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Banking in uncertain times

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Re: Banking in uncertain times

#361

Post by fwlr »

lliamander wrote: post #338

So, I'm a layman here, but I feel like he makes narrow banking (i.e. full-reserve or maturity-matched banking) sound more dangerous than it probably is, for instance: > Take an exploding mortgage, the only way to finance homes in a dystopian alternate universe. It’s like the mortgages you are familiar with, except it is callable on demand by the bank. If you get the call and can’t repay the mortgage by the close of t…

An exploding mortgage wrapped in mortgage insurance has exactly the same shape as a conventional mortgage from a fractional reserve bank. The insurer would be doing something like “fractional reserve insurance”, i.e. only holding some fraction of the total insurance payout it’s liable for, and you’d have the same problems. If you legislate that insurers can’t do fractional reserve insuring, the cost of insurance would go up so high that the only people who could afford insurance are people who could plausibly afford to buy the house outright.

The reason “fractional reserves” keep creeping back in whenever you try to offer mortgages to more than just rich people is because fractional reserves are a way to invent money out of thin air, and you have to invent money out of thin air because the not-rich people buying the houses do not have the money to afford the house (but they can make that money if they focus on it for 10 or 20 or 30 years).

You often see people demand to know why banks are allowed to do fractional reserve banking. And this is the reason: it lets banks offer mortgages and credit cards to most of the public. Most people don’t have much money, but do have a lot of future earnings. Giving people access today to large chunks of their future earnings is a big social good but it fundamentally requires money to be invented from thin air, and that invented money is then gradually filled in with real money over time as the earnings come in.

So somebody somewhere has to be inventing trillions of dollars. This is risky. The capitalist way is to have private entities who profit when they manage their risk well, since that provides the strongest incentives for competency. And the democratic-capitalist way is to heavily regulate those private entities, eating some portion of their profit to provide some extra value to the public.

Re: Banking in uncertain times

#362

Post by amluto »

lordnacho wrote: post #104

As a former trading desk guy I struggle to see how the system allows things to be marked-to-cost. Or rather, why is it that we allow a bank to not mark-to-market a security for which there is a liquid market? Allowing the bank to pretend it has more assets than it actually has seems to be an invitation to hide risk. If they had to MTM their underwater bonds, they would would have been pushed to raise capital earlier,…

> It should be straight up "I have these deposit liabilities, I have this book of assets, oops, my assets are down a bit, lets do something about it". Instead of "I'm gonna run the gauntlet and hope the business survives until these bonds come in".

Have a read of Matt Levine:

https://archive.is/l4nLU

The “let’s do something about it” could actually be business as usual. Look at the “deposit beta” in that article: when interest rates increase, mean rates banks pay on deposits increase less. So you can have a bank with a low mark-to-market value (assume all deposits liquidate at par and securities are sold at mid-market), but that ignores the value of the enterprise itself. Or you can project forward (to a specific time or times, not necessarily to the arbitrary maturity of each security), and you may well find that you end up with enough money at every point in the future to be quite comfortable, assuming your deposits stick around and continue to earn less than market interest.

Imagine you worked at a magic trading desk where you could issue a very special bond: you borrow money right now, and you pay a floating interest rate that is set at 1/2 the federal funds rate. This is a great deal, but it comes with a catch: the bond holder can call the debt at any time, which they will do on occasion at random but will do en masse if they don’t like you. Also, people can lend you money on these terms and you have to accept the deal. How would you make money on these? How would you account for them?

I agree that HTM accounting, done carelessly, can lead to wrong conclusions.

Re: Banking in uncertain times

#363

Post by jessaustin »

peripitea wrote: post #318
floathub wrote: post #55

The claim that, "when interest rates rise, all asset prices must fall" seems, uhm, somewhat off. If this were true, it would be trivial to stop and reverse inflation (i.e. deflate) with any increase in interest rates (?). While it's certainly useful to think about prices as signals that, "embed an interest rate derivative", it seems a stretch to claim every single one of those derivatives is perfectly negatively corr…

Yes, but you don't want to deflate for other (often worse) reasons. So could they raise interest rates to 10% and kill inflation? Easily. The trick is in raising them to the appropriate level to curb inflation without suffocating the economy.

They have already raised rates enough to suffocate the economy; this episode is just one example. They have not raised rates enough to kill inflation, because the inflation we're seeing today is due to input costs and monopoly rents. The interest rate could be 15% and it wouldn't change those facts.

The real reason interest rates are rising is to kill the infant unionization trend in its crib. SVB is just collateral damage.

Re: Banking in uncertain times

#364

Post by gumby »

landemva wrote: post #344
gumby wrote: post #267

Earlier quoted context omitted.

> As a former trading desk guy I struggle to see how the system allows things to be marked-to-cost. Or rather, why is it that we allow a bank to not mark-to-market a security for which there is a liquid market? Many of their assets aren't really fungible either. Mortgages are the canonical example: yes they can now be turned into MBS, but your local credit union just issues and holds them). The same is true of the co…

> your local credit union just issues and holds them [mortgages] I was on BoD of a CU. About the only thing we didn't resell were loans which did not conform. The business was to originate, quickly resell, and do some more.

Thanks for this info!

Re: Banking in uncertain times

#365

Post by jessaustin »

Der_Einzige wrote: post #89
floathub wrote: post #55

The claim that, "when interest rates rise, all asset prices must fall" seems, uhm, somewhat off. If this were true, it would be trivial to stop and reverse inflation (i.e. deflate) with any increase in interest rates (?). While it's certainly useful to think about prices as signals that, "embed an interest rate derivative", it seems a stretch to claim every single one of those derivatives is perfectly negatively corr…

Not sure why you wrote this since nearly all prices are falling right now, directly due to interest rate hikes. How could you conclude that an interest rate hikes wouldn't reduce all asset prices?

If "nearly all prices" really were falling, wouldn't that show up on this chart?

https://fred.stlouisfed.org/series/CPIAUCSL

Re: Banking in uncertain times

#366

Post by s1artibartfast »

chordalkeyboard wrote: post #356
s1artibartfast wrote: post #351

Earlier quoted context omitted.

Im fine with your terminology and reference. The current date (or that of reporting) can be the reference time for a real dollar valuation. I fully understand how bond market prices are impacted by interest rates. What most people seem ignorant of is the fact that bonds are not simply market trades asset, but are also have a value at maturity. Most people don't seem to know that HTM assets are reported separate from…

> It seems obvious to me that if you never intend to sell a bond, the maturity value is a measure of interest. The reason this matters is because in the case of a bank who needs the funds to operate then they very much might need to sell the bonds, or revalue them at NPV because of statutory requirements. This entire discussion is because the NPV of HTM assets is now relevant.

That doesn't mean it is universally relevant, nor does it mean it is more relevant than the maturity value in the asset table.

Most importantly, Banks already DO report the unrealized losses and Fair market value on HTM securities. Just not in the assists section, but in a dedicated section on the HTM assets. It is not some big secret.

You can even look at it in silicon valley Banks filings if you want(1). They break down the HTM losses and fair market value plain as day starting on page 125.

At the time of filing, they reported a mature value of 91 billion, fair value of 76 million, and unrealized losses of 15 billion. They break it down by the duration of maturity and interest they earn on them. Everything someone could ask for is there.

It seems to me that this whole question of reporting fair market value instead of maturity in the asset table comes from people who have never read a 10-k filing and think there is some conspiracy.

SVBs HTM loss situation should have been no surprise to anyone looking. The real conspiracy is their HTM position was common knowledge.

https://www.sec.gov/Archives/edgar/data/719739/0000719739230...

Re: Banking in uncertain times

#367

Post by ars »

echion wrote: post #116
lordnacho wrote: post #104

As a former trading desk guy I struggle to see how the system allows things to be marked-to-cost. Or rather, why is it that we allow a bank to not mark-to-market a security for which there is a liquid market? Allowing the bank to pretend it has more assets than it actually has seems to be an invitation to hide risk. If they had to MTM their underwater bonds, they would would have been pushed to raise capital earlier,…

> why is it that we allow a bank to not mark-to-market a security for which there is a liquid market? Because at maturity, the bank gets back its money. So it is perfectly valid to say "in ten years, this $100m bond is worth $100m...and I intend to hold it for ten years, so it's worth $100m [equivalent] today". The "I intend to hold it" is the relevant part of the valuation, though.

Let's extend your example - I have a bond that costs $1 today, but is worth $1,000 at maturity - except that maturity is in 1,000 years.

So, can the bank claim it has $1,000 now?

Re: Banking in uncertain times

#368

Post by bostik »

jnwatson wrote: post #282
bostik wrote: post #247

Earlier quoted context omitted.

From all the information I've gathered, there is an unstated aspect to this. If any number of HTM bonds are sold to cover withdrawals, then all of them must be revalued and losses realised on the whole lot.

What. That’s insane. Essentially, if your deposit modeling is off just a little bit, you’re dead.

I'll turn that around: if as a bank your risk modeling does not account for outlier events, you're dead. Because the way banks and bank accounts are used these days (eg. payroll providers), the society is not willing to accept the second-order effects. As OP's example, a payroll provider was using SVB as their bank to hold funds in transit in order to make payments to third parties. Result?

    Every regulator sees the world through a lens that was painstakingly crafted over decades. The FDIC institutionally looks at this fact pattern and sees this as a single depositor over the insured deposit limit. It does not see 300,000 bounced paychecks.
But back to your point. Banks are over collateralised. Let's take an example from just this week. Credit Suisse is in trouble - their collateral has gone from ~170% to ~150% - they have the collateral to cover their total deposits, but they don't have nearly enough of them as liquid assets to cover the increased outflows.

Until last week I didn't know about HTM ("hold to maturity") and AFS ("available for sale") categories. I have since been educated.

Re: Banking in uncertain times

#369

Post by lliamander »

fwlr wrote: post #361
lliamander wrote: post #338

So, I'm a layman here, but I feel like he makes narrow banking (i.e. full-reserve or maturity-matched banking) sound more dangerous than it probably is, for instance: > Take an exploding mortgage, the only way to finance homes in a dystopian alternate universe. It’s like the mortgages you are familiar with, except it is callable on demand by the bank. If you get the call and can’t repay the mortgage by the close of t…

An exploding mortgage wrapped in mortgage insurance has exactly the same shape as a conventional mortgage from a fractional reserve bank. The insurer would be doing something like “fractional reserve insurance”, i.e. only holding some fraction of the total insurance payout it’s liable for, and you’d have the same problems. If you legislate that insurers can’t do fractional reserve insuring, the cost of insurance woul…

You raise some interesting points. Let me see if I can address them.

> An exploding mortgage wrapped in mortgage insurance has exactly the same shape as a conventional mortgage from a fractional reserve bank. The insurer would be doing something like “fractional reserve insurance”, i.e. only holding some fraction of the total insurance payout it’s liable for, and you’d have the same problems.

They are similar in that in both cases we have an institution that may not be able to pay its obligations. Those kinds of risks will always be present in society. However, I do think that the shape of these risks are different in important ways.

First, in the full-reserve scenario, no money is being invented out of thin air. Insurance is a risk pooling scheme, that is it.

Second In a fractional-reserve system, bank runs are self-fulfilling prophesies, because the game-theoretic optimal move in the event of a bank run (or a reported bank run) is to run on the bank! Because no other conditions are necessary for a bank run (other than a widespread belief that one is happening) a bank run can literally be memed into existence. I believe that, to a certain extent, the functioning of a fractional reserve system relies on the general public being ignorant of how it actually works.

I don't think insurance acts like that. You can't make an insurance claim just because other people are doing it: you have to actually have a qualifying event. It also doesn't seem reasonable to assume that calling of the mortgage loans would start spreading just because of a rumor - there would have to be some other cause.

> You often see people demand to know why banks are allowed to do fractional reserve banking. And this is the reason: it lets banks offer mortgages and credit cards to most of the public. Most people don’t have much money, but do have a lot of future earnings. Giving people access today to large chunks of their future earnings is a big social good but it fundamentally requires money to be invented from thin air, and that invented money is then gradually filled in with real money over time as the earnings come in.

I think lending is an essential economic service, but I don't think the easy credit enabled by inventing money is a good thing. At a macro level, there are arguably all sorts of market distortions caused by too much money chasing too little "stuff" to invest in. At a micro-level, easy credit plus inflation incentivizes bad habits of spending money for instant gratification and discourages prudent saving and financial preparedness for most people.a instant gratification of spending more money noa instant gratification of spending more money no

Re: Banking in uncertain times

#370

Post by CraigJPerry »

HWR_14 wrote: post #352
CraigJPerry wrote: post #249

Earlier quoted context omitted.

>> Interpreting "printing money" to replace the more technical "controlling the size of the monetary base[1]" These are different things. Printed money is cash (or currency) and it represents a small amount of the total money in use, just under 3% in the UK. I don't have the figure to hand for the US but it's comparable, less than an order of magnitude difference. Printing money isn't a significant driver of the size…

I am skipping the digression about whether "printing money" should taken literally to mean the actions of the actions of the Mint/Bureau of Engraving as opposed to the controlling the monetary base. The Fed both controls the rate that commercial banks are charged (via the discount rate, or other rates based on it) to access the discount window and the rules for doing so. Infinite reserves[1] that charge interest when…

>> I am skipping … controlling the monetary base

You can’t really do that and hope to have a handle on how money works. If you don’t have a grasp on the meaning of reserves, you’re sunk.

What are reserves, how are they created, how are they destroyed and why are they exchanged between banks? If you can answer these then you’re a solid third of the way to fully understanding this space.

You’ve talked about controlling the monetary base which makes me think you’ve fallen down the exogenous money hole. While you’re stuck in that alternate reality you won’t be able to accurately describe how banking works. Money, as we experience it today, is endogenous.

>> instead through controlling other things that then controlled the money supply.

They don’t control most of the money supply, commerical banks do. Capital requirements rein in commercial banks desire to “print” more money into the economy.

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