Bonds are typically sold at discount. In other words, a $1000 bond does not cost $1000, but whatever amount would produce $1000 at the bond’s interest rate on the maturity date.
Interest rates were so low for so long that many banks parked a substantial portion of depositor funds in what everyone considered very safe Treasury bonds and premium mortgage bonds. For many recent years these paid very low rates, typically around 2% for 2 to 30 years.
If the bonds were held to maturity, the face amount would be paid, so exact cost and earnings would be known. If the investing bank needed to use some of the funds invested before the maturity date, the bond could be sold on the open market. Its face-value at maturity would not change, but its present value would be based upon the market rate on the day of sale. For example:
I buy a $1000 discounted bond with 2% interest rate and a 5 year maturity. I would pay approximately $910 (5 years of 2% annual interest on $910 would be about $90.) But it happens that I need to sell the bond in 2 years, and market interest rates are much higher than when I made the purchase, let’s say 5%. I will only be able to sell it for the amount that will produce $1000 in three years at 5% interest. This would be approximately $875, but I have been carrying this bond on my books either at cost ($910) or face value ($1000.) I have experienced a real loss, and if the total value of my investments of this kind were great enough, I could be in real trouble.
SVB needed to sell some bonds at a loss in order to satisfy depositors’ withdrawal requests. Some of the bank’s large customers noted this and recognized immediately that the bank wouldn’t have been locking in a loss like that unless it were having problems. This stimulated more withdrawals and voila! The awful barnyard offal hit the air-propulsion device.
Large companies with large payrolls and large recurring accounts payable need a place to park cash that will be needed in just a few days for the payment of these obligations, and lots of them will not find the $250,000 of guaranteed FDIC insurance nearly enough to protect them from the possibility of a bank failure. These companies have the option to purchase insurance at very low rates to reduce their risk on whatever excess funds they expect to have in these mega-accounts.
Many, if not all of the larger customers of Silicon Valley Bank declined to purchase this insurance in order to save a relatively small amount of money. The decision by Federal banking authorities to make the uninsured depositors whole is making their decision the right one by deciding to let US taxpayers (and USD0llar holders worldwide) pay the cost of that risk.
Every D0llar borrowed or created to reimburse them for losses reduces the purchasing power of every other D0llar — worldwide — already in circulation. For example, if your D0llar will buy a pound of potatoes today, and the FED doubles the amount of D0llars in the world tonight, your D0llar will only buy a half pound of potatoes tomorrow.
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