3 ms·

Notice the risk free rate is based on short term bonds. Those are not as sensitive to rate changes as they regularly reach maturity and you roll them over. If

Notice the risk free rate is based on short term bonds. Those are not as sensitive to rate changes as they regularly reach maturity and you roll them over. If SVB had owner those they would not have had liquidity problems which lead to insolvency.

nonethewiser 4y ago
Why is n earth did they buy 10 year bonds at historically low rates? I don’t understand why that seemed like a good idea.
- muzz 4y ago
  Because the rate in long term bonds was 1.x% compared to 0% for the short term bonds. It was a risky move but one that could have panned out if the deposits had remained.
  - NhanH 4y ago
    It could only have panned out if the interest rate have remained. Once the interest rate increased, the deposits will chase higher rate, which SVB can’t provide and depositors will naturally withdraw their funds.
    - muzz 4y ago
      True but that doesn't happen all at once. Rates have been rising for more than a year now (not in a straight line but overall of course). They could have unwound this carry trade in March 2022 and probably come out ahead. Had they waited until summer 2022 they probably would have had a small loss. As it turns out though they held on for bigger losses.
- riffraff 4y ago
  Banks often do this, trade short term risk for long term and pocket the difference. It seems SVB didn't account for the fact that there was a strong correlation between the source of their money (tech propped up by low rates) and their investment risk (bonds/loans propped up by low rates). I'm honestly unsure if we can ascribe this to to incompetence or greed.
- lordnacho 4y ago
  This is a form of the carry trade. You're borrowing at a lower yield to lend at the higher yield, and the risk is that you have to liquidate before the long one is mature. Traders do this all the time, because every day you carry this position you're making the difference in yields. The risk is always the same: the value of the things that give you the yield may change by enough to wipe out the interest difference.
  - MrMan 4y ago
    buy side traders blowing up is a lot different than a bank blowing up so the risks are not the same
- asimpletune 4y ago
  Because rates were near 0 at the time for short term bonds. Interest rates were so low that there was nowhere else to park the money. Usually this is fixed with loans but with startups having lots of VC money they didn’t need loans.
  - deleted 4y ago
    [deleted]
deleted 4y ago
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amluto 4y ago
> Notice the risk free rate is based on short term bonds. Those are not as sensitive to rate changes as they regularly reach maturity and you roll them over. That is not why they are less sensitive to interest rates. They are less sensitive to interest rates because the value of a bond (assuming no coupon) is (whatever you get paid at maturity)^((1+rate)^(-time to maturity)). The sensitivity to rates increases exponentially with the time! If you buy 30-year bonds, hold them to maturity then roll them over, and don’t mark to market, you are just taking the graph of your returns and heavily smoothing it. And the smoothing obscures a fascinating thing about bonds: they’re sensitive to rates both ways. When rates go up, existing bonds lose present value immediately, but they start to gain present value at the new higher rate forever, or at least until the next rate change or until you sell them or let them mature without rolling them over. If you want to do an honest HTM forecast of SVB’s position, you need to project everything out to the same future time, say 10 years. So you’re looking at SVB’s portfolio, with a reasonable expectation (with error bars or confidence intervals) of returns over 10 years, in 2033 dollars. In this model, the value of SVB’s 10-year bonds didn’t change, but the value of its liabilities exploded: it needs to pay a lot more interest on its interest-bearing deposits, and customers (I assume) are a lot more likely to demand interest when rates are high.
- amluto 4y ago
  whoops, I can’t type. That’s (1+rate)*(-time to maturity) in the exponent. It’s exponential but not doubly exponential.

nonethewiser 4y ago

Why is n earth did they buy 10 year bonds at historically low rates? I don’t understand why that seemed like a good idea.

muzz 4y ago
Because the rate in long term bonds was 1.x% compared to 0% for the short term bonds. It was a risky move but one that could have panned out if the deposits had remained.
- NhanH 4y ago
  It could only have panned out if the interest rate have remained. Once the interest rate increased, the deposits will chase higher rate, which SVB can’t provide and depositors will naturally withdraw their funds.
  - muzz 4y ago
    True but that doesn't happen all at once. Rates have been rising for more than a year now (not in a straight line but overall of course). They could have unwound this carry trade in March 2022 and probably come out ahead. Had they waited until summer 2022 they probably would have had a small loss. As it turns out though they held on for bigger losses.
riffraff 4y ago
Banks often do this, trade short term risk for long term and pocket the difference. It seems SVB didn't account for the fact that there was a strong correlation between the source of their money (tech propped up by low rates) and their investment risk (bonds/loans propped up by low rates). I'm honestly unsure if we can ascribe this to to incompetence or greed.
lordnacho 4y ago
This is a form of the carry trade. You're borrowing at a lower yield to lend at the higher yield, and the risk is that you have to liquidate before the long one is mature. Traders do this all the time, because every day you carry this position you're making the difference in yields. The risk is always the same: the value of the things that give you the yield may change by enough to wipe out the interest difference.
- MrMan 4y ago
  buy side traders blowing up is a lot different than a bank blowing up so the risks are not the same
asimpletune 4y ago
Because rates were near 0 at the time for short term bonds. Interest rates were so low that there was nowhere else to park the money. Usually this is fixed with loans but with startups having lots of VC money they didn’t need loans.
- deleted 4y ago
  [deleted]

deleted 4y ago

[deleted]

amluto 4y ago

> Notice the risk free rate is based on short term bonds. Those are not as sensitive to rate changes as they regularly reach maturity and you roll them over. That is not why they are less sensitive to interest rates. They are less sensitive to interest rates because the value of a bond (assuming no coupon) is (whatever you get paid at maturity)^((1+rate)^(-time to maturity)). The sensitivity to rates increases exponentially with the time! If you buy 30-year bonds, hold them to maturity then roll them over, and don’t mark to market, you are just taking the graph of your returns and heavily smoothing it. And the smoothing obscures a fascinating thing about bonds: they’re sensitive to rates both ways. When rates go up, existing bonds lose present value immediately, but they start to gain present value at the new higher rate forever, or at least until the next rate change or until you sell them or let them mature without rolling them over. If you want to do an honest HTM forecast of SVB’s position, you need to project everything out to the same future time, say 10 years. So you’re looking at SVB’s portfolio, with a reasonable expectation (with error bars or confidence intervals) of returns over 10 years, in 2033 dollars. In this model, the value of SVB’s 10-year bonds didn’t change, but the value of its liabilities exploded: it needs to pay a lot more interest on its interest-bearing deposits, and customers (I assume) are a lot more likely to demand interest when rates are high.

amluto 4y ago
whoops, I can’t type. That’s (1+rate)*(-time to maturity) in the exponent. It’s exponential but not doubly exponential.