Bank insolvency is everywhere...

• I woke up today to news articles listing the top 20 banks with balance sheets similar to the three banks which failed this weekend.
• These banks were insolvent, which in the simplest of terms, means that their assets didn't match their liabilities on their balance sheet.
• The common denominator between them was simple: Banks purchase low interest rate long term securities in low interest rate markets. The Federal Reserve, AKA Mr. Powell executed a three quarter run of rate hikes which are unprecedented, as in there is no historical equal, no time period in which the Federal reserve consistent raised rates, this much, and this often.
• Then market forces took over, as Bond Interest Rates rose with the Federal Rate raised by Mr. Powell, and Banks who invested millions of dollars of customers cash in these safe United States Treasury Bonds, found the face value of these low interest rate bonds plummeting in the face of swiftly rising interest rates.
• Suddenly these bonds were worth less then their purchase price, and the bank's balance sheet, where assets are suppose to equal liabilities, were out of balance.

Qick Explanation

• Customer funds are liabilities.
• Bonds you buy with customers funds are assets.
• If you spend 100 million dollars of customers funds on 100 million dollars worth of US Treasuries, your balance sheet shows 100 million dollars worth of liabilities, which is the cash your customers deposited, and which you owe them. Your balance sheet also shows 100 million dollars worth of US Treasury Bonds, which are your assets.
• Your bank balance sheet is balanced, as in your liabilities equal your assets.
• And 100 million dollars invested at 1 percent interest earns you one million dollars a year.
• The banks balance sheet is balanced, the bank is making money, and all is good in the banking world.

What happens when the Federal Reserve raises interest rates every quarter for 3 quarters?

The rising interest rates which the Federal Reserve loans money to banks at means the US Treasury has to raise the rates it pays on Long Term Treasury Bonds to be competitive with other yields in the market. When the US Treasury raises the interest rate from 1% to 2% on bonds it sells this quarter, that lowers the value of the 1% bonds it sold last quarter. Now the 1 million dollar US Treasury bond a bank bought for 1 million isn't worth one million on the open market, it's worth 900,000. But it's not a problem if the bank holds the bond to maturity. It would get one million dollars.

• The problem is that if customers want to with drawal their cash, the bank has to give them cash. And if the bank starts to run out of cash to satisfy customer with drawals, it has to sell the Long Term low interst rate bonds at a loss.
• This has a double effect on the banks balance sheet.
• The customers cash is a liability, but it's used to buy bonds, which are an asset, so the value of the bonds must equal the value of customer deposits.
• If the value of the bonds goes down, that's a loss, but it is an unrealised loss.
• So even though the balance sheet is technically balanced by the face value of one million dollars for the bond, the balance sheet is actually unbalanced because the bank knows if it sold the bond it wouldn't get one million for it,it would get 900,000. So the bank has to notify regulators, and of this unrealised loss.
• The bank isn't insolvent, but it is technically insolvent, because if it had to sell it's assets to pay it's liabilities, it would come up short, and that is insolvent. - And regulators are suppose to assist the bank with short term bonds infusions to add to the asset side of the balance sheet, so that even with the unrealized losses, the bank balance sheet shows assets equaling liabilities.
• At least that's how I understand that is how it is suppose to work.

The problem, people withdrawling their money

• People are a pesky necessary evil for banks, LOL
• People need cash to pay for food, rent, and employers need cash to pay employees and bills.
• The problem occurs when to many people want their cash, the banks have to sell to many assets at a loss, andd then the banks balance sheet shows the previously unrealized losses, as realized losses, and soon liabilities are larger then assets, and the bank is technically insolvent.
• If the FDIC can't provide enough assets to help the bank balance it's balance sheet. Then the bank is declared insolvent and the Federal Regulators seize it, close it, and sell it's assets to satify it's creditors, the main ones are the depositors.
• Investors in the bank who bought stock will probably see the price of their stock go to zero.
• The fascinating thing about Silicon Valley Bank is that it is a Bank Unicorn, very uique. The majority of it's depositors were venture capitolists, tech start-ups, and other tech savy and hyper active individual companies and people. The percentage of accounts over the FDIC bank account insurance limit of 250,000 US was over 93%.
• These people live on a hair trigger to remove their money.
• Reportedly they removed 20% of all bank deposits in 24 hours.
• One company is reported to have moved 400 million out in an hour.
• Silicon Valley Bank had ample cash reserves, but not enough for such a huge number of withdrawals. It couldn't pay it's debt obligations, it moved from technical default to actual default, and it was seized and closed.

The problem is that many regional banks are in this Long Term Bond predicament.

• Now that we have that background out of the way. The article I read this morning stated that over 20 regional US Banks have large unrealized losses on their books.
• So technically they are insolvent
• But it's technical insolvency not real insolvency.
• So as long as they have enough cash on hand to pay their bills and satify withdrawals,they are okay.
• But when they can't pay their debt payments they are insolvent, and the FDIC will seize them and close them.
• I think that nuance is particularly interesting because it suggests that many banks are just one bank run away from closing, and then being bought by bigger banks or just closing.
• I wonder if this is the beginning of a systemic collapse?
• During the last great economic collapse of 2008 the US Congress passed the Dodd Franks Laws to make banks more secure. Some of those laws were repealled in 2018. It is unclear to me what impact those repealled laws may have...but here we are again, on the edge of another economic collapse.
• @shortsegments

picture source