> Moody's also AAA rated a bunch of housing derivatives in
2008
The products rated AAA by and large performed as such. (I have never seen contraevidence. Though the massive intervention introduces unremovable endogeneity.) They weren’t necessarily liquid the entire time. In that way they bear fun-house mirror similarity to this crisis, where the creditworthiness of Treasuries wasn’t ever in question. But their value in the interim, and thus liquidity, was.
The problem of 2008, with the benefit of hindsight, wasn’t rating agencies being funny. Those senior tranches were creditworthy. But we weren’t sure, and they sure as hell weren’t liquid.
Moody's gave them AAA ratings because just like the Moody's rep in The Big Short, Moody's has competition - a big bank doesn't like the rating Moody's gave their bonds? Oh, well, they'll just go to a competitor of Moody's, who is more than happy to give said bank the desired rating.
Effectively the financial version of judge shopping.
A regulator who might have his eye on a swanky corner office at KPMG? That tight little ring-less executive assistant . .
I say this without judgement; if there's any industry where the revolving-door policy has utterly destroyed value, it's mine. The good' ol military industrial complex. Hell we practically invented the revolving door. So anything I say here is going to be next-level hypocrite, givn where my checks come from.
You're not being hypocritical - you're simply pointing out where conflicts of interest tend to pop up, because you've probably seen such conflicts first hand in your line of work.
Regulators are humans too, and it's hogwash to think that they aren't susceptible to the same corrupting forces that the rest of us are. In fact, they are probably even more susceptible to corruption - seeing that they are generally underpaid and overworked. An underhanded in-passing comment like "hey, if you help us pass this audit, we'll make sure it's worth your efforts.... by the way there is an opening at our company that could be filled by someone with your skillset. Oh yeah it also pays 4x what you're making now. Think about it."
Fair point, and that helps with the ol' conscience. I appreciate it.
But "such conflicts" . . I feel like every year the industry gives me another shock to the testicles. There's entire floors filled with nothing but former Procurement Officers (CPOs). I realized it's the only trick BD even has: find the CPO, blow a couple grand on "dinner", invent a new VP role, then Avada Contracta, get the thirty year deal. BD lost the ability to sell anything except for the prospect of double dipping officer pay and a salary - the lazy uncreative man's path towards being a millionaire.
And everyone brags about it. That's the kick in the nuts. It's totally normal. You go to a conference, everyone in uniform is chatting up how much they're dishing out for Miracle Product X and how pretty Product X secretaries are. HAR HAR HAR HAR. All hands meetings, CEOs brag about it, to their own minions. People dialed in. "Welcome our new VP of Pointless Wankery, Captain Hoser from the C-17 Product X program, who just signed a thirty year . ." Even FCPA's a frickin joke now, given the sheer quantity of "Saudi Nephew NPOs" everyone keeps on the rolodex. I thought, circa 2020, that at least - at least - FCPA was solid, and now, shit. The nonprofit scene made a complete mockery of that.
I agree with the sentiment that it's not the auditors, but actually the Fed only drives short term interest rates, while what is cause issues is duration on long term interest rates (particularly mortgages/MBS with 10+ year duration). Those rates are mostly set by the market and inflation expectations. So actually, quickly lowering inflation is key to keeping long term rates from going way up! In that sense what the Fed is currently doing is actually keeping the value of the bonds/MBS higher than otherwise (by driving the economy into recession).
Now where you could argue that the Fed made a mistake was in buying MBS (lowering net interest margin) during 2020 early in the pandemic. That drove mortgage rates down right when fiscal stimulus was increasing bank reserves and everyone who could refinanced.
Isn't the fed driving rates high to encourage unemployment to put pressure on inflation? Everything else is a byproduct of that move. I think the mortgage rate move was planned for an upcoming reset in housing prices.
There is a big difference between bonds and MBS that have already been issued and future ones. What the FED is doing now is tanking the value of securities with lower fixed interest issued in the past.
But that value depends on their duration and the current interest rate on bonds of similar duration. If bond/MBS buyers don't believe that the Fed will beat inflation back down to 2% then rates at 5-20year will rise very significantly! They have been doing this over the past year by setting the Fed Funds rate (and by QE buying bonds/MBS etc in extreme circumstances like 2020 and 2008 and then eventually unwinding with QT).
So, if they don't convince traders they will stop runaway inflation 5-20y rates could go to 10% or higher (inflation rate + net interest margin), which would absolutely crush long duration bond values! If you think a 10% fall in value is big, it could easily be 50% down and that would be a big deal for all banks.
If you hold to maturity, you know exactly how much you make for the duration. This is one reason banks put them in their hold to maturity portfolio. They are a known quantity with basically no intrinsic risk (at least for bonds).
If you don't hold to maturity, you have to think about spot/resale prices. These fluctuate based on market demand, and what new securities are being offered at. If the fed is selling 5% bonds, nobody will want your smelly old 1% bonds.
If you are holding cash, you are probably stoked to buy some 5% bonds.
When you say:
>In that sense what the Fed is currently doing is actually keeping the value of the bonds/MBS higher than otherwise
Im matters which bonds you are talking about. Bonds issued last year, Bonds issued today, or 5 years in the future.
The Fed is cranking up bond rates today. This devalues bonds issued last year. I agree that it ALSO decreases the rate of bonds 5 years in the future (by driving inflation down as you say.
They're all just time limited cash flows (ok not zero coupons), but that cash flow and duration matters as does what people will pay for it (if you need the cash). The challenge comes when your depositors either want their money back or want higher rates today (on money you've already invested/loaned). These guys were going to burn billions in negative cash flow even if they "got their money back", but might have survived for the year or so it takes for 10+ year yields to fall back down a point or so and make them liquid again with survivable losses... assuming inflation fell, but who knows what actually ends up happening. The MOVE has be been crazy.
> We know exactly why banks are failing. Federal rate increases pushed they are long-term Holdings underwater and account holders made a run on the bank.
No, they failed because the banks didn’t hedge interest rate risk whatsoever. It isn’t the Fed’s fault for doing it’s job to tame inflation. It is the banks’ fault for not doing basic risk reduction at the expense of some profit. They optimized for profit and not resiliency.
Hedging doesn't eliminate risk, it moves it around. If you hedge away $100B of interest rate risk then your counterparty takes that hit when interest rates go up. Who's that counterparty supposed to be? Another bank? Pension funds?
Whichever party has short duration assets to match short duration liabilities. Matching long assets to short liabilities is idiotic.
If you can’t find someone with short duration assets then you don’t lock into 10+ year fixed rate bonds. Maybe you don’t leverage up your balance sheet as much.
I think implicit in your comment is that this was unavoidable, and I am vehemently against this stance. Just like 2008’s financial crisis, this was entirely avoidable.
Banks are in the business of maturity transformation, they have to borrow short to lend long. Silicon Valley, Signature and First Republic all blew up because depositors withdrew their deposits.
You can "fix" this with withdrawl limits, (In which case connected insiders can get their money out early and regular guys get screwed) full FDIC insurance, ("Unlimited bailouts for banks", moral hazard) or just end fractional-reserve banking entirely. (Say goodbye to 30 year mortgages, or any mortgages at all.)
Ending bank crises essentially requires ending the "business cycle" of credit expansion and credit contraction, which would take deleting quite a lot of the economy and turning everything into state owned enterprises.
I agree most people ignore the difficulty of estimating run risk, which is what actually killed these banks.
However, this isn't really an all or nothing situation. There is are material reasons why some banks will make it through this just fine while others will fail, despite all running on the same fractional-reserve system and buying the same securities.
Some will be right about their customer flight risk estimates, and others will be wrong. How much of this is due to better models or just luck is anyone's guess.
They didn't hedge for something that is a once in the history of our nation's experience basically and quite literally freezing one of the most investable markets, housing.
The increases have been relentless and its unclear that it is stemming inflation driven by corporate greed at all
I think that's overly simplistic and a bit misleading. Banks weren't betting that rates would stay low, they were betting that their depositors wouldn't run in Mass.
How many of your customers will flee is much more difficult to Gauge then if rates will go up.
This is why we see winners and losers. Most banks have the same exact Long-term securities and will continue to make money off of them.
It isn't as much about the investment as it is the investor.
I might make 5% putting money in a CD account. You might put money in the same account and lose 5% because you have to pull out early. The difference is our situation, not the account
> Banks weren't betting that rates would stay low, they were betting that their depositors wouldn't run in Mass.
I think you are confusing causality. The depositors fled because of the bad bet that rates would stay low. As a bank your entire existence depends on confidence. Make risky bets that rates will stay low forever, and you are eventually going to be proven wrong and then confidence in your institution will drop and depositors will flee.
Yep there are banks happy sitting on billions of dollars of low interest MBS and securities happily making profit. The assets themselves turn profit no matter what the current interest rate is. You only lose the "bet" when there is a run, not when interest rate Rises.
If there is no run on your bank, the MBS will always add to your profit no matter what the Fed rate is.
No one is saying that and the tone of your comment is honestly wild.
Its' betting that they wouldn't raise faster than ever in history. ( yea we all know interest rates were higher and have been subjected to the same posts about interest rates in the 80s)
That would still not be sufficient to make any kind of inference. Plenty of people who die drank from the same well shortly before their death. Everyone in the city of New York who died in the past week drank water from the same source shortly before their death.
The water analogy is thus: everyone who dies drinks water, but lots of people drink water and don't die, therefore water is unlikely to be the cause of death.
However, some estimate that over half of U.S. banks are insolvent. That's like half the population dying after drinking water. At what point do you start worrying about the water?
They're all insolvent because they were required to buy USG bonds, whose value has gone down as the Fed increased rates to fight inflation.
The only way to fix the insolvency crisis would be to invent a time machine to go back and stop QE/ARP/IRA.
If you print a trillion dollars, inflation goes up. To stop it, you have to take a trillion dollars out of the economy. When you do that, it's painful and unpleasant and businesses go bankrupt. This should not be a surprise.
However, some estimate that over half of U.S. banks are insolvent.
Some people don't understand fractional reserve banking, and consequentially make inaccurate estimates that make for clickable headlines but not useful analysis:
They absolutely are useful analysis. The fact that under fractional reserve banking, banks do not have enough cash on hand to pay out all their deposits at once does not make them insolvent. Every time a bank writes a loan they create an asset (the loan) and a matching liability (the bank deposit created when that money was loaned out). Their inability to pay everyone out at once is a liquidity problem, not one of solvency; they have the assets to cover their liabilities so long as their loans are still good. (The banking system isn't actually fractional reserve anyway, but the exact details of why that's wrong aren't particularly important here.)
The problems that've been happening recently - duration mismatches on ultra-safe assets like treasuries together with record rates of interest rate rises from record low levels - do actually make banks insolvent. The actual present-day market value of their assets is less than their liabilities to depositors because the fact that investors can get higher interest rates elsewhere means they'll only buy those assets at a discount that reflects the lower interest rate. Alternatively, the banks would have to pay more in interest to convince depositors to keep their money there until the assets reach maturity than they'd receive in interest themselves. Either way they're in deep trouble.
How is this different from what the parent poster said?
If banks cannot match their liabilities at any time that makes them insolvent (granted, some reasonable period might be useful. But we're talking days/a week, no more). The fact that they may be able to match those liabilities in the future does not matter.
It's different because banks with liquidity issues can be unwound and the depositors made whole using the proceeds, but that's not possible with these insolvent banks no matter how much time they're given. Sure, maybe they could pay out the face value of their deposits in a few decades when their treasuries mature, but that'd actually be a worse deal for depositors than just receiving whatever fraction of their deposits can be paid out from the fair market value of those treasuries right now - if they're willing to wait they can just invest in the same treasuries themselves, but they can also invest the money or spend it in other ways if they'd prefer.
In more concrete terms, the Fed has a funding scheme in place right now that lends banks money to smooth over any liquidity problems they're having and ensure they can process withdrawals. That funding scheme lets them borrow against assets based on their face value ignoring losses due to interest rates, but it still charges current market interest rates, which means they're bleeding out money that way. It didn't save First Republic Bank and neither would any other solution that didn't involve either depositors taking a loss or the FDIC making up that loss using its own funds, because they were insolvent, not just lacking liquidity. The very real gap between assets and liabilities to depositors had to be filled from somewhere.
I doubt depositors will consider themselves made whole if they have to wait 2 to 10 years on their money. Plus waiting comes with interest. Those depositors deposited money in the bank because of the expectation they could spend it, all of it, at any time they wanted. So if it isn't insolvency, what is it? "Breach of trust"?
Plus the depositors may need that money for reasons. Pushing the loans to make up for it on depositors is eventually the same as taking a haircut on the deposit.
I mean, I get that this plays into the FED's hand. They want to take money out of the economy, that's what high interest rates are for, and this certainly does that. But ...
There are two related concepts: liquidity and solvency. When a bank accepts deposits and loans some of those deposits out, i.e. fractional reserve banking, it is exchanging a liquid position (cash) for an illiquid position (the loan). However, the bank is still solvent because the loan has a value and the value of the loan is typically close to the value of the deposits.
What we're seeing now is that the banks are actually insolvent, which means they did everything I listed above, but now the value of those loans has dropped enough where they may have serious issues meeting their obligations to depositors. You can't just waive your hands in the air and say "this is all fine because of fractional reserve banking."
KPMG audits more US banks than any other accounting firm because it is more willing to sign off on weak financial statements than any other accounting firm.
They've been fined by the PCAOB for this several times and have lost several major clients (Skechers, Herbalife) in the Los Angeles area alone due to severe audit practice issues.
Your analogy fails. Its not about every dead person drinking water. A better analogy would be: If everybody drinks the same brand of bottled water, poisoning the source would affect a lot of people.
"...KPMG alumni have also gone on to play significant roles in the banking sector,
including at former clients. The chief executives of Signature and First Republic
were both former KPMG partners..."
That still doesn’t prove that accounting audits should prevent a bank run. The more likely culprit here is what the FDIC called out in its report, namely a failure of oversight and a loosened regulatory regime.
"...The Fed’s report last week revealed the extent of weaknesses in SVB’s risk management and internal audit functions, both of which need to be assessed by a company’s external auditors.
Jeffrey Johanns, a former PwC partner who teaches auditing at the University of Texas at Austin, said that could raise a question of whether KPMG should have highlighted these failings to investors as material weaknesses that could affect the financial results..."
It's all the consumers' fault, except for the part where the bank leadership was making exceptionally risky investments, and also actively and successfully lobbied to be allowed to work around reserve rules designed to explicitly keep this from happening.
They failed because they over invested in near 0% interest US treasuries, and then the Fed rapidly hiked rates to 5%, quickly collapsing the value of those low interest treasuries on the market.
The investments themselves, and the promised return, were always "risk free", but the house of cards collapses when everyone demands their money now. And when people are looking at their savings interest rate of 0.1%, and seeing other banks offering 4%, it becomes very easy for a bank run to start as people simply move their money chasing yield.
The problem seems multi-faceted and complex, and like most complex problems, true blame is likely diffuse and shared amongst everyone, the customers, the banks, and the Fed. This is usually the kind of situation where societies elect a scapegoat to murder so they can all go about their business pretending to solved the problem and purged the evil from amongst their ranks.
Over investing in treasuries IS a risky investment. Especially when bank accounts are supposed to be the least risky place to put money. Treasuries have interest rate risk that needs to be hedged.
Sure, although the Fed at the time was signalling no chance of raising rates any time soon, then they turned around and jacked them at the fasted pace in recent history.
A big lesson there, beyond don't fight the Fed, is don't trust the Fed.
These banks were not hedging their duration risk, which means that they were in fact making risky investments. Their failures lie solely on the bank management and fund managers.
You make it sound like they were funding Musk's purchase of Twitter, when in fact they simply had too much of their money locked in treasury bills (typically considered the safest possible investment) to face off a sudden and massive run on their bank.
I heard that even the TP crisis made sense, people stopped using TP outside of home (work/school/etc.) and that put stress on the home TP supply chain.
It's kind of crazy to me that we all lived through that and most people still don't understand why it happened. Like you said, many all working from home more, so demand for TP went up. Suddenly shelves are empty more and the news starts talking about a TP shortage, so next time you're at the store and see TP in stock you buy a case even if you don't need it yet. Actually who knows when it'll be in stock again and at what price, you so might as well buy another case too. The shortage got worse and worse, and in order to absolve themselves of any personal responsibility people imagined that evil preppers were going around and buying up all the TP and hand sanitizer and PPE. The problem is that in reality the system was irrational (people buying TP they don't really need) but individuals were behaving rationally (stock up when you can).
That definitely caused the TP "crisis" but it was sustained by lag on the supply side. Paper manufacturing was tooled up to make "commercial" toilet paper, which saw an immediate drop in demand when we suddenly stopped going to the office. Manufacturers had to re-tool for residential toilet paper, which saw an immediate and sustained rise in demand.
In retrospect, I'd say that the first wave of people overstocking TP weren't totally irrational.
There was plenty of TP, it was just packaged incorrectly for individual consumption. The supply chains couldn't quickly change the packaging. There were even stories of TP available from Mexico that couldn't legally be sold because the labeling was in Spanish and not up to American regulations.
Same thing happened for other items like flour. Suddenly everyone was baking at home and restaurants weren't buying 50lb sacks of flour anymore. Plenty of flour, improperly packaged.
The bank's only moral imperative (a misnomer for a bank, I'm aware), per their agreement with you, is to have your money safe when you come for it (even if "you" is everyone).
The TP company, they want to use just-in-time inventory, and that works 90%+ of the years, fine, but don't go blaming the consumer because they did too much of a good thing for you, and your workflows were too fragile to scale up.
I'm not seeing a lot of consumer irrationality here to be honest. Actually there wasn't a lot of consumer irrationality in the toilet paper shortage either, that's the trouble with bank runs and supply shortages, they make the rational decision for the individual the one that hurts everyone.
