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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 re

by 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.
    - tripletao 4y ago
      Assuming I buy the bond today, the two accounting treatments agree (correctly) that in 2033, the bond is worth $1000 2033-dollars. The problem is that when interest rates increase, a 2033-dollar becomes worth relatively less than a 2023-dollar. So that agreement in future says nothing about the economic value of the bond today. That's the loss that took down the SVB, and it's a real economic loss. If the SVB's depositors behaved like the simplest textbook model, then as soon as short-term Treasury rates increased, they'd insist on correspondingly increased interest on their deposits. The cost of that extra interest would be the SVB's loss--the cash flows in from the bonds stay the same, but the cash flows out to the depositors would need to increase. In reality, I understand that depositors are generally "stickier" than that, leaving their funds at their existing banks even when bank interest rates increase slower than Treasury rates. That gave the SVB some hope that they could earn their way out of the hole, passing the loss slowly to their depositors over time by paying below-market interest rates. That's the behavior that HTM accounting roughly models. The SVB's depositors had no economically rational incentive to accept that though, and they didn't.
      - NovemberWhiskey 4y ago
        >The cost of that extra interest would be the SVB's loss--the cash flows in from the bonds stay the same, but the cash flows out to the depositors would need to increase. ... but SVB expected to have positive net-interest-income with increasing rates. Look here: https://www.sec.gov/Archives/edgar/data/719739/000071973923000021/sivb-20221231.htm#ibb4dd73a1d3f4bff944b5d35fd2c5e2a_172 https://www.sec.gov/Archives/edgar/data/719739/0000719739230... A 100bp increase in interest rates would've increased net-interest-income by 1.8%; a 200bp increase by 3.5%. This is typical for banks, because lending rates go up more than deposit rates as the base rate increases, increasing interest margin. So the idea that this is about NPV of future cash flows is not right.
- ouid 4y ago
  Paying out from the FDIC insurance fund is inflationary, at the very least, which means everyone takes a bath.

by ouid 4y ago

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.
  - tripletao 4y ago
    Assuming I buy the bond today, the two accounting treatments agree (correctly) that in 2033, the bond is worth $1000 2033-dollars. The problem is that when interest rates increase, a 2033-dollar becomes worth relatively less than a 2023-dollar. So that agreement in future says nothing about the economic value of the bond today. That's the loss that took down the SVB, and it's a real economic loss. If the SVB's depositors behaved like the simplest textbook model, then as soon as short-term Treasury rates increased, they'd insist on correspondingly increased interest on their deposits. The cost of that extra interest would be the SVB's loss--the cash flows in from the bonds stay the same, but the cash flows out to the depositors would need to increase. In reality, I understand that depositors are generally "stickier" than that, leaving their funds at their existing banks even when bank interest rates increase slower than Treasury rates. That gave the SVB some hope that they could earn their way out of the hole, passing the loss slowly to their depositors over time by paying below-market interest rates. That's the behavior that HTM accounting roughly models. The SVB's depositors had no economically rational incentive to accept that though, and they didn't.
    - NovemberWhiskey 4y ago
      >The cost of that extra interest would be the SVB's loss--the cash flows in from the bonds stay the same, but the cash flows out to the depositors would need to increase. ... but SVB expected to have positive net-interest-income with increasing rates. Look here: https://www.sec.gov/Archives/edgar/data/719739/000071973923000021/sivb-20221231.htm#ibb4dd73a1d3f4bff944b5d35fd2c5e2a_172 https://www.sec.gov/Archives/edgar/data/719739/0000719739230... A 100bp increase in interest rates would've increased net-interest-income by 1.8%; a 200bp increase by 3.5%. This is typical for banks, because lending rates go up more than deposit rates as the base rate increases, increasing interest margin. So the idea that this is about NPV of future cash flows is not right.
ouid 4y ago
Paying out from the FDIC insurance fund is inflationary, at the very least, which means everyone takes a bath.