Comment by ctchocula | Hacker News Reader

Comment by ctchocula | Hacker News Reader

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You're confusing cause and effect here. In 2021, even crap 1% 10-year treasury notes cost $100 to purchase, not $80. It's only after interest rates went up in 2022 due to faster than expected Fed rate hikes that 1% treasury notes were no longer as valuable. An intuitive way to think about this is a seller of 1% treasury notes can only ask for $80 when 3% treasury note new issues are available for $100, to compensate the buyer of the 1% treasury note for the lower, less attractive interest rate. The interesting quirk is that it's only the mark-to-market price that is underwater i.e. worth $80. If SVB had the privilege to hold these assets to maturity (i.e. waiting 10 years), they could get their principal $100 back + $10 in interest.

If they did do what you said i.e. "spend $80 to buy $100's worth of treasury notes", then they wouldn't be in the conundrum they're in today. Because their cost basis in that case would be $80 and they could simply sell that treasury note for $80 and they wouldn't have a capital loss at all (in fact, they would be up since they earned coupon payments). It's only because:

1. 2021: they purchased low interest treasury notes before interest rates jumped

2. 2022: interest rates jumped faster than expected

This caused SVB incurring capital losses, which meant their assets to be worth less than their deposits.

If you are curious and want to visualize some of the changes on a graph, you can check out VFITX [1], which is a mutual fund that holds a mix of treasury bills, bonds and notes for an average of around 7-year duration.

-2021 Jan 1: $11.63/share

-2022 Jan 1: $11.12/share = 4.4% cap loss (before factoring in coupon payments)

-2023 Jan 1: $10.15/share = 12.7% cap loss (before factoring in coupon payments)

[1] https://www.marketwatch.com/investing/fund/vfitx

That’s essentially what I’m saying, except that I’m explaining why they bought 10 year bills in the first place instead of shorter and more liquid ones.

Forget the numbers.

The long term ones are advantageous on their books because they cost less to purchase than short term ones but still record at the full HTM value.

With stable and low demand on withdrawals, using that HTM value isn’t unreasonable since the bills are sure to mature and so the difference of cost between short and long term bills means their books look better for less. There’s predictable risk to the play, but they probably needed the extra bit of wiggle room on their balance sheet and felt it should be fine as long as interest rates stay low and deposits don’t pick up.

But of course neither of those was going to hold. And so (as you noted) their bills grossly devalued and their account holders changed borrowing and withdrawl patterns as the economy shifted. Both factors built into the risk fell through and they went from probably-marginal to downright-damned.

Actually, the yield curve was inverted at the time they made the purchases, compounding how strange their decision was.

Bond yield and price are inversely related, meaning when the price goes up the yield goes down and vice versa and this relationship creates the risk.

If a company buys low interest bonds (i.e. interest is yield) in a market where interest rates are going up, at some point the cash rate will exceed their bond yield and at that point the bond price drops to match the current interest rate.

Why this happens is when the interest rate is above the bond yield, no one will purchase the bond at the original price, as they can get a much better return in the overnight cash market.

That means the price of the bond falls to a point where the bond yield now matches the cash rate plus some margin for any future risk. That lower price gives the asset it's true value.

So as the cash rate continues to rise the bond price continues to fall and without doing anything, SVG finds itself bleeding hundreds of millions in asset value, with no end in sight.

That then creates the panic and the rest is history.

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