Is the stock market going to tank?

[LeeLau]

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. “

[rod9301]

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.

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

Sent from my moto g 5G using Tapatalk

[Mustonen]

which it should.

Sent from my moto g 5G using Tapatalk

Why?

[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.

[JimmyCarter]

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.

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.

[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.

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

[JimmyCarter]

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.

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.

[JimmyCarter]

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

Check the date.

[RoooR]

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

Sent from my moto g 5G using Tapatalk

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.

[JimmyCarter]

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

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

[JimmyCarter]

See the link above

And again, look at the dates covered.

[4matic]

Mark to market is not as simple as a last sale price. Last sale price is just that. It could have been for one share or one contract. Not 10 million. Oil is a good example. Big transactions are rarely made at the market price so mark to market does not represent market price

[MultiVerse]

And again, look at the dates covered.

Ok, to your point, after the financial crisis of 2008, there were changes made to SFAS 157 that were intended to address concerns about the impact of mark-to-market accounting on market volatility. The changes allowed for more flexibility in the use of fair value measurements and provided more guidance on how to determine fair value. Fair enough.

However, there is still some academic research that suggests that accounting rules, including updated SFAS 157, can contribute to increased market volatility. For example, one study published in the Journal of Accounting and Economics in 2018 examined the impact of mark-to-market accounting on the volatility of bank stocks. The study found that mark-to-market accounting was associated with increased volatility during the financial crisis and that this effect was particularly pronounced for banks with high levels of fair value assets.

And to 4matic's point, another study published in the Journal of Financial Economics in 2017 examined the impact of fair value accounting on the volatility of commodity prices. The study found that the use of fair value accounting by financial investors, such as hedge funds and commodity index funds, could lead to increased volatility in commodity prices.

These studies suggest that accounting rules, including updated SFAS 157, can have a significant impact on market volatility, particularly during times of market stress.

[JimmyCarter]

What paper?

[MultiVerse]

I came to the same conclusion and deleted the post prior to seeing your response. Here are two better more recent, 2018 & 2019, studies referenced in the post above reaching similar conclusions:

https://www.sciencedirect.com/scienc...65410107000286

https://www.tandfonline.com/doi/abs/...aj.v62.n2.4083

[JimmyCarter]

Ok, to your point, after the financial crisis of 2008, there were changes made to SFAS 157 that were intended to address concerns about the impact of mark-to-market accounting on market volatility. The changes allowed for more flexibility in the use of fair value measurements and provided more guidance on how to determine fair value. Fair enough.

However, there is still some academic research that suggests that accounting rules, including updated SFAS 157, can contribute to increased market volatility. For example, one study published in the Journal of Accounting and Economics in 2018 examined the impact of mark-to-market accounting on the volatility of bank stocks. The study found that mark-to-market accounting was associated with increased volatility during the financial crisis and that this effect was particularly pronounced for banks with high levels of fair value assets.

And to 4matic's point, another study published in the Journal of Financial Economics in 2017 examined the impact of fair value accounting on the volatility of commodity prices. The study found that the use of fair value accounting by financial investors, such as hedge funds and commodity index funds, could lead to increased volatility in commodity prices.

These studies suggest that accounting rules, including updated SFAS 157, can have a significant impact on market volatility, particularly during times of market stress.

“Telling investors how bad things currently are can influence their decision making” doesn’t really sound like a problem to me.

[JimmyCarter]

I came to the same conclusion and deleted the post prior to seeing your response.

Noted, thanks.

[MultiVerse]

“Telling investors how bad things currently are can influence their decision making” doesn’t really sound like a problem to me.

Now we're just circling around the original point. 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, despite accounting standards updates.

[JimmyCarter]

Now we're just circling around the original point. 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.

Efficient markets require access to all relevant information, which tends to be in short supply during most crises, but that doesn’t change the fact that assets are changing hands at those prices so people are making real money decisions and not hypotheticals.

[MultiVerse]

Right, the efficient markets hypothesis goes to heart of the matter. If a person believes markets are always efficient and there's never any behavioral factors during times of stress then ignore the history of banking crises and the academic research... it comes down to the point made here repeatably this past week: fixing financial market problems requires time and growth. Time to work things out and growth to make working those things out easier. Mark-to-market accounting takes both of these away during times of stress.

[Mustonen]

“Telling investors how bad things currently are can influence their decision making” doesn’t really sound like a problem to me.

Impairment, sure, but if principal balances are guaranteed why should anybody have to write off all their capital just to recover it until maturity if they consider it HTM? That doesn’t represent reality at all, even if it’s some kind of ad hoc expression of liquidity through capital position (which feels dubious). It’s all just accounting, and given that unrealized gain/loss represents a very prominent home on the balance sheet I expect a discerning investor has no problem identifying that particular weakness without the morans of the world starting a bank run because they don’t understand what HTM means.

[rod9301]

Impairment, sure, but if principal balances are guaranteed why should anybody have to write off all their capital just to recover it until maturity if they consider it HTM? That doesn’t represent reality at all, even if it’s some kind of ad hoc expression of liquidity through capital position (which feels dubious). It’s all just accounting, and given that unrealized gain/loss represents a very prominent home on the balance sheet I expect a discerning investor has no problem identifying that particular weakness without the morans of the world starting a bank run because they don’t understand what HTM means.

It's not just accounting, these are real losses.
If you invest in a bond that pays 2 percent, and inflation goes to 6 percent you are losing money holding it to maturity.

Sent from my moto g 5G using Tapatalk

[MultiVerse]

It's not just accounting, these are real losses.
If you invest in a bond that pays 2 percent, and inflation goes to 6 percent you are losing money holding it to maturity.

Just here to say change over time is a thing, and it matters.

[JimmyCarter]

Impairment, sure, but if principal balances are guaranteed why should anybody have to write off all their capital just to recover it until maturity if they consider it HTM? That doesn’t represent reality at all, even if it’s some kind of ad hoc expression of liquidity through capital position (which feels dubious). It’s all just accounting, and given that unrealized gain/loss represents a very prominent home on the balance sheet I expect a discerning investor has no problem identifying that particular weakness without the morans of the world starting a bank run because they don’t understand what HTM means.

Time value of money. If you can wait that long, it’s worth X. If you need it now, it’s worth X-

That’s why HTM is allowed, but also why SVB was fucked by dried up funding, because deposit outflows forced them out of HTM.

[Mustonen]

It's not just accounting, these are real losses.
If you invest in a bond that pays 2 percent, and inflation goes to 6 percent you are losing money holding it to maturity.

Sent from my moto g 5G using Tapatalk

No, I’m losing value. I don’t lose any dollars. It’s just a balance sheet entry either way. Not blowing away my capital doesn’t mean I’m not paying attention to NEV, either.