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Comment by rsync | Hacker News Reader

"97% of these MBS were 10+ year duration, with a weighted average yield of 1.56%."

I'd like to learn more about the dramatic drop in MBS - elsewhere, downthread, it is asserted that they have dropped 30-50% ?

I understand the inverse relationship between bond price and yield ...

... but I am surprised that an asset yielding ~1.5% drops 30% in value when treasuries of similar duration rise to 3-4%.

Are there other factors at play with MBS in early 2023 - such as increased delinquencies - that are putting downward pressure on their price ?

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I will first try to explain with simplified numbers and then do the equivalent calculation somewhere else.

Let's assume you buy a $100 bond with 0% rate for 10 years. For simplicity, let's assume it's a riskless bond. Now, let's suppose those same bonds now pay 5% a month later. Well, the smart thing to do would be to sell your 1-month old bond and buy the new one. Of course, everyone is doing the same thing so the price has to drop until the bonds are equivalent. You would get $100/1.05^10 = $61.39. Of course, the old bond still pays 0% but now, on paper, the price of the bond should grow 5% every year as we get closer to maturation.

Going to the real world, it would be something like 4.5% (current Fed rate - expected to be higher) minus 1.5% (the MBS rate they have) is 3% difference and so $100/1.03^10 = $74.41. Now, you said 10+ and so doing the same thing with 15 years is $64.19. This is also not including the fact that MBS is strictly worse than treasuries in terms of riskiness and so it's easy to imagine 50% off.

> You would get $100/1.05^10 = $61.39.

Emphasis on the exponential decay relationship between market price and time-to-maturity. If you change that 10 to a 30, the bond is worth $23, and if you change it to a 50, it's $8.72. For a bond that pays $100 at maturation.

I think laypeople intuitively guess that long-dated bonds are safer, because that is sort of how it feels when you are borrowing money to buy a house. But in terms of the market value of the bond, you add exponentially more interest rate sensitivity as the time-to-maturity increases.

The rule of thumb is that for each 1% increase in interest rates, a bond loses its years to maturity as a percentage.

So a bond with five years to maturity would lose 5%, and a bond with ten years to maturity would lose 10%.

If SVBs bonds had a ten year maturity when purchased, that's probably nine years remaining when interest rates increased from 1.5% to 5.0%, so that's 9 * 3.5 = 31.5% reduction in value.

If they bought $80 billion of these, that's a $25 billion dollar loss.

If their shareholders equity was $16 billion, then that's zeroed and a combination of depositors, the FDIC (for insured deposits) and other creditors would have to eat the remaining $9 billion.

It's pretty straightforward -- if you have asset yielding 1.5% forever, you can make it an asset yielding 3% by cutting its price in half.

In this case it's a little more complicated since you also get the principal back in pieces, but you can calculate the price today to create the equivalent of a 3% yield instead of 1.5%, and you'll get a significant price reduction.

There’s a misconception that bonds are safe investments. They are not. You’re just trading one kind of risk for another. You can do the math, compare 4% and 1.5% compounding for 10 years and that’s why no one wants the bonds yielding 1.5%. Dumping 90%+ of your liquid funds into a single thing other than cash is completely insane especially when it’s not yours.

Treasury bonds are "safe" in the sense that you will (because the US Government will not default on her debt) get your money back. The caveat is you will get your money back at maturity; if you need it before then, well, market value adjusts based on current yields.

If you're investing in bonds without building a ladder you're honestly doing it wrong. With the past 15 years of easy money and low yields it might have seemed pointless given rates barely moved, but completely giving up on any ability to capitalize on higher yields if rates move up is just poor investing :/

Bond ladders are the CPU pipelines of finance ;)

Bonds are perfectly safe investments when the normal consideration of safety is that you cannot lose money and you know your exact return through maturity. Can you miss out on better investments, ofcourse. The only issue is investing someone else's money into bonds - because they are the ones to decide when the cash is needed, not you. But I'd be shocked if at any given time at least 90% of cash is not invested in someway. You only want to keep what you need immediately out of investments.

Safe investment means you're not risking losing the money, not that there will never be a better opportunity (that may be just as safe). Alternative cost is not really coming into play here IMO.

MBS have a double whammy when rates rise. Not only are the mortgages yielding less relative to current rates but prepays decline so the duration extends. A lower relative rate for a longer time means a lower market price.

Interest rate rise will cause the same loss for bonds of the same duration. However MBS don’t have fixed durations. As interest rates go up, borrowers are expected to hold onto their mortgage longer. So the expected duration goes up for an MBS as well and loss is expected to be higher than bonds with similar duration to begin with. However there is a mitigating factor for MBS in a rising rate environment, that is they are amortizing instruments. So the duration doesn’t go up as dramatically as callable bonds/CDs.

Go watch Margin Call.

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