The collapse of a Silicon Valley bank last Friday exposed a larger problem with “safe” securities bought with government guarantees during the pandemic. Following SVB’s implosion, the Federal Reserve sought to contain potential risks to other banks holding similar securities and help them avoid forced asset sales, which could further undermine confidence in the banking system. Concerns about European banking giant Credit Suisse, CS, -13.94% , which has lost money for five straight quarters, intensified Wednesday after Bloomberg reported that its top shareholder said he could no longer invest in the bank beyond its 10% threshold. . Turmoil related to banks is weighing on the stock market and bonds. Here’s an explainer on what went wrong with the Silicon Valley bank’s investment securities and why it matters to calm markets and the Fed’s inflation fight. SVB Financial SIVB, -60.41% disclosed a week ago the sudden sale of about $21 billion of high-quality, rate-sensitive mortgage and treasury securities at a loss of $1.8 billion, which caused customers to flee with their deposits and ultimately hurt the bank. Failure on Friday. The Fed’s focus, with the help of a new emergency bank funding program released over the weekend, is preventing any contagion to other US banks with paper losses from similar low-coupon pandemic-era securities. Its efforts are intended to help stabilize markets, even if they are not a complete cure. “It doesn’t change interest-rate risks,” said Scott Buchta, head of fixed-income strategy at Brain Capital, the bank’s access to the Fed program. “But the idea is that banks can get access to liquidity without being forced sellers, so you have fewer banks acquiring.” Buchta, a veteran of Bear Stearns’ mortgage division before his fall, said that instead of the Fed cleaning up the toxic subprime mortgage mess that brought down banks in 2008, central bankers in the past few days have been “pushing it out. They helped start the fire.” The new Fed facility provides up to $25 billion in credit protection to banks using it, which is set to last at least until March 11, 2024. ‘This is not toxic’ In the past two decades, last year it began raising interest rates aggressively to fight inflation that had hit a 40-year high. However, higher rates reduced the value of most bonds, including low-coupon bonds considered “safe” because of their government guarantees that protect investors from credit losses if the borrower defaults. Because interest-rate and liquidity risks aren’t covered by those guarantees, the flood of low-coupon bonds created in 2020 and 2021, like the ones Silicon Valley Bank was buying as its pandemic deposits surged, are acutely vulnerable to the Fed’s faster bonds. The pace of rate hikes in decades. This chart shows the US The value of investment securities held at banks shows a downward spiral since the Fed began lifting rates from near zero last March, mounting a projected $620 billion unrealized deficit at the end of 2022. Banks are based on high quality. , but rate-sensitive mortgage bonds and Treasury debt at extremely low rates during the pandemic to offset rising deposits. FDIC, Whelan Global Advisors “They’re not toxic,” said Chris Michener, a professor of economics at Santa Clara University and an expert on the history of financial crises. Treasuries and government-backed mortgage bonds were also what the Fed has been buying since unleashing a bazooka of pandemic support in 2020, pushing its balance sheet to a peak of nearly $9 trillion. Since last year, however, the Fed has been vocal about its focus on taming inflation, including dramatically shrinking the size of its balance sheet of Treasuries and mortgage bonds by letting assets it has mature. A lingering question after Silicon Valley Bank’s collapse is why it and other midsize banks didn’t protect their portfolios against the Fed’s reversal of its easy-money stance, Michener said. “It’s a puzzle,” he said. “Because bank management should be concerned about interest-rate exposure and duration risks. That’s something I’m teaching my undergraduates.” Investors buying new 10-year Treasury notes TMUBMUSD10Y, 3.466%, could yield about 2.1% a year ago, up from 4% last week, according to Dow Jones market data. and was close to 3.5% on Wednesday. “When yields rise, of course, it becomes more difficult to exit those positions,” said Robin Marshall, director of fixed-income and multiset research at FTSE Russell. While larger than the subprime days that fueled the global financial crisis As assets held by banks have been heavily scrutinized by regulators, Marshall said risks at some regional banks seem to have “slipped under the radar.” Treasuries and guaranteed mortgage bonds, which have long been considered liquid assets because of their backstops. , the kind securities regulators encouraged major banks to own as a buffer against potential losses in the post-2008 era. Buchta said the new Fed facility, plus the Federal Home Loan Bank if Ruri, which has raised more than $88 billion in short-term funding for banks to deposit, could help calm investors in the mortgage bond market. The iShares MBS ETF, MBB, +1.01% which tracks an index of government-backed mortgage securities, rose 1% on Wednesday, while the S&P 500 index fell 0.7% and the Dow Jones Industrial Average fell 0.9%. Market concerns around banks should calm, Buchta said, hoping the Fed can focus on fighting inflation. “They have to keep it going,” he said. See: High mortgage rates: One reason it’s so hard for the Fed to unload trillions of dollars in housing debt
