Is the stock market going to tank?

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Originally Posted by Cono Este

Usually I’d say a stock like frc would stay down for the count and all premium will rot on the vine.

But who knows what stupid bailout they’ll get for being dumb.

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I dunno. How were they dumb? Their financials show they were well run. They bought conservative things ; treasuries etc and made loans ( as they should). Their spending isn't outrageous. They treated customers well.

What they didn't do was hedge their long dated book exposure but now doing a bit more digging i see interest rate swaps were pricy.

Also, putting on thinking cap; accounting standards wouldn't allow FRC to show hedges as offsetting hold to maturity assets so the hedges would show on the books as a naked negative bet on rates which, in and of itself, would also be susceptible to criticism.

Basically damned if you, damned if you don't. Which, to me, means many other FIs are open to the same analysis as FRC. Ergo the feds will bailout the entire system.

Would like to hear other viewpoints. But any thesis which says that big money will protect itself is more likely imo

Anecdotally: investments that an FI could hold on their balance sheet were few and far between for a while there. Smaller players would swing at a few million of something and get beat by somebody like Chase who swooped in to buy the whole thing.

I think there was some irrationality around just buying something, anything, to put all that overnight cash to work. There weren’t a lot of other strategies available other than to just hold the cash in overnight, earning next to nothing. The industry did not anticipate rates flying up like they did.

The heat being heaped on these guys for buying treasuries, of all things, is a little bit absurd. Unrealized losses are due to interest rate environment, not credit issues. Balance sheet is solid there, it’s just not a ready source of liquidity. As long as liquidity in general is managed then these investments are just as good as they were 18 months ago, just not as good as what’s available right now.

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Originally Posted by Mustonen

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The heat being heaped on these guys for buying treasuries, of all things, is a little bit absurd. Unrealized losses are due to interest rate environment, not credit issues. Balance sheet is solid there, it’s just not a ready source of liquidity. As long as liquidity in general is managed then these investments are just as good as they were 18 months ago, just not as good as what’s available right now.

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Ditto the heat for mark to mark unrealized losses. In more halcyon times ( ie a month ago), many FIs carried unrealized gains without waving pom poms about them.

This is a far far cry from the gross negligence of 2008 with the packaged MBS and derivative of derivatives toxic assets.

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Originally Posted by LeeLau

I dunno. How were they dumb? Their financials show they were well run. They bought conservative things ; treasuries etc and made loans ( as they should). Their spending isn't outrageous. They treated customers well.

What they didn't do was hedge their long dated book exposure but now doing a bit more digging i see interest rate swaps were pricy.

Also, putting on thinking cap; accounting standards wouldn't allow FRC to show hedges as offsetting hold to maturity assets so the hedges would show on the books as a naked negative bet on rates which, in and of itself, would also be susceptible to criticism.

Basically damned if you, damned if you don't. Which, to me, means many other FIs are open to the same analysis as FRC. Ergo the feds will bailout the entire system.

Would like to hear other viewpoints. But any thesis which says that big money will protect itself is more likely imo

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Interesting point about the accounting, I dunno about all that stuff.

I do know, risk is risk. It’s quite simple to identify and manage. Buying long dated treasuries to earn a bigger spread, without hedging it, is simply naked and greedy. To add that treasuries were at a historic high when they did it, thats just plain out a stupid amount of risk. Basically a texas hedge. Long, hedged with even longer. Idiots.

If I went unhedged for one day, the phone rang. And no matter the loss, you took it or were fired.

This is not exclusives to banks. How many of us have had dumb ass partners who can’t respect a business can only grow, safely, so fast? Same lack of respect for risk and what separates professionals from gun slinging morons who ruin everything for everyone.

Last rant.

The problems with all of these companies is that they are run by the slicks who bring in the money in. The country club gigalo a, and no one cares, or pays for genuine risk management/traders/nerds who know actually what they are doing. And the customers are worse, they go where the free masters tickets are made available.

I’d even argue they don’t, because they don’t even know what risk management is, or how to hedge risk. Since I’ve left my previous business, I’ve met people who manage ALOT of money, and they are like a deer in the headlights when I try explaining what “professional” trading desk/firms are actually doing. They aactually get offended for being so clueless.

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Originally Posted by LeeLau

I dunno. How were they dumb? Their financials show they were well run. They bought conservative things ; treasuries etc and made loans ( as they should). Their spending isn't outrageous. They treated customers well.

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Part of the problem is FRC got in bed with crypto. It wasn't a big portfolio component, maybe ~10%, but enough to spark rumors. After crypto friendly Silvergate failed USDC depegged and panic selling of USDC sparked a bank run. This is an agnostic description of what happened, not an argument for or against crypto:

Attachment 452670

The reality is any fractional reserve bank is vulnerable to panic regardless of how they are run. At some level banking, unless we're talking about narrow banking and the like, is something of a confidence game. In 2008 the iPhone had only existed for a year and Twitter had not yet sprung into existence. We like to talk about practical things like financials but If enough people stop believing in a bank, especially if it happens very quickly, it will go bust.

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Originally Posted by MultiVerse

The reality is any fractional reserve bank is vulnerable to panic regardless of how they are run. At some level banking, unless we're talking about narrow banking and the like, is something of a confidence game. In 2008 the iPhone had only existed for a year and Twitter had not yet sprung into existence. We like to talk about practical things like financials but If enough people stop believing in a bank, especially if it happens very quickly, it will go bust.

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Aye that is the ugly truth and the nature of the beast hence the existence of the Yellen, JPow and the fed put in buttressing the system.

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Originally Posted by Cono Este

Interesting point about the accounting, I dunno about all that stuff.

I do know, risk is risk. It’s quite simple to identify and manage. Buying long dated treasuries to earn a bigger spread, without hedging it, is simply naked and greedy. To add that treasuries were at a historic high when they did it, thats just plain out a stupid amount of risk. Basically a texas hedge. Long, hedged with even longer. Idiots.

If I went unhedged for one day, the phone rang. And no matter the loss, you took it or were fired.

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I would say that in my time in the industry if I came in with an idea to originate a deal or take a position and I didn't have a clear plan for hedging risk that I'd have been shot down immediately. Bottom line is I agree. But just throwing out a devils advocate take for debate

So if "risk is risk"...lol what is actuarial science?

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Originally Posted by Cono Este

This is not exclusives to banks. How many of us have had dumb ass partners who can’t respect a business can only grow, safely, so fast? Same lack of respect for risk and what separates professionals from gun slinging morons who ruin everything for everyone.

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Asset/deposit growth is a different sorta thing. Some really interesting times where the levers to control growth all sorta stopped working. If you’re paying 0.01% (not allowed to pay zero on an interest earning account) what do you do when the money just keeps flowing in? Be mean to people? Start charging exorbitant account fees?

And then once you have all that cash sitting in your checking account, what do you do with it? Let it earn almost nothing? Or toss it into something safe and boring like treasuries so you can add a few million bucks to earnings without taking too much risk?

ETA: and deposit growth is more a capital concern than anything else. These guys weren’t over leveraged in any traditional sense of the term: equity, resource, etc. Those deposits were at risk whether they arrived last week or had been sitting there for a decade. The chunk of treasuries would maybe have looked a little less chunky, though… Primary difference being optics.

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Originally Posted by highangle

So if "risk is risk"...lol what is actuarial science?

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Bear with me as I know actuaries and it's intensely boring! Actuarial science's biggest dependency is lifespan. There's other dependencies in subfields (insurance in particular but the main contingency is a statistically well-researched slowly changing variable.

Risk in terms of financial instrument is limited only by human ingenuity in dreaming up all manner of esoteric instruments to pile risk onto risk onto risk. There are many critics of the main tool used to assess and manage risk (value at risk - I'm one of them) but it's an imperfect tool used to attempt to assess risk in a constantly changing field.

To me; actuaries deal with mainly a single variable modified by multiple variables but constrained within a range. VaR on the other hand is infinitely multi-variable.

Bro you're sorta way off on that, but what the hey? Maybe watch Margin Call, or thumb through a primer on financial risk management. NBD though.

Suffice to say "risk management" is a lot more rigorous and computationally complex than you may be aware of - on par with meteorology and high energy physics.



Source: Two of my daughters are actuaries, and they code deep.

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Originally Posted by highangle

Bro you're sorta way off on that, but what the hey? Maybe watch Margin Call, or thumb through a primer on financial risk management. NBD though.

Source: Two of my daughters are actuaries, and they deep code

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Fair point. My brother was an actuary and my friend's also one but both in pension funds. I may very well be out of touch

Can someone explain to me how investment risk is hedged? Not as in the actual mechanism, but how does that even work to anyone’s financial advantage.

For example, let’s say an investor was making a risky $10M bet and wanted to hedge it. If the counterparty being used as a hedge was aware of the riskiness of the original investment, then they’d be pricing it accordingly (including making it profitable for themselves) and in that case it’s probably better for the initial investment not to be hedged but to just be smaller in the first place to limit downside risk?

I kind of get the idea of hedging to smooth out returns over time, but seems different than hedging an investment bet.

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Originally Posted by J. Barron DeJong

Can someone explain to me how investment risk is hedged? Not as in the actual mechanism, but how does that even work to anyone’s financial advantage.

For example, let’s say an investor was making a risky $10M bet and wanted to hedge it. If the counterparty being used as a hedge was aware of the riskiness of the original investment, then they’d be pricing it accordingly (including making it profitable for themselves) and in that case it’s probably better for the initial investment not to be hedged but to just be smaller in the first place to limit downside risk?

I kind of get the idea of hedging to smooth out returns over time, but seems different than hedging an investment bet.

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You hedge differently depending on the investment. Sometimes you take different sides of the same trade
(Long S&P, short S&P at different price target), sometimes you open a correlated position (long S&P/short VIX, short S&P/long gold)

Also, they tend to hedge with leverage/etc. If you think markets are up directionally but you’re wrong, you get a better return by buying an offsetting put on SPY than by reducing your long position.

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Originally Posted by JimmyCarter

If you think markets are up directionally but you’re wrong, you get a better return by buying an offsetting put on SPY than by reducing your long position.

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I think this is the kind of example I don’t understand. Seems like if the offsetting position is expected to be (consistently) more profitable, then risk is being mis-priced somewhere.

(I don’t know what I’m talking about here, so could be completely off base.)

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Originally Posted by J. Barron DeJong

Can someone explain to me how investment risk is hedged? Not as in the actual mechanism, but how does that even work to anyone’s financial advantage.

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For individuals there are various “all weather” portfolios. Ray Dalio has a fund but there are also better easier versions. The All Asset No Authority (AANA) portfolio, for example, has beaten the standard 60:40 portfolio going back almost a century. It's equally balanced amounts invested in seven different asset types:

1. U.S. large-caps
2. U.S. small-caps
3. 10-year Treasuries
4. U.S. REITS
5. International stocks
6. Commodities
7. Gold

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Originally Posted by J. Barron DeJong

I think this is the kind of example I don’t understand. Seems like if the offsetting position is expected to be (consistently) more profitable, then risk is being mis-priced somewhere.

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It's typically not entirely offset. The way it often works is one investment performs well in one time period and another performs well in another time period. It's not necessarily binary, it's more of a ranked ordering of returns. Banks are facing mark-to-market (MTM) losses but if they're able to hold into the future even to maturity then it quite possibly becomes a different story.

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Originally Posted by MultiVerse

For individuals there are various “all weather” portfolios. Ray Dalio has a fund but there are also better easier versions. The All Asset No Authority AANA portfolio, for example, has beaten the standard 60:40 portfolio going back almost a century. It's equally balanced amounts invested in seven different asset types:

1. U.S. large-caps
2. U.S. small-caps
3. 10-year Treasuries
4. U.S. REITS
5. International stocks
6. Commodities
7. Gold

It's typically not entirely offset. The way it often works is one investment performs well in one period and another performs well in another period.

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To be clear, I’m not looking at how to reduce risk in my 401k. That’s invested in a wide variety of index funds covering US/international, large/small cap, majority stock but a small amount of bonds (still well away from retirement age).

But when LeeLau says if he wanted to take a big position, it would be shot down if he didn’t have a plan to hedge it, how does the hedging work to make the profit/risk calculation better than just taking a smaller position?

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Originally Posted by J. Barron DeJong

But when LeeLau says if he wanted to take a big position, it would be shot down if he didn’t have a plan to hedge it, how does the hedging work to make the profit/risk calculation better than just taking a smaller position?

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You hedge exposure to risks, not the specific security. Say you want to buy NVDA stock because you think it’s going to do better than the market, but are uncertain about which direction the broader market will move. You don’t reduce your investment in NVDA, you just reduce some of that market risk by buying puts on the S&P.

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Originally Posted by J. Barron DeJong

how does the hedging work to make the profit/risk calculation better than just taking a smaller position?

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Jimmy provided one way of doing it. Another way is interest rate futures contracts. It's easier to show how it works with equations because you can see the math. I typed up a simple example below but it really is a toy example and might not make things any clearer. In reality, banks use a range of financial instruments, including interest rate futures contracts, to hedge against interest rate risk of U.S. Treasuries, helping them to manage their portfolios and protect against potential losses.





In words, a bank could hedge against interest rate risk of U.S. Treasuries is by using interest rate futures contracts. Suppose the bank holds a portfolio of U.S. Treasuries and expects interest rates to rise, which would cause the value of the portfolio to decline. To hedge against this risk, the bank could enter into a futures contract where it agrees to sell Treasury bond futures at a fixed price on a specific date in the future.

For example, if the bank holds $10 million worth of U.S. Treasuries and expects interest rates to rise, it could enter into a futures contract to sell $10 million worth of Treasury bond futures at a fixed price of 102.00. If interest rates do rise, the value of the bank's Treasury portfolio would decline, but the bank would make a profit on the futures contract because it would be able to sell the futures at a higher price than the prevailing market price. The profit on the futures contract would offset the decline in the value of the bank's Treasury portfolio, thereby reducing the bank's interest rate risk.

So if a bank sells $10m of Treasury bond futures at a fixed price of 102.00 and if interest rates rise the futures contract would increase in value by some amount, e.g. $100,000 ($10 million x 1% x 1.02)

The bank could then sell the futures contract at a higher price of 103.02, realizing a profit of $102,000 ($10 million x 1.02 x (103.02 - 102.00)).

The profit on the futures contract would offset the decline in the value of the bank's Treasury portfolio due to the rise in interest rates, thereby reducing the bank's interest rate risk.

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Originally Posted by J. Barron DeJong

To be clear, I’m not looking at how to reduce risk in my 401k. That’s invested in a wide variety of index funds covering US/international, large/small cap, majority stock but a small amount of bonds (still well away from retirement age).

But when LeeLau says if he wanted to take a big position, it would be shot down if he didn’t have a plan to hedge it, how does the hedging work to make the profit/risk calculation better than just taking a smaller position?

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One example. We would lend a company a sum of money (a bond so to speak) with interest rates, payment requirements. The loan had a conversion feature so that it could convert to shares. The conversion rate depended on the company's fair market value; which we would set as a formula (stock market price at end of day; or vol weighted average price etc) but I'd always negotiate a pre-set higher limit price for conversion. We would then short the stock of the company within a certain time period so as to obtain enough proceeds to justify making the initial loan worthwhile. When I say short the stock I mean either short the listed equity on a stock market or write/sell calls. To cover the short, we could then convert the loan into stock. There's some risk but most of it is hedged. The ultimate risk is that the company refuses to convert the loan into shares so we're left short stock without the ability to cover the short. This is now often called a toxic floorless convertible.

- If we never took a stock position; we'd get paid interest for the loan
- If the stock goes up against the short, we'd convert at the pre-set price and be protected against unlimited losses and still make money on the loan
- If the stock craters; we'd make money on the short and, still get paid out on the loan.

Another example for the banks in question. Buy a set of bonds that pay out 10% interest in 3 years. Then buy credit default swaps against the bond issuer that pays out money if the issuer defaults. Keep the CDS alive for the length of the loan term

- If the bonds pay out the bank makes 10%
- If the bonds default, the CDS pays out the equivalent (or close to it) of the bond principal.

Goal will be cap profit at the 10% and also cap losses at principal + close to 10%. There may be slippage based on the amount of CDS protection bought but that's the job of risk management to figure out.

EDIT Multiverse already typed out a nice example for the banks hedging interest rate movements

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Originally Posted by J. Barron DeJong

Can someone explain to me how investment risk is hedged? Not as in the actual mechanism, but how does that even work to anyone’s financial advantage.

For example, let’s say an investor was making a risky $10M bet and wanted to hedge it. If the counterparty being used as a hedge was aware of the riskiness of the original investment, then they’d be pricing it accordingly (including making it profitable for themselves) and in that case it’s probably better for the initial investment not to be hedged but to just be smaller in the first place to limit downside risk?

I kind of get the idea of hedging to smooth out returns over time, but seems different than hedging an investment bet.

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Professionals rarely take naked positions. 90% of volume involves somekind of arbitrage. Most of the shit you hear about from citadel etc. all hedged, all somekind of arbitrage. Otherwise, if you’re just pushing a buy/sell button, why spend millions on exchange seats and whizz kid geniuses? There is risk of course, and there is no such thing as a perfect hedge but to close out the position, but you do it the best you can with what you can. That’s why warrants all get gobbled up, they Are basically options sold at a massive discount. These firms put themselves in a position to capture that. Could be through technology, could be relationships. It’s called “theoretical edge”. It’s not scalable, but thats why the well run firms just get bigger, and don’t need other peoples money, especially retail money. The best trades are usually OTC now. Firms ripping off their own customers, then dispersing that risk (hedging) across the public mkts. I.e. Picking the rest of us off.

You are correct though, it’s not free. Take Mark Cuban for example. I chuckle when he talks about the massive risk reversal he put on in the otc mkt, with whatever that company was that bought him. He still has no clue that the firm that took the other side of that trade only did that because it was priced so they couldn’t lose money. They sold put, bought call, shorted the stock for like a 10 dollar credit. I’m sure it was a split strike, for net zero to him, so not completely risk free but probably $10 in theo, the firm that did that probably laid off half the risk in the listed mkts, then whatever they kept, and . So long as the stock did not gap down, they made a fortune. He should have just sold the shares, but the risk reversal was probably more liquid and under the table. But hey, happy customer, even if ignorant. Probably cost him 5%.

I’d rather make a nickel risk free than bet a dollar.

I appreciate the discussion… much of this is outside of my wheelhouse.

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Originally Posted by MultiVerse

The profit on the futures contract would offset the decline in the value of the bank's Treasury portfolio due to the rise in interest rates, thereby reducing the bank's interest rate risk.

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I know you’re speaking generally, but what killed SVB wasn’t really IRR. It was liquidity risk (exacerbated by IRR, granted). Remember the bulk of their portfolio was HTM, and treasuries HTM are still a source of liquidity with FHLB and direct with the fed, though at market, not par (BTFP flipped that to par, not market). Reading recently that they were trying their damndest to get in front of the run using this source of liquidity and missed the mark by hours, if not minutes, because nobody is apparently gonna miss happy hour just to prevent a bank failure. One of those DR type scenarios that nobody expects to actually happen.

Hedging may have been a great idea, but I don’t think it would have made any difference in this scenario. At all. Unless hedging the treasuries would have made them more liquid somehow?

Not arguing that they did everything right by any stretch, just doggedly holding on to the notion that they weren’t quite as idiotic as we all would like them to be because them being morons makes us feel better, either about ourselves or about the security of the world. And that should give you some small pause.

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Originally Posted by MultiVerse

Jimmy provided one way of doing it. Another way is interest rate futures contracts. It's easier to show how it works with equations because you can see the math. I typed up a simple example below but it really is a toy example and might not make things any clearer. In reality, banks use a range of financial instruments, including interest rate futures contracts, to hedge against interest rate risk of U.S. Treasuries, helping them to manage their portfolios and protect against potential losses.





In words, a bank could hedge against interest rate risk of U.S. Treasuries is by using interest rate futures contracts. Suppose the bank holds a portfolio of U.S. Treasuries and expects interest rates to rise, which would cause the value of the portfolio to decline. To hedge against this risk, the bank could enter into a futures contract where it agrees to sell Treasury bond futures at a fixed price on a specific date in the future.

For example, if the bank holds $10 million worth of U.S. Treasuries and expects interest rates to rise, it could enter into a futures contract to sell $10 million worth of Treasury bond futures at a fixed price of 102.00. If interest rates do rise, the value of the bank's Treasury portfolio would decline, but the bank would make a profit on the futures contract because it would be able to sell the futures at a higher price than the prevailing market price. The profit on the futures contract would offset the decline in the value of the bank's Treasury portfolio, thereby reducing the bank's interest rate risk.

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I find all of this really interesting as a complete moran. So clearly I'm not understanding all of this, especially when acronyms are thrown in. Thank you Google.

Question, so the bank enters into a futures contract to sell at 102.00, who exactly is buying that and what is the benefit for the other party? How are they making a profit? Everyone is in the game to win, that's the confusing part for me. I guess the hedging all over the place is to balance out any losses is just beyond my scope.

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Originally Posted by Mustonen

Hedging may have been a great idea, but I don’t think it would have made any difference in this scenario. At all. Unless hedging the treasuries would have made them more liquid somehow?

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A recurring theme here has been they were illiquid but not insolvent. That's more or less the point of post #17727 above. Hedging might have helped SVB avoid the need to raise capital, which is normal, thus avoiding Peter Theil's attention. But yeah, no bank of SVB's size is liquid enough to survive a -$42billion single day run.

There is a solution. We could allow narrow banks for business banking. A narrow bank would invest deposits in interest-bearing reserves at the Fed and then provide business services for a small fee. A narrow bank would be safe. There would be no need for deposit insurance, for risk regulation, or for capital requirements.

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Originally Posted by jackstraw

Question, so the bank enters into a futures contract to sell at 102.00, who exactly is buying that and what is the benefit for the other party? How are they making a profit? Everyone is in the game to win, that's the confusing part for me. I guess the hedging all over the place is to balance out any losses is just beyond my scope.

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The full complexity of markets, let alone how things will look in the future, is beyond anyone's comprehension. All anyone can do is use abstractions and simplifications to try an make useful predictions.

At an elemental level you have “speculators” and “hedgers.” Speculators are trading primarily to expand opportunities or returns in the future. The hedger trades mainly to preserve existing opportunities in their portfolios. They're both making bets about the state of the world at different times. Market claims on these bets in the various states of the world are constantly being passed back and forth between and within these two groups of transactors.

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Originally Posted by Mustonen

I appreciate the discussion… much of this is outside of my wheelhouse.



I know you’re speaking generally, but what killed SVB wasn’t really IRR. It was liquidity risk (exacerbated by IRR, granted). Remember the bulk of their portfolio was HTM, and treasuries HTM are still a source of liquidity with FHLB and direct with the fed, though at market, not par (BTFP flipped that to par, not market). Reading recently that they were trying their damndest to get in front of the run using this source of liquidity and missed the mark by hours, if not minutes, because nobody is apparently gonna miss happy hour just to prevent a bank failure. One of those DR type scenarios that nobody expects to actually happen.

Hedging may have been a great idea, but I don’t think it would have made any difference in this scenario. At all. Unless hedging the treasuries would have made them more liquid somehow?

Not arguing that they did everything right by any stretch, just doggedly holding on to the notion that they weren’t quite as idiotic as we all would like them to be because them being morons makes us feel better, either about ourselves or about the security of the world. And that should give you some small pause.

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You’re buying insurance. It’s not free, it digs into profits, but pigs get slaughtered. Like these morons.

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Originally Posted by Cono Este

Professionals rarely take naked positions. 90% of volume involves somekind of arbitrage.....
You are correct though, it’s not free. Take Mark Cuban for example. I chuckle when he talks about the massive risk reversal he put on in the otc mkt, with whatever that company was that bought ........So long as the stock did not gap down, they made a fortune. He should have just sold the shares, but the risk reversal was probably more liquid and under the table. But hey, happy customer, even if ignorant. Probably cost him 5%.

I’d rather make a nickel risk free than bet a dollar.

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Cuban' company was broadcast.com bought by YHOO. He got YHOO shares but was locked up. His contract allowed him to hedge his YHOO position and he did. A wise move

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Originally Posted by Cono Este

You’re buying insurance. It’s not free, it digs into profits, but pigs get slaughtered. Like these morons.

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Yeah, like I said. Whatever makes you feel better.

Neither earnings nor capital killed them - both were adequate and they could have ridden out both for quite some time.

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Originally Posted by MultiVerse

A recurring theme here has been they were illiquid but not insolvent. That's more or less the point of post #17727 above. Hedging might have helped SVB avoid the need to raise capital, which is normal, thus avoiding Peter Theil's attention. But yeah, no bank of SVB's size is liquid enough to survive a -$42billion single day run.

There is a solution. We could allow narrow banks for business banking. A narrow bank would invest deposits in interest-bearing reserves at the Fed and then provide business services for a small fee. A narrow bank would be safe. There would be no need for deposit insurance, for risk regulation, or for capital requirements.

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I wonder what the exec team bonus structure looked like? They didn’t NEED capital by any measure, and they didn’t really NEED the earnings potential afforded by liquidating those investments. It’s not entirely illogical that they would do what they did, but I wonder if they were influenced by some language within their contract that caused them to act less than rationally, if they actually had any clue how tenuous their situation was?

For Mustonen and other finance reg dorks

https://www.economist.com/finance-an...ons-of-dollars

"“America’s banks are missing hundreds of billions of dollars
How the Federal Reserve drained the financial system of deposits

Mar 21st 2023

The Federal Reserve's decision next week could nudge rates even higher, and that jump in borrowing costs is catching some businesses, investors and households by surprise. It is easy to understand how money gets destroyed in a traditional bank run. Picture the men in top hats yelling at clerks in “Mary Poppins”. The crowds want their cash and bank tellers are trying to provide it. But when customers flee, staff cannot satisfy all comers before the institution topples. The remaining debts (which, for banks, include deposits) are wiped out.

This is not what happens in the digital age. The depositors fleeing Silicon Valley Bank (svb) did not ask for notes and coins. They wanted their balances wired elsewhere. Nor were deposits written off when the bank went under. Instead, regulators promised to make svb’s clients whole. Although the failure of the institution was bad news for shareholders, it should not have reduced the aggregate amount of deposits in the banking system.

The odd thing is that deposits in American banks are nevertheless falling. Over the past year those in commercial banks have sunk by half a trillion dollars, a fall of nearly 3%. This makes the financial system more fragile, since banks must shrink to repay their deposits. Where is the money going?

The answer begins with money-market funds, low-risk investment vehicles that park money in short-term government and corporate debt. Such funds, which yield only slightly more than a bank account, saw inflows of $121bn last week as svb failed. According to the Investment Company Institute, an industry outfit, in March they had $5.3trn of assets, up from $5.1trn a year before.

But money does not actually flow into these funds, for they are unable to take deposits. Instead, cash leaving a bank for a money-market fund is credited to the fund’s bank account, from which it is used to purchase the commercial paper or short-term debt in which the fund wants to invest. When the fund uses the cash in this way, it then flows into the bank account of whichever institution sells the asset. Inflows to money-market funds should thus shuffle deposits around the banking system, not force them out.

And that is what used to happen. Yet there is one new way in which money-market funds may suck deposits from the banking system: the Federal Reserve’s reverse-repo facility, which was introduced in 2013. The scheme was a seemingly innocuous change to the financial system’s plumbing that may, just under a decade later, be having a profoundly destabilising impact on banks.

In a usual repo transaction a bank borrows from competitors or the central bank and deposits collateral in exchange. A reverse repo does the opposite. A shadow bank, such as a money-market fund, instructs its custodian bank to deposit reserves at the Fed in return for securities. The scheme was meant to aid the Fed’s exit from ultra-low rates by putting a floor on the cost of borrowing in the interbank market. After all, why would a bank or shadow bank ever lend to its peers at a lower rate than is available from the Fed?

But use of the facility has jumped in recent years, owing to vast quantitative easing (qe) during covid-19 and regulatory tweaks which left banks laden with cash. qe creates deposits: when the Fed buys a bond from an investment fund, a bank must intermediate the transaction. The fund’s bank account swells; so does the bank’s reserve account at the Fed. From the start of qe in 2020 to its end two years later, deposits in commercial banks rose by $4.5trn, roughly equal to the growth in the Fed’s own balance-sheet.

For a while the banks could cope with the inflows because the Fed eased a rule known as the “Supplementary Leverage Ratio” (slr) at the start of covid. This stopped the growth in commercial banks’ balance-sheets from forcing them to raise more capital, allowing them to safely use the inflow of deposits to increase holdings of Treasury bonds and cash. Banks duly did so, buying $1.5trn of Treasury and agency bonds. Then in March 2021 the Fed let the exemption from the slr lapse. Banks found themselves swimming in unwanted cash. They shrank by cutting their borrowing from money-market funds, which instead parked cash at the Fed. By 2022 the funds had $1.7trn deposited overnight in the Fed’s reverse-repo facility, compared with a few billion a year earlier.

After svb’s fall, America’s smaller banks fear deposit losses. Monetary tightening has made them even more likely. Use of money-market funds rises along with rates, as Gara Afonso and colleagues at the Federal Reserve Bank of New York find, since returns adjust faster than bank deposits. Indeed, the Fed has raised the rate on overnight-reverse-repo transactions from 0.05% in February 2022 to 4.55%, making it far more alluring than the going rate on bank deposits of 0.4%. The amount money-market funds parked at the Fed in the reverse-repo facility—and thus outside the banks—jumped by half a trillion dollars in the same period.

A licence to print money

For those lacking a banking licence, leaving money at the repo facility is a better bet than leaving it in a bank. Not only is the yield higher, but there is no reason to worry about the Fed going bust. Money-market funds could in effect become “narrow banks”: institutions that back consumer deposits with central-bank reserves, rather than higher-return but riskier assets. A narrow bank cannot make loans to firms or write mortgages. Nor can it go bust.

The Fed has long been sceptical of such institutions, fretting that they would undermine banks. In 2019 officials denied tnb usa, a startup aiming to create a narrow bank, a licence. A similar concern has been raised about opening the Fed’s balance-sheet to money-market funds. When the reverse-repo facility was set up, Bill Dudley, president of the New York Fed at the time, worried it could lead to the “disintermediation of the financial system”. During a financial crisis it could exacerbate instability with funds running out of riskier assets and onto the Fed’s balance-sheet.

There is no sign yet of a dramatic rush. For now, the banking system is dealing with a slow bleed. But deposits are growing scarcer as the system is squeezed—and America’s small and mid-sized banks could pay the price. “

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Originally Posted by MultiVerse

A recurring theme here has been they were illiquid but not insolvent. That's more or less the point of post #17727 above. Hedging might have helped SVB avoid the need to raise capital, which is normal, thus avoiding Peter Theil's attention. But yeah, no bank of SVB's size is liquid enough to survive a -$42billion single day run.

There is a solution. We could allow narrow banks for business banking. A narrow bank would invest deposits in interest-bearing reserves at the Fed and then provide business services for a small fee. A narrow bank would be safe. There would be no need for deposit insurance, for risk regulation, or for capital requirements.



The full complexity of markets, let alone how things will look in the future, is beyond anyone's comprehension. All anyone can do is use abstractions and simplifications to try an make useful predictions.

At an elemental level you have “speculators” and “hedgers.” Speculators are trading primarily to expand opportunities or returns in the future. The hedger trades mainly to preserve existing opportunities in their portfolios. They're both making bets about the state of the world at different times. Market claims on these bets in the various states of the world are constantly being passed back and forth between and within these two groups of transactors.

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They were insolvent if the mark to market rule still existed, which it should.

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Originally Posted by rod9301

which it should.

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Why?

Because Tyler Durden said so. In fever swamps there are folks who want to see it all burn and history shows, 1930s & 2007, mark-to-market accounting is one way to ensure that happens.

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Originally Posted by MultiVerse

Because Tyler Durden said so. In fever swamps there are folks who want to see it all burn and history shows, 1930s & 2007, mark-to-market accounting is one way to ensure that happens.

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FAS157 post 2009 assumes an orderly market sale, not a fire sale/forced sale, so it wouldn’t have the same effect. Not following it is a gross misrepresentation of a company’s actual financial position because you’re completely ignoring liquidity.

Mark-to-market accounting a la FAS157 increases transparency and accuracy in bank accounting by requiring the use of observable market data to determine fair value. However, it can also increased the volatility of bank financial statements, particularly during times of market turbulence.

Excessive volatility in financial markets can exacerbate economic downturns. It can result in "herd mentality" among investors, where they all rush to sell assets at the same time in response to market fluctuations, causing prices to spiral downward. It comes down to whether prices quoted in financial markets are always reflective of the true value of an asset, and whether market prices could be influenced by factors such as speculation or panic selling.

So it works both ways. It increases transparency & accuracy at times when prices are stable and it also affects the economy by amplifying financial market problems. Mark-to-market accounting could also encourage banks to take on excessive risk, as they may be more likely to invest in risky assets if they believe they can quickly adjust the value of those assets to reflect market fluctuations.

Here's a good overview from an economics perspective: https://www.forbes.com/2009/02/23/ma..._stimulus.html

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Originally Posted by MultiVerse

Mark-to-market accounting a la FAS157 increases transparency and accuracy in bank accounting by requiring the use of observable market data to determine fair value. However, it can also increased the volatility of bank financial statements, particularly during times of market turbulence.

Excessive volatility in financial markets can exacerbate economic downturns. It can result in "herd mentality" among investors, where they all rush to sell assets at the same time in response to market fluctuations, causing prices to spiral downward. It comes down to whether prices quoted in financial markets are always reflective of the true value of an asset, and whether market prices could be influenced by factors such as speculation or panic selling.

So it works both ways. It increases transparency & accuracy at times when prices are stable and it also affects the economy by amplifying financial market problems. Mark-to-market accounting could also encourage banks to take on excessive risk, as they may be more likely to invest in risky assets if they believe they can quickly adjust the value of those assets to reflect market fluctuations.

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Financial statements are a snapshot of a firms financial standing. If you don’t need the liquidity you can hold these things as HTM, but if you need to claim them as liquid assets you have to mark them to current realities. Again, the 2009 changes reduce the “amplifying market problems”, or at least eliminate that as a real excuse. Blaming fair value for that has always been a copout for shitty management/investing.

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Originally Posted by MultiVerse

Here's a good overview from an economics perspective: https://www.forbes.com/2009/02/23/ma..._stimulus.html

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Check the date.

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Originally Posted by rod9301

They were insolvent if the mark to market rule still existed, which it should.

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While we're at it lets apply mark to market to homeowners, car owners, small business owners as well. Underwater on a loan but still generating cash flow to make the payments? Sorry it's the banks now. Same basic idea.

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Originally Posted by MultiVerse

Yeah, we're talking about two different things at the same time: FAS157 specifically and mark-to-market accounting in the abstract sense.

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Fair value and mark to market are the exact same thing.