When interest rates rise, the price of long-term assets falls. As a result, when the Fed starts raising interest rates in 2022, the value of bonds and mortgages falls, resulting in large accounting losses for banks that are heavily invested in these assets. Silicon Valley Bank was disrupted, for example, because investors fled when they realized it was holding large amounts of Treasury bonds.
Interest rates remain high and many banks have huge losses on their books. According to recent FDIC data (see below) unrealized losses currently total $516.5 billion, far surpassing levels seen during the 2008-2009 financial crisis. Price risk is not the same as default risk and if banks can’t hold onto their assets to maturity they will be solvent. The real risk, like SVB, is if unrealized losses are combined with deposit runs. So far that doesn’t seem to be happening but it is within the realm of possibility.
In other news, Hypertext has an issue dedicated to Anat Admati and Martin Hellwig’s The Banker’s New Clothes. Admati and Hellwig write:
The Dodd-Frank Act of 2010 in the United States promised an end to bank bailouts and “too big to fail” institutions. The European Union’s 2014 law on dealing with potentially failing banks was said to provide a “framework” to “deal with banks experiencing financial problems without spending taxpayers’ money or risking financial stability.” In November 2014, Mark Carney, then governor of the Bank of England and chairman of the Financial Stability Board (FSB), a body of financial regulators from around the world, triumphantly announced that the agreement on the new rules of the thirty largest. and more complex, “globally organized” financial institutions can prevent future bailouts. Many people in politics and the media believe these allegations.
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