http://www.brooock.com/a/svb-collapse-exposes-cracks-in-economy The Collapse of SVB Exposes the Largest Crack in the Economy. By Brock Whittaker Today's news of Silicon Valley Bank undergoing receivership marks the second-largest bank failure in US history. This failure was created by two important moments in time: 1. Between 2020-2022, SVB purchased around $100B worth of long-dated government bonds that were yielding very low interest rates (said to have averaged around 1.5%). As interest rates have dramatically risen over the past year, the value of those bonds has dropped dramatically. 2. In reporting a several billion dollar loss relating to the sale of those bonds, the company spooked its customers into one of the largest bank runs in history. To think, however, that Silicon Valley Bank is the only bank affected by this would be a mistake. On the other side of every single low interest rate loan issued since the beginning of the pandemic has been a company like SVB that is now rapidly marking down their balance sheet. In early-2021 as the latest housing run-up started to rapidly intensify, the 10Y treasury (a proxy for 30Y fixed rate mortgages), was as low as 1%. Now with the 10Y T-Bill having reached 4% this week, the value of mortgages the banks issued has dropped. 10Y T-Bill (01-04-21) 10Y T-Bill (03-02-23) Price $100 $100 Yield 0.93% 4.00% Value (today) $79.33 $100 A 10Y T-Bill purchased on the first trading day of 2021 is now worth less than $0.80 on the dollar, a massive loss for an asset class that is spoken of in terms of "safety" and "risk-off". It's important to note that many financially conservative institutions, pensions, and banks have historically been large consumers of bond offerings and mortgage backed securities. These conservative institutions can't make themselves susceptible to the unpredictable swings of the stock market. However this historically unprecedented series of rate hikes has directly impacted the institutions who are most sensitive to losing money. One major lesson per decade This brings us to what I would consider to be the "one major lesson" that happens every decade in the financial world. In the 2008 crisis, a major lesson was that you can't effectively reduce risk by bundling together lots of risky assets into one major asset. Ultimately, when the United States went through the largest correlated downturn since the advent of modern mortgages, we learned that even "diversified" mortgage backed securities would still create massive correlated losses. This decade's learning: bonds aren't a universally safe asset class. On yesterday's call the CEO of SVB mentioned around half a dozen times that their money was parked and being re-invested in "safe government bonds". This statement begs to clarify what the word "safe" really means. One aspect of safety, is not losing your entire investment due to default. Another aspect of safety, is not shouldering massive asset value losses due to macroeconomic changes. In this case, we need to think of bonds as two separate classes: short and long-term. It's unlikely that anyone will get fired or force the closure of a business due to the purchase of short-term bonds. They leave one exposed to very little risk other than the risk of default, and perhaps the opportunity cost of higher returns elsewhere. However, in the case of SVB, poorly-timed long-term bond purchases were enough to create a death spiral from which they couldn't recover (and if they could, would have suffered billions in losses from). We can't look at the safety of 1Y bonds and compare them with the safety of 10Y bonds when we now have proof of how rapidly the government can change rates and forcefully devalue investments. What this means going forward An unintended side effect of the Federal Reserve's massive rate hikes is that many banks and institutions are holding an unfathomable amount of low-yield debt that is now worth far less than it was a year ago. We went from a world where 100-Year Austrian bonds would pay only 0.39% yields, to one where we're now concerned about 8-9% annual inflation, in just two years. If institutions now rightfully start deeming long-dated bonds to be a risky asset not worth holding on sensitive balance sheets, it could lead to increased yields for long-dated bonds--meaning that bonds dated 10+ years will carry higher rates going forward, as investors are squeamish about buying into something long-term when certainty of future rates is unclear. This could have knock-on effects for many many industries. For example, US mortgage rates could remain higher as they're typically tied to the 10Y treasury price, and the cost of infrastructure projects could grow massively. If a municipal bond issued to fund roadway improvements needs to pay 1% more per annum to attract investors, that could raise the overall cost of the project by more than 10%, making all future municipal projects more expensive. Have thoughts? Write me an email. Follow me on twitter at @____brock____. Dark mode [ ]