4 ms·

Curious what are the ways SVB could have hedged in this scenario?

wskinner 4y ago
Buy T-Bills or other short maturity assets instead of long maturity T-Bonds and mortgage-backed assets.
snuxoll 4y ago
Not investing such a large percentage of their capital in long-duration fixed income vehicles all at once. There's nothing wrong with going long on duration, it's a hedge against decreasing rates. The problem is when you go all-in on long duration investments and rates suddenly shoot up like they did, you now can't sell those assets without eating a massive loss. An appropriate hedge would have been doing what every retail bond trader does, build a ladder. If they had simply bought a wider variety of say 1/2/5/10 year securities then they could have let the longer-dated ones sit and sell the shorter duration ones (and they wouldn't have suffered such a huge loss of market value that spooked depositors and started the run in the first place).
- teacpde 4y ago
  Makes me wonder why they made the risky move in the first place, they surely knew the risks, but still did it, because of greed for higher yields?
  - snuxoll 4y ago
    Yields on short-term fixed income securities were absolute shit, barely above 0%. If you've got a bunch of cash and nowhere to put it to work then even a horribly yielding MBS seems like a good idea, and the inflation monster hadn't yet come to roost making the Fed start jacking rates up far earlier than anybody would have expected. Even at the time it should have been seen as a short-sighted move, however. It was obvious ZIRP wouldn't go on forever and rate risk would bite you in the backside, so I can't call it anything but careless yield chasing without proper risk management.
actionablefiber 4y ago
They took deposits from depositors who would blow up if interest rates went up, and then used those deposits to buy assets that would blow up if interest rates went up. Interest rates went up, so their assets crashed at the same time that deposits plummeted and withdrawals skyrocketed. If you want to standardly hedge against interest rate risk, that's what swaps are for. If you want to take on a comparatively less rate-sensitive portfolio, then you buy shorter-dated bonds. They yield less, but surely that's better than "the FDIC seizes your bank and your equity goes to zero."
- bjornsing 4y ago
  > They yield less, but surely that's better than "the FDIC seizes your bank and your equity goes to zero." For the individual banker, perhaps it's not? If rates stay low they get a fat bonus, if they go up they just get a new job somewhere else.
  - actionablefiber 4y ago
    Depends on the equity/cash split of your compensation. A failed bank is worth zero. Cash is cash.
  - MrMan 4y ago
    I think the chief risk officer at this bank left last year, they may have been the person who got the bank into these positions. it will be interesting to see if there is news coverage about that person's role in the crisis.
testfoobar 4y ago
Interest rate swaps is one solution. Here is a primer: https://www.pimco.com/gbl/en/resources/education/understanding-interest-rate-swaps https://www.pimco.com/gbl/en/resources/education/understandi... This is another (PDF): https://www.treasurer.ca.gov/cdiac/publications/math.pdf https://www.treasurer.ca.gov/cdiac/publications/math.pdf

Buy T-Bills or other short maturity assets instead of long maturity T-Bonds and mortgage-backed assets.

Not investing such a large percentage of their capital in long-duration fixed income vehicles all at once. There's nothing wrong with going long on duration, it's a hedge against decreasing rates. The problem is when you go all-in on long duration investments and rates suddenly shoot up like they did, you now can't sell those assets without eating a massive loss. An appropriate hedge would have been doing what every retail bond trader does, build a ladder. If they had simply bought a wider variety of say 1/2/5/10 year securities then they could have let the longer-dated ones sit and sell the shorter duration ones (and they wouldn't have suffered such a huge loss of market value that spooked depositors and started the run in the first place).

teacpde 4y ago
Makes me wonder why they made the risky move in the first place, they surely knew the risks, but still did it, because of greed for higher yields?
- snuxoll 4y ago
  Yields on short-term fixed income securities were absolute shit, barely above 0%. If you've got a bunch of cash and nowhere to put it to work then even a horribly yielding MBS seems like a good idea, and the inflation monster hadn't yet come to roost making the Fed start jacking rates up far earlier than anybody would have expected. Even at the time it should have been seen as a short-sighted move, however. It was obvious ZIRP wouldn't go on forever and rate risk would bite you in the backside, so I can't call it anything but careless yield chasing without proper risk management.

actionablefiber 4y ago

They took deposits from depositors who would blow up if interest rates went up, and then used those deposits to buy assets that would blow up if interest rates went up. Interest rates went up, so their assets crashed at the same time that deposits plummeted and withdrawals skyrocketed. If you want to standardly hedge against interest rate risk, that's what swaps are for. If you want to take on a comparatively less rate-sensitive portfolio, then you buy shorter-dated bonds. They yield less, but surely that's better than "the FDIC seizes your bank and your equity goes to zero."

bjornsing 4y ago
> They yield less, but surely that's better than "the FDIC seizes your bank and your equity goes to zero." For the individual banker, perhaps it's not? If rates stay low they get a fat bonus, if they go up they just get a new job somewhere else.
- actionablefiber 4y ago
  Depends on the equity/cash split of your compensation. A failed bank is worth zero. Cash is cash.
- MrMan 4y ago
  I think the chief risk officer at this bank left last year, they may have been the person who got the bank into these positions. it will be interesting to see if there is news coverage about that person's role in the crisis.

testfoobar 4y ago

Interest rate swaps is one solution. Here is a primer: https://www.pimco.com/gbl/en/resources/education/understanding-interest-rate-swaps https://www.pimco.com/gbl/en/resources/education/understandi... This is another (PDF): https://www.treasurer.ca.gov/cdiac/publications/math.pdf https://www.treasurer.ca.gov/cdiac/publications/math.pdf