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The collapse of Silicon Valley Bank last week sent investors into a panic as it highlighted a larger problem in the banking sector: The widening gap between the value big lenders place on the bonds they own and their market value.
SVB’s decline was linked, in part, to the plunge in the value of bonds it acquired during boom times, when lots of customer deposits were coming in and it needed somewhere to park its cash.
But SVB is not the only institution with this problem. U.S. banks had $620 billion in unrealized losses (assets that have fallen in value but not yet been sold) at the end of 2022, according to the FDIC.
What happens: When interest rates were near zero, US banks hoarded a lot of bonds and notes. Now, as the Federal Reserve raises interest rates to fight inflation, those bonds have declined in value.
When interest rates rise, newly issued bonds start paying higher interest rates to investors, which makes older bonds with lower interest rates less attractive and less valuable.
The result is that most banks have some unrealized losses on their books.
“The current interest rate environment has had dramatic effects on the profitability and risk profile of banks’ funding and investment strategies,” FDIC Chairman Martin Gruenberg said in prepared remarks at the Institute of International Bankers last week.
“Unrealized losses weaken a bank’s future ability to meet unexpected liquidity needs,” he added.
In other words, banks may find they have less cash than they thought – especially when they need it – because their securities are worth less than they expected.
“Many institutions — from central banks, commercial banks and pension funds — have assets that are worth significantly less than what is reported in their financial statements,” said Jens Hagendorff, professor of economics at King’s College London. “The resulting losses will be great and must be financed somehow. The scale of the problem is starting to cause concern.”
However, there is no reason to panic just yet, analysts say.
“[Falling bond prices are] only a real problem in a situation where your balance sheet is sinking pretty fast… [and you] you have to sell assets that you wouldn’t normally have to sell,” said Luc Plouvier, senior portfolio manager at Van Lanschot Kempen, a Dutch wealth management firm.
Most major U.S. banks are in good financial shape and will not be in a situation where they are forced to realize bond losses, Gruenberg said.
Shares of the biggest banks steadied on Friday after falling to their worst day in nearly three years on Thursday.
— Julia Horowitz and Anna Coobin contributed reporting.
Last week, Senator Elizabeth Warren spoke to Federal Reserve Chairman Jerome Powell about US job losses as potential casualties of the central bank’s battle against high inflation.
Warren, a frequent critic of the Fed leader, noted that an additional 2 million people would have to lose their jobs if the unemployment rate rose from its current rate of 3.6 percent to reach the Fed’s forecast of 4.6 percent. until the end of the year.
“If you could speak directly to the two million working people who have decent jobs today, whom you plan to lay off next year, what would you say to them?” Warren asked.
Powell argued that all Americans, not just two million, are suffering from high inflation.
“Will workers be better off if we quit our jobs and inflation stays at 5% or 6%?” Powell replied.
Warren warned Powell that he was “playing with people’s lives.”
The debate was part of a larger cost-benefit analysis debate that keeps cropping up in the labor market: What’s worse – widespread work loss or increased inflation?
CNN spoke with two leading financial analysts with different perspectives to gain a deeper understanding of the debate.
Below is our interview with Roosevelt Institute director Michael Konczal. Tomorrow you’ll hear from Johns Hopkins economics professor Laurence Ball.
This interview has been edited for length and clarity.
Before the bell: Do we need unemployment to rise to ease inflation rates?
Michael Konczal: The demand for labor is so high that we probably have the ability to take the heat out of the economy by slowing some measures of hiring — the attrition rate or the job opening rate, for example — that would allow wages to slow and shrink the economy, but not necessarily put many people out of work.
Powell argued that high inflation could be worse for the economy and people than rising unemployment. What is your take on this cost-benefit analysis?
What blew my mind was that Powell said that if he left his job inflation would stay at 5 or 6%. Inflation over the last three months wasn’t 6%, depending on what you look at, it wasn’t actually 5% either.
Inflation has a high cost when it’s at 5% or 6%, but when it drops to 2.5% or 3%, I’d like to know how urgent he thinks it is to get that last mile to 2% inflation meant that two million plus people were unemployed. I think the dirty secret is that economists can’t really tell you what the downside is to inflation at 2.5% instead of 2% — there are some winners and some losers, but the net economic cost is less clear.
It will be really brutal on the labor market to reduce inflation in this last mile, it may involve trade-offs that are incredibly hard. I think it would be really devastating for so many people to lose their jobs over what is essentially a made up number [the 2% inflation target].
How serious do you think Powell is about sticking to his 2% inflation target?
Powell doesn’t want financial markets to get frothy or economic conditions to loosen, so he has to look hawkish, even if he doesn’t want to be that hawkish. On the other hand, they are playing with live ammunition. This is real, millions of people will lose their jobs if the Fed does what it says it wants to do.
