I’ve thought about this for a little while now but here’s my logic for why this may happen a lot more in the coming year or two: Here’s the issue: All banks took in a massive amount of deposits in 2020/2021, likely due in part to Covid stimulus. Short term Treasury rates were near 0 and in some cases had negative yields! Treasury management is the life blood of any bank. Without it the bank fails. So let’s say a bank took in $100 in deposits. In 2020/2021, mortgage rates were the lowest in history. ~50% of outstanding mortgages were either originated or refinanced during this time at 3% or lower rates. For every one of us that has these sweet mortgage deals, there’s a bank or loan company on the other end. So let’s say the bank loaned out $50 in mortgages at 3% average rate during this time. That leaves the bank with $50 left. They keep $10 as cash reserves for day to day deposit/withdrawals of their customers. In most cases they must keep this ratio of cash as regulated by law (give or take a few dollars). That leaves $40 left that they need to generate return on to increase profitability of the bank. Since short term treasuries pay near 0 at this time, they have to search for long term, HTM (hold to maturity) securities that generate SOME return. So they buy these long term securities, they can be mortgage backed or 10 year us treasuries, etc. these securities paid around. 1-2% if held to term. Fast forward to 2022 and the fed raises rates at the fastest pace in modern history. Now the risk free short term us treasury is paying nearly 5%. Just a year before it was paying near 0. So the bank is generating 3% off the mortgages and 2% off the long term treasuries with $10 in cash reserves. The rational customer will realize, hey I can move my money to vanguard/fidelity/blackrock/etc and easily earn 5% annual on the 1 year risk free us treasuries. The bank cannot entice the customer to stay because it can’t afford to offer 4-5% savings rates on deposits. This is because it’s only generating 2-3% on its holdings of mortgages and long term treasuries. If it offers 4% savings rate it’s immediately unprofitable. The major risk here is the rational customer should move their funds somewhere else. If enough of them do that, the bank doesn’t have the reserves to cover it. It has to sell its book to do that. Since treasuries today pay 5%, they will take a huge loss on the long term treasuries that are only paying 2%. Likewise with securitizing and selling off the mortgage book. The only way another firm buys your mortgage book is if it’s at a severe discount because it’s only generating 3% risk returns compared to 5% risk free. Therein lies the problem a lot of banks will face. The bigger banks will be okay, they have the scale to outlast this. The treasury depts at smaller banks might be sounding the alarm internally. No ceo will talk about this publicly because they can’t create panic, it would collapse their bank. This is overly simplified but if this is the logical sequence of events, I can imagine it’s only the beginning of something bigger happening.
Ok.
Most banks probably sold the mortgages off in MBSs
Lol, let me change the math a little. If you deposit $100 in bank, they can loan upto $1000. When they loan money for house, they add that house as their asset. If the value of asset (house) goes down by 20%. You can do the math.
We meed a detailed scenario as OP did. My money will be under my mattress Monday morning 😅
Wouldn’t that propel the issue? They would hold illiquid housing assets they would need to unload at a loss to cover deposit outflows.
Good read. Thanks!
The bank rule hides the underlining problem. This article has good insight. https://www.forexlive.com/news/held-to-maturity-bonds-are-about-to-be-a-big-problem-20230310/
TLDR what should we do?
If you have over 250k in cash and want to keep it that way have it spread 250k max across different FDIC insured banks. Or to offset that risk just be in 6 month t bills which is as risk free as it gets and has a crazy yield of 5.3% right now
Wait, you earn 5.3% over 6 months or 5.3% yearly for 6 months?
Why the banks can't sell 2% treasures and buy the 5% current ones ?
Because the 2% treasuries they own are worth a lot less on the market right now. If they hold to maturity they’ll be fine and collect their 2%. If they have to sell they’ll be selling at a substantial loss. Why would you buy a banks 2% treasury when you can get one for 5% on the open market?
Would you buy their 2% ones when you can get 4-5% much easier elsewhere? Yeah, nobody else either!
It’s all part of the plan
How do big name banks compete with sub 1% interest rates and 4% 12-18 month CDs when an institution like Wealthfront offers 4.05% (with another 0.5% boost with referrals)
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I was waiting for this post thanks Op