Silicon Valley Bank’s collapse last week sparked significant concern among investors, revealing a broader issue within the banking sector: the growing disparity between the value that large banks assign to their bonds and their actual market worth.
SVB’s failure was partly due to a significant drop in the value of bonds it acquired during a period of high customer deposits and low interest rates.
However, SVB is not the only bank facing this challenge. At the end of 2022, U.S. banks had accumulated $620 billion in unrealized losses, which are assets that have decreased in value but have not yet been sold, according to the FDIC.
The problem arose because, during a time of low interest rates, U.S. banks purchased large quantities of Treasuries and bonds. As the Federal Reserve has since raised interest rates to combat inflation, these bonds have depreciated in value.
When interest rates increase, new bonds offer higher yields, making older bonds with lower yields less attractive and reducing their value. Consequently, many banks are experiencing unrealized losses on their holdings.
“The current interest rate environment has had dramatic effects on the profitability and risk profile of banks’ funding and investment strategies,” said FDIC Chairman Martin Gruenberg in prepared remarks at the Institute of International Bankers last week.
“Unrealized losses weaken a bank’s future ability to meet unexpected liquidity needs,” Gruenberg explained. Essentially, banks may find themselves with less cash available than anticipated because their securities are worth less than projected.
“Many institutions — from central banks, commercial banks, and pension funds — hold assets that are valued significantly lower than reported in their financial statements,” said Jens Hagendorff, a finance professor at King’s College London.
“The resulting losses will be substantial and will need to be addressed somehow. The scale of the problem is beginning to cause concern.”
Despite these concerns, analysts advise against panic.
“[Falling bond prices are] only a real problem if your balance sheet is deteriorating quickly, and you need to sell assets that you wouldn’t normally sell,” said Luc Plouvier, senior portfolio manager at Van Lanschot Kempen, a Dutch wealth management firm.
Most large U.S. banks are financially stable and unlikely to be forced to realize bond losses, said Gruenberg. Shares of major banks stabilized on Friday after experiencing their worst day in nearly three years on Thursday.
In another development last week, Senator Elizabeth Warren questioned Federal Reserve Chair Jerome Powell about potential job losses resulting from the central bank’s efforts to combat high inflation.
Warren, a frequent critic of Powell, pointed out that an additional 2 million jobs could be lost if the unemployment rate rises from its current 3.6% to the Fed’s projected 4.6% by year-end.
“If you could speak directly to the two million hardworking people who have decent jobs today, who you’re planning to get fired over the next year, what would you say to them?” Warren asked.
Powell responded by arguing that all Americans are suffering due to high inflation, not just those potentially losing their jobs.
“Will working people be better off if we simply walk away from our jobs and inflation remains at 5% or 6%?” Powell replied.
Warren warned Powell that he was “gambling with people’s lives.”
The debate centers on the trade-off between widespread job losses and persistent high inflation. CNN interviewed two top economic analysts with differing views on the issue.
The following is an interview with Michael Konczal, director of the Roosevelt Institute, with insights from Johns Hopkins economics professor Laurence Ball to follow.
