further despite the interest risk you mentioned since failure of SVB put next interest hike into question[1]?

edited for clarity

[1]https://www.marketwatch.com/story/bank-fallout-undermines-fe...


I think the Feds are going to keep fighting inflation. Will they rate hike or not I have no idea, but I'd be very surprised if they lowered rates right away.

Unless the economy really goes bonkers stupid and crashes hard, I really don't see them lowering rates anytime this year and maybe not next.

A few banks that were arguably stupid crashing and burning? Well that's part of the expected cost of fighting inflation.


Money quote:

> Regulators then heard the numbers, did a bit of modeling in Excel, and then went into wartime execution mode. Regulators have, of course, not declared this war, because it is a war on the public’s perception of reality, and to declare war is to surrender.

SO MUCH of this drama is really a war on perception more than anything else. Banks being "underwater" on 10 year treasuries is only a problem *if everyone thinks its a problem* and if everyone just goes about their daily business ignoring this story, then after 10 years all the bonds mature and nobody is the wiser.


On the recommendation of maintaining accounts with multiple banks, readers at least in the UK should be aware that for the purpose of compensation, the important part is not the brand name, but whether the banks are part of the same group. This isn't so obvious so you need to check the FCSS website if they do.


Mentioned in the article, Chart 7 from an FDIC report [1] is concerning, specifically that currently there are “unrealized losses on available–for–sale and held–to–maturity securities totaled $620 billion” — which appears to be not only a recent trend, but roughly 10x more than any point in recent history, including during 2008.

Is anyone able to provide more context and clarify how significant these losses are to the US banking system beyond what’s covered in the article?

[1] https://www.fdic.gov/news/speeches/2023/spfeb2823.html?ref=b...

_________________

EDIT: For the unfamiliar, OP article’s author is a notable user on HN:

https://news.ycombinator.com/user?id=patio11


In 2008 the Fed was decreasing interest rates, which helped support asset prices. Banks held a lot of bad loans which were worth much less than their balance sheets showed. Both of these factors could have caused the unrealized losses in 2008 to look somewhat small, but the high leverage at banks caused forced asset sales, and the uncertainty around credit losses led to asset prices tanking.

In 2023 the situation isn't necessarily worse, but it is certainly different. Asset prices seem relatively well-understood, in that their declines are a straightforward function of interest rates as opposed to an uncertain function of credit losses. Bank leverage is less than in 2008 as a result of regulation.

If the situation in 2008 was "some banks are _super_ insolvent, and it's hard to tell which ones", in 2023 it seems to be "some banks are mildly insolvent, and it's fairly clear which ones". A mildly insolvent bank can probably stay afloat as long as it continues to have access to capital, which the Fed is giving them. But if people start withdrawing their deposits from one of the mildly insolvent banks, it will become increasingly difficult for that bank to dig out of even a small solvency hole, so there's still some uncertainty as to whether the Fed lifeline is enough to save them.


these are unrealized losses so not necessarily significant if just held to maturity or sold when prices are less punishing

they can be an issue if, say, all your depositors decide to make huge withdrawals and the bank's immediate cash needs balloon, or if they have specific payments they need to make in the near term which would force those "available for sale" securities to be actually sold

none of this is an inevitable risk. there are ways to hedge against rising rates. the current rate hikes, although historic in their pace, have also long been anticipated by the market and telegraphed by the Fed. that bank administrators failed to plan accordingly is honestly baffling


Possible I am missing something, but your response appears to assume the securities will recover their loses prior to being sold and/or that these unrealized losses do become actual losses, should banks need to sell securities to meet liquidity needs.

Without additional context, seems like wishful thinking to believe such losses will ever be recovered. In fact, while I might be wrong, those unrealized losses assume current market conditions; meaning they do not represent the actual total assets at potentially at risk; might be wrong about this.

Am I missing something?


Let's simplify and think about it like owning a stock. Maybe you bought it at $100 and it's now worth $80. If you were forced to sell it today, you would have a $20 loss. But you can wait for it to trade up.

Bonds have the added benefit of a guaranteed principal at maturity. So if you buy a bond with $100 face value, it will pay that to you at maturity plus some coupon (say, 4%) between now and then. For the sake of simplicity, let's assume the bond was issued at par (meaning not at a discount or premium), so you paid $100 for that $100 face value

As time goes by and interests rate fluctuate, the price of that bond in the open market will also vary. When interest rates go up, prices go down and yields go up, because investors demand a greater return (higher yield) and since the "4%" is hardcoded into the bond, the only way to give additional yield is by trading your otherwise $100 bond for, say, $98.


The point with bonds is that they'll "recover their losses" if you hold them to maturity.

Think about three time frames:

Year 0: I buy a new-issue $100 bond paying 1.5% interest for $100. I will receive $1.50 every year for 5 years and then get $100 back.

Year 3: Interest rates have increased pretty dramatically, so 2-year bonds are now paying 3% interest. So for someone 'shopping' for a bond that matures in 2 more years, they can buy a new-issue one paying 3% or they could buy my 5-year with 2-years remaining that is only paying 1.5%. Obviously they would buy the new-issue unless I offer a substantial price discount. So if I "mark to market" my bond, I would have to sell it for something like $85 to be equivalent to the new-issue debt. My bond is still paying 1.5% and will still pay $100 when it matures, but it's much less valuable since the interest stream is smaller. I don't sell my bond because I don't want to take the loss.

Year 5: My bond matures and I receive $100 along with the final interest payment.

We're talking about step 2 above -- the losses are only realized if you sell the instrument, so you don't need to "recover" any losses, the underlying debt is still as likely to pay out as they were before, it's just a debt maturity question.


They are bonds. Unless they default they will eventually reach maturity and pay out the original gain.

The problem is that might be a 20% gain 10 years from now, so nobody will be willing to buy that bond off of you for the price you paid since they can 40% on new 10 year bonds.

The only time a bond price decline is concerning is if you have to sell it rather than holding to maturity.


> Am I missing something?

Yes. As bonds get closer to their maturity date, the discount one would have to sell them at to garner a higher prevailing interest rate goes away. That is, the nominal loss "naturally" goes away over time. The article kind of explains this.


They are unrealized losses if the assets are sold at market. They are not losses if the assets are held to maturity.


Everyone will say they are “unrealized” losses. Some people (let’s call them “busters”) will argue this means real losses that already happened but banks are allowed to pretend it hasn’t. Other people (let’s call them “holders”) will argue these losses aren’t real and will only become real if the bank is forced to sell them, while if they manage to hold onto them for the full ten years then the losses never become real and vanish.

The truth is roughly that both sides are right, and the sum of their claims is much weirder than either subset.

The actual instrument in question is a little tough to get your head around. The first part is the basic bond mechanism: you give the government a thousand bucks, and ten years later they give you back that thousand dollars (guaranteed: they can print money so they will never default, only risk is they have to print so much money to pay you back that the economy explodes, and everyone has bigger problems at that point). Why would you do this? You wouldn’t, there is no upside, you only get back what you put in and it’ll be worth a little less because of inflation by then as well. Nobody does it, so right now what we have is not a real financial instrument.

So let’s make a first attempt at offering some upside: if you let them hold a thousand bucks for ten years, they’ll give you 10 bucks twice a year. Now you’ll take it - unless you think you can make more than 20 dollars out of your 1000 dollars each year by putting it somewhere else. What controls how much you can make on your 1000 dollars elsewhere? A lot of factors that all ultimately rest on the interest rate. Okay, so the government can’t just offer a flat 10 bucks twice a month, they have to offer something competitive with the current interest rate. But there’s the kicker: the current interest rate. Once you buy the bond, that amount is fixed, even if the interest rate later changes.

If the interest rates go up after you buy a bond, next years bonds will be offering higher per-year payments, so your bonds are inferior by comparison (they pay the same at the end, but less on the way, and they’ve already paid out some of the payments to you) and thus are worth a lot less. This is important because aside from holding them you can also sell them to someone else for any price you agree on, and whoever buys them from you gets the rest of the yearly payments and the final payout instead of you. They’re a hard thing to sell if interest rates have gone up, because you’re offering 20 bucks a year for five years while the government is offering 50 bucks a year for 10 years.

So: the money you get back eventually is worth less than when you handed it over because of inflation, but you’re getting small payments all along the way based on the interest rate at the time of the agreement. You care about interest and about inflation.

We have to stop for a moment and talk about interest rates and inflation. It is generally accepted that an increase in interest rates will cause a decrease in inflation a few years later. Confusingly, people will also say that interest rates move in the same direction as inflation but with a lag. It’s not that confusing though:

an increase in inflation at time t=0…

…will cause an increase in interest rates at time t=1…

…which will cause a decrease in inflation at time t=2…

(…which will cause a decrease in interest rates at time t=3…)

(…which will cause an increase in inflation at time t=4, and we’re back to step 1)

And so the cycle goes.

So in effect, you’re betting on this tension between interest and inflation resolving in your favor. In practice I believe the effect of inflation is smaller than the interest payments, so it’s also generally believed you always have a way out of the bet: just hold for the full ten years and the interest payments over that time will more than cover the inflation loss.

Except you can’t just hold on to the bet, because you’re a bank, and that thousand dollars you gave to the government is not your thousand dollars - it is some customer’s deposit, and they might want it back. So you better plan to have another thousand dollars somewhere else that you can give that customer, because the only way you can turn this bond back into money before the 10 years is up is selling it. And as mentioned before, if interest rates have recently gone up, your bond is not going to sell for anywhere close to breaking even.

That’s what that unrealized loss figure of 600 billion is: if you sold them for market value today, how much would you lose? As pointed out in the article, because interest rates were extremely low when these bonds were made, their yearly payout is very low. Because interest rates have risen rapidly, new bonds have much higher yearly payouts. And because interest rates have risen recently, we’re still in the lag period before inflation falls, so the final payout is also worth less (once again, I believe the effect of inflation differential is smaller here, and the price is I think mostly driven by the interest rate differential).

Concretely, right now, you could probably sell those bonds for no more than 75 cents on the dollar, and likely closer to 65 cents. If the Fed keeps raising interest rates like they’re doing now until the end of the current Presidential term (where someone else will get to tell the Fed what to do), we might get below 50 cents on the dollar, or even lower.

Banks bought 2 trillion dollars of an asset and right now that asset is only worth 1.4 trillion. That is, objectively, a huge loss. Point to the busters.

…But if we just hold the asset long enough, it is worth about 2 trillion again. Point to the holders, and this is why we call them “unrealized” losses.

…But if we can’t hold the asset (because, say, everyone withdraws at the same time), we have to sell at the current market rate, and those losses are forced to be realized. Point once more to the busters.

…But if we can rely on the FDIC or the government or other banks to step in and cover our withdrawals, we aren’t forced to sell - we can hold until the value returns, and pay back the FDIC or the government or the other banks then. Point once more to the holders.

And so it goes, back and forth between the busters and the holders. Who is right? In aggregate it’s both and neither, but at specific times for specific banks it could very visibly be one or the other. No wonder it’s so confusing!

There’s a lot more of these back and forths at every level that further complicate things. The government is jacking up interest rates so they’re causing the pressure… but banks know this dynamic exists and didn’t prepare for it so they made themselves vulnerable to this pressure… but the government regulations make these investments much more attractive to banks (very roughly: regulations say you only have to put up 0-20% of the value of these investments as collateral, for other investments it could be 100% or even 400% collateral) so the government pushed the banks in this direction… and so this cycle goes, too.

The fundamental dynamic is these bonds were an easy investment that turned into a giant Sword of Damocles over your head that’s growing by the day. In ten years you can step out from under the Sword, but any day now your depositors might panic and drop it on you, but if they do drop it the government might catch it before it kills you.

Thus, finally, some insight into the title of the post: very uncertain times indeed.


He seems to say that the fractional reserve system is the only way society can work. But is that actually true? Quite a few banks (e.g. Brex) now allow you to keep your money in a money market fund, which invests in short term US treasuries that are protected by the full faith and credit of the US government. Importantly, in this setup, you own all the assets and the bank just acts as a custodian. And you tend to get better interest. That just seems so much saner than the bank being allowed to invest your money in risky and illiquid assets, and then we just hope that those investments don't lose too much money, or that a lot of people don't want to withdraw their money all at once.


It's the only way to keep society working. Most of the money that exists today (over 90%) is actually bank IOUs kept in their database and is what people see when they log on into their accounts.

Without a fractional reserve system, the liquidity that drives all economic activity grinds to a halt as everyone fights over the few remaining real dollars rather than managing their deployed capital.

Banks basically act to multiply the amount of money in the world today by creating promises about the future that act as a bridge that moves money from the future into the present. That money then flows into restaurants, dog walkers, software engineers, etc... Inflation is kept in check b/c the promises force the money to be paid back to the bank via monthly loan repayments.

Banks that only hold short term reserves or cash equivalents like Brex don't act as this multiplier. Going forward it's likely small banks will move towards this model as only the big banks that are too big to fail (b/c they are necessary as multipliers) can afford to take on the risk of longer term investments or creating loans.


A traditional bank used to take people's deposits and loan them to other for a fee. the fee would then be returned on aggregate to depositors less the cost of business and profit. this is so called fractional reserve banking.

But that doesn't really provide that much interest to depositors, in this age of loose money supply.

So there are more exotic functions that "investment" banks fiddle with. Ie trading on the stock market (regulated betting) buying companies, and trading on futures and other pure bets.

The problem is that banks are bigger, and have more depositors. So when one pops, other go because they are all doing the same shady shit to make profit.

In the UK there are still a few building societies that offer traditional, boring, consumer banking and mortgages. But they are now large national behemoths.

But to your point, Brex is a payment manager/facilitator. Its not really offering banking, its more a service to manage expenditure. This might seem like pedantry, but its different enough to make the point.


I would disagree that Brex (and many others in the space) aren't offering banking. I can deposit money, I can withdraw it, I have a credit card, I earn interest, etc, they seem to offer everything a traditional bank would.

To your point about risky investments, like stocks, I agree that that's very sketchy. But I think even very prudent banks that don't invest in stocks etc still take on a lot of risk, like we see with the bank collapses caused by the high interest rates these days.


>The U.S. banking system lost $620 billion. Six hundred twenty billion dollars. That is a loss no less real than if money had been loaned out to borrowers who defaulted

Uh, no. That's just nonsense. If you lend money to a borrower who defaults, you immediately lose your principal and future interest, subject to whatever recovery rate you achieve. It's an actual, realized loss.

Banks have masses of unrealized losses on their long-dated Treasury holdings, but if you hold those bonds to maturity, you're going to get your principal and your interest.

It should be pretty clear those are Not The Same. The clue is in the word "realized", right?


The term "real" is overloaded. The author is clearly using a meaning here that is different from the one you are using, but that is intentional. His usage makes sense in the context of that particular segment of his writing. From an equity perspective, those losses are very real whether they are realized or not.


As Schumpeter predicted, the complexity of our economy is has outstripped our language and consequently our ability to understand it.


now we’re getting into weird philosophical questions: if every bank had sold these treasuries (realizing the loss) and used the proceeds to buy similar treasuries, their portfolio would be basically the same: same present value (obviously), and same to within a few percent future cashflows. at any layer above the balance sheet, these two worlds are difficult to distinguish. so what makes one “real” and the other not?


There need to be a separation between funds transaction and investing. Just like the separation between Church and State or Investment Banking and Commercial Banking.

Currently there isn't because you are forced to invest if you want to be able to transact. As a matter of fact the figure you see in your checking account is expressed in dollars but that is false because those are IOUs from the bank exressed in dollars. You are defacto investing in the loan portfolio of your commercial bank.

It's a very different thing.

Maybe CBDC will allow all of us to 'bank with the Fed' so we will know for sure that those dollars are real and not being put to work in any way , shape or form.


The claim that, "when interest rates rise, all asset prices must fall" seems, uhm, somewhat off. If this were true, it would be trivial to stop and reverse inflation (i.e. deflate) with any increase in interest rates (?).

While it's certainly useful to think about prices as signals that, "embed an interest rate derivative", it seems a stretch to claim every single one of those derivatives is perfectly negatively correlated with interest rate changes.

[EDIT: change "interest price" to "interest rate"]


> The claim that, "when interest rates rise, all asset prices must fall" seems, uhm, somewhat off.

It’s a necessary condition of the discounted cash flow asset pricing model.

https://en.wikipedia.org/wiki/Discounted_cash_flow?wprov=sft...


Yes, a future stream of cash flows will be worth less now if interest rates rise, because the time value of money has changed. But not every asset (let alone every price) represents a future stream of cash flows.

Monetary policy could be performed by a couple of NAND gates if it were genuinely the case that any interest rates rise would necessarily lower the price of everything.


It's basically true. A simple example is housing. People will generally borrow as much as they're allowed and spend all of that on the best house they can afford. That tends to raise property prices as the borrowed money chases housing stock. That's been very evident these last years.

The opposite occurs when interest rates go up, people can no longer borrow enough to pay asking prices, demand falls and prices fall to meet demand.

There are obviously other factors involved but the basic relationship holds.


The mechanism is mentioned by another, but the idea is that higher interest rates reduce the present value of future cash flows, resulting in lower asset prices. However, this analysis is holding everything equal, which is not true in real life. For instance, if higher interest rates are due to higher inflation expectations reflecting stronger nominal growth, then some assets might do better in such an environment.

Your second argument is that it would be trivial to stop and reverse inflation if it were true, but even if it were true it would not be so easy. The way we measure inflation is based on the prices paid for goods and services of consumer goods. If the only change from an interest rate hike were on asset prices, then this doesn't directly impact prices of consumer goods.


> it would be trivial to stop and reverse inflation (i.e. deflate) with any increase in interest rates (?).

As trivial as it sounds it is exactly the premise with which fed operates. Their mandate is price stability (~2% inflation) with low unemployment rate. And interest rate is a key lever they have. So yes they are going to keep rising rates until they see inflation come down to around 2%. They harp on this at every FOMC meeting[1]. They believe raising rates to around 4.75% will bring down inflation to 2%.

Will be interesting to see how it plays out.

[1] https://www.federalreserve.gov/newsevents/pressreleases/mone...


That was on February 1st though. They also have a mandate to keep the financial system stable.


> The claim that, "when interest rates rise, all asset prices must fall" seems, uhm, somewhat off.

Of course there are instruments like interest rate derivatives where you can make money when rates rise, but he's talking about ordinary assets like bonds and equities.

The reason all prices do indeed embed an interest rate is that all future cash flows need to be valued somehow, and those values go down as interest rates go up. So your equity that (somehow) is guaranteed to pay 10c next year is worth less if interest rates go up, just like if it were a bond.


Yes, but you don't want to deflate for other (often worse) reasons. So could they raise interest rates to 10% and kill inflation? Easily. The trick is in raising them to the appropriate level to curb inflation without suffocating the economy.


They have already raised rates enough to suffocate the economy; this episode is just one example. They have not raised rates enough to kill inflation, because the inflation we're seeing today is due to input costs and monopoly rents. The interest rate could be 15% and it wouldn't change those facts.

The real reason interest rates are rising is to kill the infant unionization trend in its crib. SVB is just collateral damage.


Not sure why you wrote this since nearly all prices are falling right now, directly due to interest rate hikes.

How could you conclude that an interest rate hikes wouldn't reduce all asset prices?


If "nearly all prices" really were falling, wouldn't that show up on this chart?

https://fred.stlouisfed.org/series/CPIAUCSL


Bond prices fall. Not all assets.


"If this were true, it would be trivial to stop and reverse inflation (i.e. deflate) with any increase in interest rates"

Well, that is the strategy of the Fed. Raise interest rates when we experience too much inflation.


The Fed strategy is to reduce the rate of growth (1st derivative) or prices, not reduce the actual price level (which would be deflationary). And that's non-trivial for many reasons, including the fact that not every price signal responds the same to short term interest rate movements.


I have been seeing conflicting opinions from people in the financial know-how. On one hand, patio11 says that you can ignore this and that the banking system is very resilient. On the other hand, him and others mentions that you need to use 3rd party providers in order to distribute your deposits in order to have full insurance coverage. Is there any way for a non sophisticated person to avoid these headaches? Otherwise why is this so different than the knowledge required to self custody crypto-assets?


If you are storing more than $250K (the standard insurance limit), then you need to distribute your deposits. It is as simple as opening accounts in N/250000 banks, although if you are close to an integer or expect the cash to increase substantially, you might want more than that.

So for individual people, this affects... maybe 5%. It certainly affects small companies, but those are entities that we, as a society, expect to have good financial advisors. (It turns out that many of them do not.)

Every bank and credit union I've ever dealt with has prominently placed the FDIC or NCUA insurance terms on their paperwork, website and physical doors. When you sign up for an account with a brokerage/bank, they are always explicit about what accounts, if any, are protected savings and which are unprotected investment accounts.


It's just not remotely practical to keep dozens of banks accounts with $250k in them for most companies. Many payrolls are larger than that, if you're renting a venue for an event, it'll be larger than that. Obviously well-staffed finance teams could shuffle funds endlessly, but there's just no economic value to creating treasury jobs for the sake of it. We'd be much better off just upping the FDIC limit to something like $5M and mandating better quality assets for the insured portion of bank deposits.


recently had a call with Fidelity about this. many places including Fidelity will automatically split your cash between many banks on the bank end. for Fidelity the money in my Cash Management account will be split into up to 20 different banks which means that up to $5 million is FDIC insured. https://www.fidelity.com/why-fidelity/safeguarding-your-acco...


It seems like a hack that really should be built into the system.

It is insurance only for those in-the-know.


The idea is that if you're keeping 250k+ in cash sitting around you should probably be in-the-know. Deposit sweep accounts are incredibly easy to use, Fidelity lets you open one in ~5 minutes. Further, this isn't just some hack, as distributing funds around many banks makes each individual bank less brittle.


That is the point of having a competent CFO.

The letters "CFO" are pronounced "those in the know".

Doing a cash sweep is NOT rocket science and there are lots of services that can do it for you.

A company can also project forward and ladder treasury instruments to mature at the right times to provide liquidity. T-{notes,bills,bonds} are issued by the US government and thus have at least as much resiliency as the SDIC.


I think that advice was meant for different audiences. If you're a W2 employee who has modest savings, you're in the class of people who can safely choose not to add/remove/change any of your banking relationships. You are who the FDIC was designed to protect. If you're feeling like you must "do something" then open another checking account somewhere and keep a month's expenses there. That redundancy is probably worthwhile in good times and bad.

If you're an owner and you need over 250k to be liquid on daily to weekly timescales, but hiring a three people to manage manage your bank accounts sounds unaffordable, you should find a 3rd party that can do that "cash sweep" thing for you.


If you are over $250K limit and need that money under 2-3 years then T-bills is the way to go. I haven't used it as I'm not a US resident but I hear that it's straightforward.

Beyond 3 years it makes sense to spread it among Index fund, gold ETF etc., depending on your need, risk appetite etc., But then we are venturing into "investment" and not "safe keeping".

https://www.treasurydirect.gov/marketable-securities/treasur...


> Is there any way for a non sophisticated person to avoid these headaches?

On your own account, once you reach $250k in cash (not pensions or home equity etc) you're basically in the financial 1% and you're sort of expected to be either sophisticated or speak to a "wealth management" firm.

As a business it's more complicated in the intermediate zone before you can hire a Treasury Officer to deal with this, which is basically patio11's argument.


Pretty much nobody has enough cash held in a bank account for this to be a concern. People were worried about SVB because it was so overrepresented with accounts of more than the insured limit because it was used by cash-rich technology companies. A normal person, even if they’re rich, probably has most of their net worth in assets (real estate, investments) and is not holding cash.

Just don’t exceed the insured amount in a single bank, and if you do need to have more than $250k in cash… either open a second account at a different bank or donate it.


Why should someone donate their savings?

Putting money in the stock market is not the answer for everyone and their savings.


Banks are slow moving institutions. I think most have not yet come to grips with the idea of a bunch of 20-somethings getting handed millions of $ for a nice plan but with $0 revenue. OTOH, SVB was supposed to be specialized in such cases.


Apologies in advance if I'm missing some context here but from my understanding it's pretty straight-forward: in the U.S. an individual is insured by the FDIC up to $250K. So anything you have over that in the one account is "susceptible" to bank failure losses (and even then it's not guaranteed that you'd lose your $...just possible).

So if you have $1M parked in one account then you're at risk. $250K parked in 4 accounts caries zero risk.


Per person per account type.

Joint accounts are covered at 500k

When a revocable trust owner names five or fewer beneficiaries, the owner's trust deposits are insured up to $250,000 for each unique beneficiary

So 4 people = $1m

https://www.fdic.gov/resources/deposit-insurance/brochures/i...


If you have more than $250,000 in cash, keeping it in checking accounts is just dumb. Open a TreasuryDirect account and start buying T-bills... they're paying 5% right now, way more than a checking account.


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