More Than $16 Trillion Of Underwater Bonds Are Out There

[g5000]

Appreciate this concise explanation.

It was extremely informative.

I was having trouble understanding how Treasury Bonds with a 1.78% return rate were losing money.

I was under the impression that no one wanted these bonds because as interest rates went up, new bonds were paying significantly higher returns...more than double what these bonds were paying.

Is there any truth to that notion...or am I way off?

You are exactly right. That is the very nature of the problem.

If someone is sitting on an older bond, and they get into a cash crunch, they will have to sell that bond for less than they paid for it. They are underwater.

Just like when mortgages were underwater. House values plummeted and people had mortgage debt that was higher than what their house was worth. If they got into a cash crunch, they had to sell their house at a loss.

This is what is going on in the bond market now.

 

[g5000]

We've had ZIRP for a decade - worldwide and negligible inflation. What changed recently?

Inflation changed everything. To lower inflation, the Fed has had to raise interest rates, thereby making older bonds worth a lot less. They are underwater.

 

[g5000]

So, what is the likely projection of where this will go?

To be honest, I am very concerned.

It all depends on how well banks are capitalized, and whether or not they have hedged their interest rate risk.

Just imagine. $16 trillion, with a T, of US treasuries are underwater. And then there is all that underwater corporate debt out there.

And then there is the entire planet's sovereign and corporate debt.

Something has to give. This could get very, very ugly.

 

[g5000]

That makes no sense. Please elaborate.

Which would you rather have: A bond which pays 1 percent interest, or a bond which pays 7 percent interest?

If you buy a 1 percent bond, you are getting a much smaller return on your investment. Therefore, it is more expensive.

If you buy a 7 percent bond, you are getting a bigger return on your investment. Therefore, it is cheaper.

Here is the 10 year Treasury note yield history: 10 Year Treasury Rate - 54 Year Historical Chart


Would you rather own a 2020 0.89 percent US Treasury, or a 2023 3.69 percent US Treasury?

See the problem?

There are investors sitting on trillions and trillions and trillions and trillions and trillions ad infinitum of bonds no one wants to buy. If they get into a cash crunch, they are royally fucked.

 

[iamwhatiseem]

We are in a massive bond bubble, and it is beginning to pop. Silicon Valley Bank and Signature Bank are only the beginning.

You can picture bond prices this way: The lower the interest rate a bond pays, the more expensive a bond is. The higher the interest rate it pays, the cheaper that bond is.

Thanks to the Federal Reserve, bonds have been extremely expensive since 2008. From 2015 to 2020, the Fed tried to bring the price of bonds back down, but then the pandemic hit and bonds became extremely expensive again.

This is what was called ZIRP. Zero Interest-Rate Policy. The Fed kept ZIRP way past the point they should have. The initial "quantitative easing" was to save the economy during the Great Recession. But once the recession was over, the Fed kept ZIRP around, and that is where they really fucked us. Especially savers.

The Obama and Trump administrations took full advantage of ZIRP. Since it was really cheap to borrow money, they borrowed $16 trillion.

Corporations also went on a massive borrowing spree since they could borrow money cheaply, too.

Bond bubble.

If you are an investor who is required by your by-laws to buy only investment-grade bonds, then you aren't very happy about this. Investment grade bonds were extremely expensive.

To get any kind of decent returns, you had to buy astronomical quantities of these expensive bonds.

If you aren't required to buy investment-grade products, then the temptation to invest in riskier and riskier products is just too overwhelming to resist. And that's what a lot of investors have done.

The thing about being able to borrow money cheaply is that you end up borrowing more than you should and spending it on stupid shit. Our federal government did that, and corporations did that, and colleges did that.

Another incentive for the federal government to borrow a lot of money and spend it on stupid shit is that government spending is a significant part of GDP. So spending a lot of money on stupid shit is a great way to artificially juice GDP growth as you borrow and spend, borrow and spend, borrow and spend.

Nevertheless, all the printed money was moving around pretty slowly. It wasn't really heating up our economy the way our big spenders were hoping it would.

I have likened the sluggishness to borrowing a trillion dollars and burying it in your backyard. As long as it is buried, it isn't contributing to inflation.

Then the pandemic hit, and the economy ground to a halt. Money was not moving around at all.

Once the pandemic passed and the markets opened back up, consumer demand boiled over to record levels. Money began flying around at a rapid clip. Those trillions of dollars buried in the back yard were dug up and put into action.

GDP surged, and inflation took off.

The President can't stop inflation. Pretty much only the Fed can. And the only tool they have in their tool box is to raise interest rates.

Suddenly, bonds are cheap!

The fallout from this is that all those old expensive bonds are now underwater. Just like all those mortgages people had in 2008 were underwater when house prices fell.

Investors are sitting on $16 trillion of underwater government bonds, plus however many underwater corporate bonds there are.

And this isn't just a US problem. It's a global problem. All that old sovereign and corporate debt planet-wide is underwater.

SVB is the canary in the coal mine. After parts of Dodd-Frank were repealed in 2018, they went on a bond buying spree. They increased their sovereign and corporate debt by 158 percent in a single year!

If your mortgage is underwater, you won't have a problem so long as you can keep paying your mortgage. But if your mortgage resets to a higher monthly payment, as it did for tens of millions of Americans, then you are screwed. You go belly up.

That is the picture all those bond holders are facing now.

Today... the FED exist primarily to keep the investing machine afloat, no matter what.
No matter how over-bought, over-priced... no matter how absurdly over valued anything and even everything is - the FED is always there to ensure that possibility of continuing to enrich the uber-wealthy keeps going.
There is nothing fiscally responsible about the FED today. No one could possible say with a straight face they didn't see the mortgage crises looming, and kept right on supporting till the last hour. And today... it's not like they aren't knowingly doing it all over again... and we already know... if it pops again. This administration will bail them all out again and then that is when the real shit hits the real fan.

 

[CrusaderFrank]

Inflation changed everything. To lower inflation, the Fed has had to raise interest rates, thereby making older bonds worth a lot less. They are underwater.

The "Fed has to raise rates to combat inflation caused by excess money printing" sounds like it was dreamed up on Jekyll Island.

The government causes inflation by printing excess money -- and we convert that into interest payments to us! SWEEEEEEEEEEEEETTTTT!!

 

[Flash]

My oldest son and his wife are CFOs for smaller corporations.

Both of them worked all through the weekend and extended hours this week to deal with the banking crisis. Most corporations have their money tied up in several banks and things are not looking good now.

My DIL's corporation had several million dollars in SVB and they were scrambling to meet payroll this week.

They are both afraid that there will be a cascading effect as everybody wants to get their money out. Most banks are in trouble.

The problem is the banks dealing with Potatohead's high interest rates.

Potatohead is really fucking this country now.

 

[kyzr]

I'm hoping PIMCO isn't about to explode.

On CNBC they usually have Muhammed El-Erian explaining bonds. Nothing to see here....

MSN

Mohamed El-Erian: SVB collapse is the result of 'overly loose' monetary policy

Amid the fallout from the failure of Silicon Valley Bank, Mohamed El-Erian said Monday that the current situation is the result of Federal Reserve’s overly loose monetary policy.

seekingalpha.com

 

[g5000]

The problem is the banks dealing with Potatohead's high interest rates.

Potatohead is really fucking this country now.

High interest rates have nothing to do with Biden.

 

[multivita-man]

Which would you rather have: A bond which pays 1 percent interest, or a bond which pays 7 percent interest?

If you buy a 1 percent bond, you are getting a much smaller return on your investment. Therefore, it is more expensive.

If you buy a 7 percent bond, you are getting a bigger return on your investment. Therefore, it is cheaper.

In other words, SVB's assets were cheap but their liabilities (thanks to interest rates) were getting costlier and costlier. It was a mismatch. Bigger investors (like Thiel) realized this and yanked their money out, but probably not before shorting the bank's stock and betting on the bank to fail.

We need to get back to Glass-Steagall and it needs to happened yesterday. Banks cannot be trusted to be both investors and lenders.

 

[g5000]

While everyone is worried about banks, here's another nightmare scenario.

Most people think insurance companies make their money from the premiums they charge you.

Actually, they make most of their money by investing your premiums. And what do they invest in? Government bonds, corporate bonds, and other instruments.

So insurance companies are also sitting on mountains of upside down paper. This won't be a problem so long as they remain liquid enough.

But suppose a Category 5 hurricane wipes out the Gulf coast? Or an earthquake wipes out San Francisco (yay!)?

If an insurance company finds itself in a liquidity crisis because of a disaster, they will have to sell their upside down assets at a huge loss to cover all the claims.

Boom. Here comes the bailout.

This is all somehow the fault of the negroes.

And Ray Epps.

 

[multivita-man]

High interest rates have nothing to do with Biden.

Yeah, it's Jay Powell and the Fed who are raising rates, and they really don't have a choice, either. They had better choices 3-5 years ago, though, and that's probably where some of the blame lies.

 

[g5000]

Yeah, it's Jay Powell and the Fed who are raising rates, and they really don't have a choice, either. They had better choices 3-5 years ago, though, and that's probably where some of the blame lies.

Just like with the mortgage crisis, the Fed kept interest rates too low for too long after the Great Recession.

After the recession in the early oughts, the only healthy part of the economy was the housing sector. And so that is where the money poured in, with the help of the Fed lowering interest rates.

After the Great Recession, every government everywhere began piling on debt. The Fed decided one quantitative easing was not enough to save the zombie banks, and kept QE alive forever.

ZIRP.

That encouraged ever more borrowing.

And here we are.

The federal government borrowed $16 trillion during the Obama and Trump administrations.

Add in the pandemic's drop in demand, followed by astronomical stimulus, followed by a massive demand shock as the world recovered, and boom. Inflation.

 

[g5000]

Remarks by FDIC Chairman Martin Gruenberg at the Institute of International Bankers​

​

Interest Rate Risk

The current interest rate environment has had dramatic effects on the profitability and risk profile of banks’ funding and investment strategies. First, as a result of the higher interest rates, longer term maturity assets acquired by banks when interest rates were lower are now worth less than their face values. The result is that most banks have some amount of unrealized losses on securities. The total of these unrealized losses, including securities that are available for sale or held to maturity, was about $620 billion at yearend 2022. Unrealized losses on securities have meaningfully reduced the reported equity capital of the banking industry.

 

[ReinyDays]

This may have already been covered ... but the OP is only talking about the secondary market for bonds ... and with the prime interest rate at 0%, one shouldn't have expected the secondary bond market to remain stable ... with rising interest rates, bonds are THE WORST place to invest ...

The risk of buying a corporate bond at 1% interest is that the next year bonds are issued at 35% interest ... you're "losing" 34% per year for five years ... sucks ... but NO ONE will buy your bond for anything more than $10 ... they don't want to be losing 34% per year for five years either ...

However ... your original capital is returned in full after these five years (barring default) ... with stocks, the original capital might not be returned ... in bankruptcy, bond-holders are usually paid off first, then the share-holders ...

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Rental units is how The Rich keep getting Richer and The Poor keep getting Poorer ... the way God wants it ... "Slaves, obey your masters" -- somewhere in the Bible ...

 

[HikerGuy83]

Or an earthquake wipes out San Francisco (yay!)?