it's a kind of Ponzi scheme. but also the gullible belief by the first investors to believe the credibility and words of a government whose secret policy is inflation, if not hyperinflation
Although not discussed in this article, TIPS now offer a positive real return, with the caveat that CPI might not measure true cost of living. Inflation is an inevitable condition of a fiat currency system. It’s only a matter of how severe inflation will get.
When my children were much younger and I was trying to explain the concepts you just described, I told them that bond buying and selling was a playground for those who love math and can apply math to the real world. Nowadays, all of this is computerized but understanding the concepts, as you demonstrated, is still critical. My more recent message: Don't get involved in games that you don't understand. Thanks for the refresher.
Too late for SVB. They needed this in 2020 apparently. Always do front loaded bond ladders when rates are terrible. (that is if you really must buy bonds at all)
As always, thank you, Ravi. I am just learning about treasuries and have a few ibonds, which were my very first bond purchases. I recently bought some short-term treasury bills, with the eye for possibly needing or wanting cash, soon.
I was aghast that SVB didn't figure that out!
It's a good lesson in people letting their needs blind them to reality. May we be forever mindful! I also understand that short-term is not the same as cash in hand, but it's something I need to walk through. Thanks, again. :)
Appreciate the simple explanation. I will use with my clients who need a primer on the relationship between bonds and interest rates.
Really mind blowing executives at a bank with billions of dollars wouldn't take the steps to mitigate interest rate risk. It's not like the fed surprised anyone with rate hikes. Maybe they happened much faster than expected, but they were very clear with their intention to raise from the beginning of 2022.
Nice explanation. The only point I would add is that if our bond investor needs to sell his low interest bond before maturity, he will be taking a loss, but this is not different if he retains the bond. The loss has already been sustained. Selling the bond just means that, for tax and accounting purposes, he is realizing the loss that he had already sustained because of interest rate changes. Likewise, SVB was already insolvent before it started selling its held-to-maturity bonds.
Yes, in the sense that even if he retains the bond, he must accept receiving interest that is far below the current rate. From an economic standpoint, what he owns is worth around $800K, not $1 million, whether he holds it or sells it. However, the loss is not crystallized unless he sells. Of course, this is precisely the situation that faced SVB in their "held to maturity" portfolio when they actually had to go and sell securities to meet deposit withdrawals.
SVB was insolvent when measuring their fixed income portfolio at market (as detailed here: https://rationalwalk.substack.com/p/the-fall-of-silicon-valley-bank) but as a going concern, it was expected that they would not be forced to sell the bonds. That's the logic behind the GAAP accounting for banks which should always have been more carefully scrutinized by investors, (large) depositors, and regulators. And of course, the problem extends way beyond SVB, one reason the Fed has offered to loan against collateral at par to avoid banks having to crystallize the losses to meet withdrawal of deposits.
Thanks for the explanation. Best layman explanation I’ve read on the relationship between interest rates and bonds. And I’ve looked.
Great read.
it's a kind of Ponzi scheme. but also the gullible belief by the first investors to believe the credibility and words of a government whose secret policy is inflation, if not hyperinflation
Although not discussed in this article, TIPS now offer a positive real return, with the caveat that CPI might not measure true cost of living. Inflation is an inevitable condition of a fiat currency system. It’s only a matter of how severe inflation will get.
When my children were much younger and I was trying to explain the concepts you just described, I told them that bond buying and selling was a playground for those who love math and can apply math to the real world. Nowadays, all of this is computerized but understanding the concepts, as you demonstrated, is still critical. My more recent message: Don't get involved in games that you don't understand. Thanks for the refresher.
This is great, thanks for sharing
Too late for SVB. They needed this in 2020 apparently. Always do front loaded bond ladders when rates are terrible. (that is if you really must buy bonds at all)
Thank you Rational.
As always, thank you, Ravi. I am just learning about treasuries and have a few ibonds, which were my very first bond purchases. I recently bought some short-term treasury bills, with the eye for possibly needing or wanting cash, soon.
I was aghast that SVB didn't figure that out!
It's a good lesson in people letting their needs blind them to reality. May we be forever mindful! I also understand that short-term is not the same as cash in hand, but it's something I need to walk through. Thanks, again. :)
Helpful explanation. Thanks.
Appreciate the simple explanation. I will use with my clients who need a primer on the relationship between bonds and interest rates.
Really mind blowing executives at a bank with billions of dollars wouldn't take the steps to mitigate interest rate risk. It's not like the fed surprised anyone with rate hikes. Maybe they happened much faster than expected, but they were very clear with their intention to raise from the beginning of 2022.
Nice explanation. The only point I would add is that if our bond investor needs to sell his low interest bond before maturity, he will be taking a loss, but this is not different if he retains the bond. The loss has already been sustained. Selling the bond just means that, for tax and accounting purposes, he is realizing the loss that he had already sustained because of interest rate changes. Likewise, SVB was already insolvent before it started selling its held-to-maturity bonds.
Yes, in the sense that even if he retains the bond, he must accept receiving interest that is far below the current rate. From an economic standpoint, what he owns is worth around $800K, not $1 million, whether he holds it or sells it. However, the loss is not crystallized unless he sells. Of course, this is precisely the situation that faced SVB in their "held to maturity" portfolio when they actually had to go and sell securities to meet deposit withdrawals.
SVB was insolvent when measuring their fixed income portfolio at market (as detailed here: https://rationalwalk.substack.com/p/the-fall-of-silicon-valley-bank) but as a going concern, it was expected that they would not be forced to sell the bonds. That's the logic behind the GAAP accounting for banks which should always have been more carefully scrutinized by investors, (large) depositors, and regulators. And of course, the problem extends way beyond SVB, one reason the Fed has offered to loan against collateral at par to avoid banks having to crystallize the losses to meet withdrawal of deposits.