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The problem here is that extremely liquid assets like treasury bonds are not being marked to market resulting in completely invisible insolvency. Banks don't ha

by ouid 4y ago

The problem here is that extremely liquid assets like treasury bonds are not being marked to market resulting in completely invisible insolvency. Banks don't have a right to have you keep your deposits when their assets do not cover those deposits, and, by extension, shouldn't have a right to lie about the market value (aka value) of those assets in order to con you into doing so. Executives were still paying out their bonuses during the period of insolvency...

tptacek 4y ago
The "insolvency" here was detailed in the SEC statements, which is, as I understand it, how the run happened --- there was chatter about it last year. Further: the "market value" thing here is complicated. The reason there is separate available-for-sale and held-to-maturity accounting for bank assets is that, in the ordinary course, the assets are held --- the only reason you sell them is because of extrinsic distress. There isn't anything wrong with the agency MBS portfolio SVB had; they're worth less because if you have to sell them in Q1'2023, they compete with even more attractive bonds and are discounted accordingly. But if you just hold them, they pay back dollar for dollar, and that's what the bank normally does anyways.
- ouid 4y ago
  I really don't see the market value thing as all that complicated. A banks liabilities are (roughly) instantaneous. They must honor withdrawals when they are requested, so their assets must be measured accordingly. There is no other reasonable definition of instanteous value except for market value. This is an extraordinary advantage of having large markets for things. Granted, it's sometimes hard to establish market value. In the case of assets with genuinely low liquidity, the market value is somewhere above the bid and probably below the ask. Accounting in this case comes with error bars, but it's not really justifiable to approximate the value of an asset outside of this range. Here's an example. Suppose a hypothetical bank receives 100 dollars in deposits at an interest rate of effectively 0. They use 85 dollars to buy a bond that matures in 1 year that pays 90 dollars, and keep 10 dollars in cash as reserve requirement. They pay themselves the extra 5 dollars as bonuses. They have met their fractional reserve requirements, and according to your scheme, their holdings should be valued at 100 dollars. Are they solvent?
  - tptacek 4y ago
    I guess the core of my argument is that SVB's viability and the damage caused by their implosion are separable concerns, and FDIC has rather neatly separated them. Nobody has to take a bath on SVB's bond portfolio; deposits are guaranteed, so they can just be held to maturity; there's no pressure to sell. Meanwhile: SVB's equity is zeroed out, so they've paid the ultimate price for their incompetence.
    - tripletao 4y ago
      I think you're assuming here that the HTM accounting means the bonds don't actually lose value if they're held to maturity? That's not the case; it's just arbitrary accounting treatment, and the regulatory decision to permit such accounting is a big part of why the SVB blew up. Accounting rules are supposed to reflect economic reality to some extent, but they obviously don't do so exactly. For example, under FIFO inventory accounting, two identical boxes in the warehouse might be on the books at different values; but I assume you'd agree they're still actually worth the same amount, since they're identical. All bonds get held to maturity by someone (unless they default, but that's not the problem here). The FMV of the bond is determined by the value of the bond's remaining cash flows to that person; so if the FMV went down, then that should be a clue that value was fundamentally lost, regardless of who's holding the bond.
      - NovemberWhiskey 4y ago
        Say you buy a theoretical 10 year zero-coupon bond with a 5% yield and a face value of $1,000. You should pay about $614 for it. You intend to hold it to maturity. Interest rates take a random walk from now until maturity. Under fair-value accounting, the balance sheet value starts at fair-value (obviously), then gyrates, but tends towards face value, and reaches it at maturity, due to time decay of bond premium. As you said yourself, every bond eventually matures in the absence of credit risks and fair-value can't indefinitely diverge from face value. Under amortized cost basis accounting, the balance sheet value starts at fair-value but then increases every year until maturity, at which point it is also face value. Surely you acknowledge that these are the same? They both describe the exact same cash flows.
rtkwe 4y ago
The weird thing is they were only insolvent under artificial pressure. A lot of banks would have similar trouble there's just not as concentrated of a depositor spread where a scant handful of people can create a run on the bank by themselves. A distinction between held to maturity assets and market priced assets makes sense though, there should be some consideration in the calculation about term though for sure. The question of that though seems very complex to answer.

by ouid 4y ago

tptacek 4y ago

The "insolvency" here was detailed in the SEC statements, which is, as I understand it, how the run happened --- there was chatter about it last year. Further: the "market value" thing here is complicated. The reason there is separate available-for-sale and held-to-maturity accounting for bank assets is that, in the ordinary course, the assets are held --- the only reason you sell them is because of extrinsic distress. There isn't anything wrong with the agency MBS portfolio SVB had; they're worth less because if you have to sell them in Q1'2023, they compete with even more attractive bonds and are discounted accordingly. But if you just hold them, they pay back dollar for dollar, and that's what the bank normally does anyways.

ouid 4y ago
I really don't see the market value thing as all that complicated. A banks liabilities are (roughly) instantaneous. They must honor withdrawals when they are requested, so their assets must be measured accordingly. There is no other reasonable definition of instanteous value except for market value. This is an extraordinary advantage of having large markets for things. Granted, it's sometimes hard to establish market value. In the case of assets with genuinely low liquidity, the market value is somewhere above the bid and probably below the ask. Accounting in this case comes with error bars, but it's not really justifiable to approximate the value of an asset outside of this range. Here's an example. Suppose a hypothetical bank receives 100 dollars in deposits at an interest rate of effectively 0. They use 85 dollars to buy a bond that matures in 1 year that pays 90 dollars, and keep 10 dollars in cash as reserve requirement. They pay themselves the extra 5 dollars as bonuses. They have met their fractional reserve requirements, and according to your scheme, their holdings should be valued at 100 dollars. Are they solvent?
- tptacek 4y ago
  I guess the core of my argument is that SVB's viability and the damage caused by their implosion are separable concerns, and FDIC has rather neatly separated them. Nobody has to take a bath on SVB's bond portfolio; deposits are guaranteed, so they can just be held to maturity; there's no pressure to sell. Meanwhile: SVB's equity is zeroed out, so they've paid the ultimate price for their incompetence.
  - tripletao 4y ago
    I think you're assuming here that the HTM accounting means the bonds don't actually lose value if they're held to maturity? That's not the case; it's just arbitrary accounting treatment, and the regulatory decision to permit such accounting is a big part of why the SVB blew up. Accounting rules are supposed to reflect economic reality to some extent, but they obviously don't do so exactly. For example, under FIFO inventory accounting, two identical boxes in the warehouse might be on the books at different values; but I assume you'd agree they're still actually worth the same amount, since they're identical. All bonds get held to maturity by someone (unless they default, but that's not the problem here). The FMV of the bond is determined by the value of the bond's remaining cash flows to that person; so if the FMV went down, then that should be a clue that value was fundamentally lost, regardless of who's holding the bond.
    - NovemberWhiskey 4y ago
      Say you buy a theoretical 10 year zero-coupon bond with a 5% yield and a face value of $1,000. You should pay about $614 for it. You intend to hold it to maturity. Interest rates take a random walk from now until maturity. Under fair-value accounting, the balance sheet value starts at fair-value (obviously), then gyrates, but tends towards face value, and reaches it at maturity, due to time decay of bond premium. As you said yourself, every bond eventually matures in the absence of credit risks and fair-value can't indefinitely diverge from face value. Under amortized cost basis accounting, the balance sheet value starts at fair-value but then increases every year until maturity, at which point it is also face value. Surely you acknowledge that these are the same? They both describe the exact same cash flows.

rtkwe 4y ago

The weird thing is they were only insolvent under artificial pressure. A lot of banks would have similar trouble there's just not as concentrated of a depositor spread where a scant handful of people can create a run on the bank by themselves. A distinction between held to maturity assets and market priced assets makes sense though, there should be some consideration in the calculation about term though for sure. The question of that though seems very complex to answer.