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Imagine you run a small regional bank. You have marketing and operational expenses you need to cover, and you also need to be attractive enough to depositors to
by simple-thoughts 4y ago
Imagine you run a small regional bank. You have marketing and operational expenses you need to cover, and you also need to be attractive enough to depositors to keep them from leaving to your giant to big to fail competitors who have explicit state backing. You’re required to buy from a very limited selection of assets that have government approval, especially government debt.
Interest rates for short term debt are at 0%, at these rates you will run at a loss. Your only choice to keep your bank competitive is to find any yield at all, so you buy long duration treasuries. Yes you take interest rate risk, but your bank is able to operate for another day.
Of course the flaw in this story is that the interest rate risk should have been hedged, and it wasn’t. But viewing this as a straightforward story of “banks greedy, government good” is not reflecting the realities for regional banks.
- User23 4y ago> Of course the flaw in this story is that the interest rate risk should have been hedged, and it wasn’t. How does the banking sector in aggregate hedge its interest rate risk exactly? They have to find a net counterparty outside the sector who wants exposure to interest rate risk. Who exactly would that be at sufficient scale to protect trillions in deposits?
- taeric 4y agoI'm also interested in this answer. I've seen running credit cards?
- lordnacho 4y agoSpeculators aka hedge funds.
- quickthrower2 4y agoDamn is no one gonna pay for the free lunch?
- balderdash 4y agoIt’s probably easier to think of who wants long duration risk, and I think the answer is 1. Speculators (who like the volatility/convexity) 2. Pension funds (they have very long dated liabilities, and so potentially want to increase the duration of their portfolio)
- xadhominemx 4y agoOk but the fact is a lot of regional banks didn’t buy very long-dated treasuries
- watwut 4y agoBut small regional banks had not done that in general.
- kgwgk 4y ago> Interest rates for short term debt are at 0%, at these rates you will run at a loss. Your only choice to keep your bank competitive is to find any yield at all […] Of course the flaw in this story is that the interest rate risk should have been hedged, and it wasn’t. If you buy long-term Treasuries for the high yield and you hedge the interest risk rate… what you get is the yield of the short-term Treasuries. Why buy them in the first place then? (There is no credit risk in this case - if you neutralize the interest rate risk there is nothing left.)
- itsoktocry 4y ago>Of course the flaw in this story is that the interest rate risk should have been hedged, and it wasn’t. Oh, so the thing that could have prevented the bank from failing (but, unsurprisingly, costs them money to do), didn't happen? But it's the governments fault?