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How does holding the bonds to maturity help? Sure, interest rates might go down, but the expectations are already factored into the market price. If they go dow

How does holding the bonds to maturity help? Sure, interest rates might go down, but the expectations are already factored into the market price. If they go down more than expected, the bigger bank wins. If they go down less than expected, the bigger bank loses. Overall, should be neutral.

anonymouskimmer 4y ago
My guess is that bond prices drop because there are better yielding things to buy instead. But for a bank the solvency concern is not that the yield will be "better" yielding, but merely sufficient to cover the obligations it owes along with its operating expenses. Having to fire sale bonds (to meet withdrawal obligations) that are selling at a discount because any potential buyers have better yielding instruments to buy results in solvency concerns from the relative excess losses. As long as the bonds yield more at maturity than you paid for them (along with the cost of the money you used to pay for them, which is very cheap for most large banks), then holding them to maturity is guaranteed to pay off. Whereas we have no idea how cheap they could ultimately become on the spot market at any given time that the owner may need to fire sale them.
- tripletao 4y ago
  > (along with the cost of the money you used to pay for them, which is very cheap for most large banks) Why should depositors leave more money than they need for short-term working capital in the SVB at 0% when a Treasury bill pays 4% with less risk? When all rates were roughly zero, it was easy to just lazily leave everything in the bank; but when rates increased, the reward for leaving and the risk of staying (because the bank is now mark-to-market insolvent, and thus particularly vulnerable to a run) both increased. When interest rates increased, the NPV of the SVB's assets decreased. Someone had to take that loss. Their managers and shareholders presumably hoped that would be the depositors, by leaving their money in a risky bank earning interest below the risk-free rate, slowly accepting the loss over time. The depositors had no economic incentive to do that though, and they didn't. For emphasis, the SVB's problem isn't that their bonds are trading at irrationally low prices due to liquidity problems (i.e., a "fire sale"). The market price for their bonds has behaved exactly like a textbook NPV model, and similar assets trade with normal tight spreads; the price is just lower than they wanted. Hold-to-maturity accounting allowed them to ignore that for regulatory purposes, but accounting doesn't change reality.
  - barrkel 4y ago
    Exactly. Low yielding long maturity assets are worth a lot less in a higher interest rate environment. The assets the bank held declined in value. This would have been a solvency issue, if not today, then someday very soon.
    - anonymouskimmer 4y ago
      Only if the depositors cash out en masse. Which SVB was at greater risk of than most banks, because of its particular clientele.
  - anonymouskimmer 4y ago
    > Why should depositors leave more money than they need for short-term working capital in the SVB > Their managers and shareholders presumably hoped that would be the depositors, by leaving their money in a risky bank earning interest below the risk-free rate, slowly accepting the loss over time. The depositors had no economic incentive to do that though, and they didn't. That's why the grandparent comment mentioned a large bank buying SVB out. Large banks have diverse, non-business deposits, many of which tend to sit, and not chase yields. People in more precarious positions keep emergency funds in the bank, not in CDs or bonds that they can't easily cash out on a moment's notice, or stocks that are risky. People in even more precarious positions are constantly paying money to the bank at a steep interest to cover their credit card payments. This is really cheap money to the bank (and more easily liquidatable at par than low-yielding bonds), though it has to cover those in the most precarious positions who default.
    - tripletao 4y ago
      But interest rates went up. A different bank with less flighty depositors might indeed still have lots of cheap deposits, due to the stickiness that you note. But why would they buy the SVB's assets at 1.5%, when they can buy similar assets on the open market yielding 4%? They'd happily buy the SVB's assets at the right discounted price; but that's the mark-to-market price, and the SVB had been mark-to-market insolvent since September. I guess a lot of people hoped that a different large bank would buy the SVB or its assets at a price that would have maintained the accounting fiction that it was solvent. Such banks had no economic incentive to do that though, and once again they didn't.
helsinkiandrew 4y ago
Say you bought a $100 5 Year US treasury bond paying 1% a year interest ($1) from the Government for $100 a year ago. Now interest rates have risen to 4-5% and any buyer could buy something else that would give them more interest so they will pay less than $100 for your bond. If you hold that bond to maturity in 5 years the US government will give you your $100 in full though. The Fed has now started a program that lets banks use their treasury bonds as collateral against cash loans - if this was going a few weeks ago it would have saved SVB.
- lordnacho 4y ago
  What is the downside of this program? It sounds like it would be much better just to get that cash loan than deal with depositors? As in, does the program let you borrow cash from the government at a lower rate than the bonds are paying? How could that work?
  - tripletao 4y ago
    The program charges market rates, so that part isn't a subsidy--they're effectively letting banks bleed out the loss over time instead of recognizing it all at once, hoping (probably correctly in most cases) that other parts of the bank's business will be profitable enough that they can slowly earn their way out of the hole. The program is undercollateralized though, so if a bank fails with such a loan outstanding then the Fed loses money. That part is a subsidy.
    - blitzar 4y ago
      "Advances made under the Program are made with recourse beyond the pledged collateral to the eligible borrower." The banks share (and bond) capital is on the line as well.
      - tripletao 4y ago
        Yeah, that's why I said "if a bank fails". They can't selectively default on just that loan, since that would be stupid--they'd just all do that immediately. It's still a subsidy though. For example, if you lend my just-barely-solvent bank $100 unsecured, then I can bet it double or nothing on a fair coin flip. If I win then I keep all the gain, so it's +$50 EV to me. If I lose, then my bank fails and you take the loss, so it's -$50 EV to you. Banks are obviously regulated in many ways to discourage that kind of risk-taking, but this policy change slightly weakens that overall edifice.

anonymouskimmer 4y ago

My guess is that bond prices drop because there are better yielding things to buy instead. But for a bank the solvency concern is not that the yield will be "better" yielding, but merely sufficient to cover the obligations it owes along with its operating expenses. Having to fire sale bonds (to meet withdrawal obligations) that are selling at a discount because any potential buyers have better yielding instruments to buy results in solvency concerns from the relative excess losses. As long as the bonds yield more at maturity than you paid for them (along with the cost of the money you used to pay for them, which is very cheap for most large banks), then holding them to maturity is guaranteed to pay off. Whereas we have no idea how cheap they could ultimately become on the spot market at any given time that the owner may need to fire sale them.

tripletao 4y ago
> (along with the cost of the money you used to pay for them, which is very cheap for most large banks) Why should depositors leave more money than they need for short-term working capital in the SVB at 0% when a Treasury bill pays 4% with less risk? When all rates were roughly zero, it was easy to just lazily leave everything in the bank; but when rates increased, the reward for leaving and the risk of staying (because the bank is now mark-to-market insolvent, and thus particularly vulnerable to a run) both increased. When interest rates increased, the NPV of the SVB's assets decreased. Someone had to take that loss. Their managers and shareholders presumably hoped that would be the depositors, by leaving their money in a risky bank earning interest below the risk-free rate, slowly accepting the loss over time. The depositors had no economic incentive to do that though, and they didn't. For emphasis, the SVB's problem isn't that their bonds are trading at irrationally low prices due to liquidity problems (i.e., a "fire sale"). The market price for their bonds has behaved exactly like a textbook NPV model, and similar assets trade with normal tight spreads; the price is just lower than they wanted. Hold-to-maturity accounting allowed them to ignore that for regulatory purposes, but accounting doesn't change reality.
- barrkel 4y ago
  Exactly. Low yielding long maturity assets are worth a lot less in a higher interest rate environment. The assets the bank held declined in value. This would have been a solvency issue, if not today, then someday very soon.
  - anonymouskimmer 4y ago
    Only if the depositors cash out en masse. Which SVB was at greater risk of than most banks, because of its particular clientele.
- anonymouskimmer 4y ago
  > Why should depositors leave more money than they need for short-term working capital in the SVB > Their managers and shareholders presumably hoped that would be the depositors, by leaving their money in a risky bank earning interest below the risk-free rate, slowly accepting the loss over time. The depositors had no economic incentive to do that though, and they didn't. That's why the grandparent comment mentioned a large bank buying SVB out. Large banks have diverse, non-business deposits, many of which tend to sit, and not chase yields. People in more precarious positions keep emergency funds in the bank, not in CDs or bonds that they can't easily cash out on a moment's notice, or stocks that are risky. People in even more precarious positions are constantly paying money to the bank at a steep interest to cover their credit card payments. This is really cheap money to the bank (and more easily liquidatable at par than low-yielding bonds), though it has to cover those in the most precarious positions who default.
  - tripletao 4y ago
    But interest rates went up. A different bank with less flighty depositors might indeed still have lots of cheap deposits, due to the stickiness that you note. But why would they buy the SVB's assets at 1.5%, when they can buy similar assets on the open market yielding 4%? They'd happily buy the SVB's assets at the right discounted price; but that's the mark-to-market price, and the SVB had been mark-to-market insolvent since September. I guess a lot of people hoped that a different large bank would buy the SVB or its assets at a price that would have maintained the accounting fiction that it was solvent. Such banks had no economic incentive to do that though, and once again they didn't.

helsinkiandrew 4y ago

Say you bought a $100 5 Year US treasury bond paying 1% a year interest ($1) from the Government for $100 a year ago. Now interest rates have risen to 4-5% and any buyer could buy something else that would give them more interest so they will pay less than $100 for your bond. If you hold that bond to maturity in 5 years the US government will give you your $100 in full though. The Fed has now started a program that lets banks use their treasury bonds as collateral against cash loans - if this was going a few weeks ago it would have saved SVB.

lordnacho 4y ago
What is the downside of this program? It sounds like it would be much better just to get that cash loan than deal with depositors? As in, does the program let you borrow cash from the government at a lower rate than the bonds are paying? How could that work?
- tripletao 4y ago
  The program charges market rates, so that part isn't a subsidy--they're effectively letting banks bleed out the loss over time instead of recognizing it all at once, hoping (probably correctly in most cases) that other parts of the bank's business will be profitable enough that they can slowly earn their way out of the hole. The program is undercollateralized though, so if a bank fails with such a loan outstanding then the Fed loses money. That part is a subsidy.
  - blitzar 4y ago
    "Advances made under the Program are made with recourse beyond the pledged collateral to the eligible borrower." The banks share (and bond) capital is on the line as well.
    - tripletao 4y ago
      Yeah, that's why I said "if a bank fails". They can't selectively default on just that loan, since that would be stupid--they'd just all do that immediately. It's still a subsidy though. For example, if you lend my just-barely-solvent bank $100 unsecured, then I can bet it double or nothing on a fair coin flip. If I win then I keep all the gain, so it's +$50 EV to me. If I lose, then my bank fails and you take the loss, so it's -$50 EV to you. Banks are obviously regulated in many ways to discourage that kind of risk-taking, but this policy change slightly weakens that overall edifice.