Just one note for those that aren't fully aware, the treasuries were only down approx 20% because they were forced to sell before the 10yr maturity. If they could have held the entire term they would get back 100%.
So in effect, as the fed raises interest rates, they are destroying the principle of every existing bond on the market. That’s a big problem for anyone owning bonds, especially if they are using them as collateral for leverage.
What principle are they destroying? Bonds are not, and never were, immune to economic changes. They're just less volatile and react differently than stocks and, if you hold them to maturity, will pay what what they promised.
It seems to me that the problem is that a whole bunch of people made investments assuming that there was effectively no risk in doing so. Like the good times would last forever or something.
If your collateral gets worse ...
*T-bills are up to 52 weeks maturity.
With regards to safety, I noted that I think there are two types of safety to note here:
1. Default risk. 2. Asset price volatility.
Ultimately if someone is willing and able to hold to expiry, they aren't subject to #2, but this clearly wasn't the case with SVB and may also be the case with other institutions. I think it lacks nuance to not consider the middle states between the purchase of a bond and the full return of the bond upon expiry.
100% back in, say, 9 years at 1.5%. Or take the 20% hit today, buy back bonds giving 4% yearly and end up with the same amount. I mean: it's literally how the price drop is calculated right?
What they actually did was put 40% of their deposits into a long term bond that would start paying a shit rate if interest rates went up. The invested money is borrowed from depositors so the only thing they really "own" is the interest. In order to keep depositors in a high interest environment it will require paying out some amount of interest too. But they have locked themselves in to gains at a now small interest rate.
This was a risky bet for the bank from the start and there's absolutely no way they would make the trade they did if they knew interest rates would go up, even if they also had a guarantee that there would not be a bank run. This isn't a simple liquidity crisis or even somebody trying to stay solvent until their GameStop puts pay off.
First off - it is not a 10Y T-bill. T-bills extend to 52 weeks. From that point through 10Y are "notes" and everything longer are bonds.
Second anyone involved professionally in the markets understands the duration (not maturity) of bonds and how coupon rate and market interest rate will effect the price of said bond. [those interested can google terms like 'modified duration']. So there is absolutely no shock that the price of 10yr paper with a 50bp coupon would be near 80 in the current rate environment.
You’ll get that money back come 2041, it just won’t be able to buy you much.
Yes. But those "100%" wouldn't be worth as much, due to inflation. There's also an opportunity cost to consider: if you sell now with 20% loss you get a chance to invest that money wiser.
So, yeah, these MBS will probably pay out when held to maturity, but their customers didn't buy MBS, they deposited their money in a bank.
I hope the bank thought it was betting, because if they didn't realize they were betting on interest rates staying low then that is a shocking level of incompetence. They probably thought it was a safe bet, but it was a bet nonetheless with obvious risk if they were wrong.
What counts is the real, not nominal, value