You don’t lose money on bonds you hold to maturity. 100% of the principal will become liquid upon maturity.
Not anymore. Now the question is, how does the government make depositors whole? I doubt they will go flog the bonds on the open market or get loans at market rate like idiots. The point of this intervention is to bypass the market mechanisms that caused this and put the government as a backstop.
Thank you, great concise explanation, lightbulb moment for me. I understood it but couldn't clearly communicate it.
So to make depositors whole today, you need to borrow money today, and the extra interest paid to borrow the money is more than the interest you get when the long-term bonds finally mature. The difference is the loss.
Which is why they had to take a loss on selling the bonds, as it's essentially the same loss. They are out money whether they sell the long-term bonds today, or if they borrow money today. Bonds are discounted appropriately by whomever buys them.
Question is, why didn't SVB do anything when they saw this coming? I've seen articles saying the board was aware of the risk issues for the past year. [1]
[1] https://www.forbes.com/sites/noahbarsky/2023/03/12/silicon-v...
What you are talking about is opportunity cost, not investment losses. If SVB could have held their bonds to maturity they would have gotten back every cent of the principal.
Interest rates rising means products with a fixed rate yield are worth less today. That value isn't gotten back by waiting until maturity. The nominal value is retrieved, yes, but the money in the future is literally worth less.
SVB was very poorly run. We can see that easily now in retrospect.
We don't live in a magical world where deposits (aka liabilities) are exempt from inflation and the assets that back them are not.
If you owe someone $1000 you owe them one thousand dollars. Not the value or purchasing power of one thousand dollars -- literally one thousand things called dollars.
So if you take $1000 in deposits, you buy $1000 in bonds, you wait until the bonds mature, and then your depositor withdraws $1000, you will be fine no matter if that happens in one year or a hundred years, no matter what the rate of inflation is. Your assets and liabilities will cancel out.
If your depositor tries to get their $1000 back before the bonds mature, you are screwed. That is what happened to SVB. If all of SVB's bonds had been mature by last Friday it would have been fine. Pretty much every article in the financial press about this fiasco has made that point.
It is amazing to see people twist themselves up in knots about opportunity cost and inflation when this is so basic. If liquid assets equal liabilities in the literal number of dollars, you are even, you are solvent, and your depositors get their money back.
> A loan today would need to be at below market rate interest in order to match up with the value of the bonds held to maturity.
Well, it's a government loan, so they can do that if they want to.
However, it also proves that holding bonds to maturity is different from selling them at market rates. It demonstrates the distinction between solvency and liquidity. Every financial publication has made this point when discussing SVB in order to educate their readership about the problems of duration risk and explain how a bank with enough assets to cover liabilities can still fail.
Now, the nice thing is, the government has time to wait for the bonds to mature. So the government can take the bonds, pay off the depositors, and get the money back when the bonds mature. The government won't lose money if they do it right -- just like they didn't lose money with TARP in 2008.
Also, at some point the difference between opportunity cost and investment loss becomes rather semantic. In a liquid market, you should be able to sell and rebuy your positions every day, which you generally don't do of course, but it does mean that the decision not to sell is similar to the decision to buy: if you wouldn't buy under these circumstances, you should sell.
With these bonds, their low interest makes them less attractive than newer bonds with higher interest, so nobody will want to buy these lower interest bonds at face value when higher interest bonds are available. They'll only buy these at a discount that would make their profit comparable to those of higher interest bonds. So the value drops, so that's a loss.
Personally I've never seen the point in buying low-interest bonds. But then I'm not a banker.
This is why the bond price falls - an outside party will not buy the SVB bonds because they can get a better return on a different bond. The bond price falls to make them equivalent.
1. Give 80 cents on the dollar to each depositor and say tough-luck. 2. Give $1 dollar to each depositor upon bond maturity [for sake of example let's say 10 years].
Option 1: Depositor takes the cash, buys a new bond with the same maturity [but it would have higher yield, say closer to 4%] at current market price. At maturity they have $1 dollar
Options 1 and 2 are equivalent, minus the bid-ask spreads which are very tight for treasuries. This is time value of money.
If I can claim inflation as a loss I need to go redo my taxes…
What matters is that principal is returned in full when bonds mature, but if you can’t wait until maturity you might have to sell them for less than the principal. That is exactly what happened to SVB.
What's stopping my Local Bank from crashing this week?
Enough consumer confidence to prevent a bank run is the only thing that prevents a run on any bank, including the largest banks in the world.