Imagine how different the calculus would have been through the pandemic had the Fed been raising rates in 17-19? They would have had runway to lower interest rates before going to zero. In hindsight, the zero interest rate regime was aberrant-unprecedented and forced the market to magic up lots of “accommodations.”

Anyway, the problem with svb was exactly that they decided to not hedge against the possibility of raising interest rates. And for much of the market, that was a bad call. So anyone defending them needs to explain the rational of keeping the zero interest rate regime post-Covid. And it’s got to be better than “line goes up and to the right” for your chosen asset

There’s interest rate risk, credit risk, and prepayment risk with the securities they buy.

On a Treasury or guaranteed bond, there is no credit risk.

On a Treasury there is no prepayment risk.

Therefore if you hedge out the interest rate risk, you’re essentially left with 0 risk.

0 risk = 0 or near 0 premium.

e.g. there’s no point in doing the trade if you hedge.

There is always a point as the risk is not binary. SVB should have hedged against big interest jump that would bankrupt them, not against any risk.

You don't need to hedge out all the risk. You can for instance hedge the risk that rates go up more than one percent and take the risk when it changes less, in return for a moderate yield. This way you limit your losses when things go wrong and probably you'll avoid bankruptcy.

Besides that, financial institutions don't only make money on re-investing deposits. They charge all kinds of fees as well, which make for a steady income.

Yes that’s the point. Treasuries are cash, they are not meant to make money for banks, they are meant to be a place for banks to put money when they don’t have anything else to do with it. Banks are supposed to make money from the premium between the base interest rate and the rate on the loans they make. The implied contract when you deposit money in a bank is that the bank has a dependable business model as a lender. They are not supposed to be gambling.

SVB got greedy. They thought that zirp would continue forever and they made long term bets on that basis and lost. Banks should not be making long bets on macroeconomic conditions: that’s not a bank, that’s a hedge fund.

> Treasuries are cash,

Obviously not.

Some brokerages break down various types of position (equity, bond, etc). Mine in particular has a "Cash and equivalents" section. Money market accounts go there, but so do treasury funds and such.

I suspect the upvotes are because you're technically correct, treasuries are not literally cash. The downvotes are because grandparent obviously meant that treasuries are considered cash equivalents (whether or not they actually should be, given liquidity concerns).

Treasuries (without further qualification) are not cash equivalents. (And it’s not because of liquidity concerns.)

Treasury bills may be cash equivalents. They present (almost) no interest risk.

Long-term treasury notes/bonds is what was being discussed. There is interest risk in that case and neither your broker nor anyone else would consider them cash equivalents (unless they are already close to maturity).

The trouble is that other US government interventions also eliminated a big chunk of the "anything else to do with it". In particular, most mortgages in the US are fixed rate for the entire duration of their term through government backing, which almost entirely eliminates one of the big sectors of loans that banks in other countries can use to make money on the premium from interest payments with less duration mismatch than 10-year or 30-year bonds. In most other countries, mortgages are either variable rate or only fixed rate for a relatively short period. Also, a substantial proportion of all US mortgages in existence apparently locked in their interest rates during the time period in 2020 and 2021 when they were at record lows.

I'm not as familiar with how mortgage markets work in other countries, but at least in the US fixed rate mortgages are almost always risk balanced against fixed rate investmentsor wrapped up in securities that move risk off the banks' books.

A bank would indeed be crazy to hold onto fixed rate 30-year loans with interest rates at near zero.

Yeah, in the US fixed rate mortgages are handed off to the government who guarantees them and bundles them up into securities... that SVB then ended up buying a bunch of because it's not like there was exactly a wide variety of low default risk options available that actually paid meaningful interest.

At least based on this article, it even sounds like this is what they wanted banks to do! The reverse-repo market was created because the Fed wanted banks to buy securities directly from them when interest rates where increased, sounds like SVB and others just followed that playbook

Maturity transformation (borrowing short and lending long) is still a core function of banking (and historically one of the key sources of profit. Manhunt this risk in a bank portfolio is one of the central jobs of management.

The naïveté was thinking the deposit base wouldn’t shrink (after growing 3x in as many years)

Would pre-2018 regulations (when they were eased for banks with deposits less than $250B) have prevented this?

I think so. I believe that this is the reason EU banks have been ok so far, as they do need to hedge interest rate risk.

EU banks are ok? Didn't Credite Suisse just go under and had to be forcedly saved by its main competitor?

Credit Suisse is Swiss. Switzerland is not a member of EU and they don't use euro.

I appreciate the correction but that probably doesn't change the point being made, as the economy of Switzerland is obviously closely tied to that of the EU (when I read EU I normally think Europe, not just European Union, which is my mistake, but in conversations like this I think "Europe" would be the better term after all).

I have no idea about the substantive discussion, but just to point out: Switzerland is not in the EU.

Credite Suisse's problems predate the interest rate issues by years.

Yeah, I almost added CS to the original post, but their problems were relatively unique to them, rather than being an extreme case of a common problem, like regional banks in the US (who didn't need to hedge interest rate risk).

Aside from where the bank is chartered...

I would suggest a read of https://en.wikipedia.org/wiki/Credit_Suisse#Controversies and consider that each time that happened they lost money and trust.

At this point, they have neither.

If you bought treasuries at the prevailing rate and swapped them at the same rate then the market price of the swap will be zero. You'll still have to pay credit and funding premia though. If, however, you only hedge once the prevailing rate moves against you, you'll pay a market premium in the form of a spread.

Oh you can get a lot more creative than that. You can hedge out "catastrophic" interest rate rises while taking your chances on smaller increases. In this case, catastrophic can easily be estimated by taking the duration of the book and the equity cushion and applying a margin of safety. Or you can simply ladder Treasury durations that inherently don't have enough duration to cause problems. SVB apparently did none of that.

There is exactly one investment strategy that presents no risk of ruin for a bank: depositing all customer deposits in the bank's account at the fed. That investment strategy is so discouraged by regulators that they literally denied the application for a charter from an organization whose stated investment strategy was exactly that. (google the narrow bank if this is unfamiliar to you).

For any other investment of any amount of your deposits, a run of sufficient size combined with an investment loss of sufficient size will ruin a bank.

That being said, SVB had by a wide margin the flightiest deposits and the most IR risk. But it was an error of magnitude, not category. There is no run-proof fractional reserve bank.

Interest isn't just compensation for risk. It's also compensation for temporarily giving up control of your money.

If the market always knows best then why do I need traders except for market making purposes? Shouldn't everyone just buy the lowest cost passive ETF of a big enough index like S&P 500 then?

I think "the market always knows best" is correct in most cases and if you think you know better you are probably wrong but there are empirical counterexamples like the Buffets of the world (unless one would claim that his gains come from some sort of other unfair advantages like the deals only he gets to make). I also think that human behaviour isn't always rational and herd effects and the like are a thing and not always priced in correctly. And while the flow of information feels pretty efficient in this day and age, I also think that there have to be some pockets where individuals can gain informational advantages.

I do like Sorros' book (Alchemy of Finance) which is dense and hard to get through but vibed well with me philosophically.

> Shouldn't everyone just buy the lowest cost passive ETF of a big enough index like S&P 500 then?

Yes, this is very best the advise to invest your money (except if your name is Warren Buffet). Buy it and hold it. There have been so many papers published that show this. You cannot predict the market, what you can do is save yourself some risk and some transaction costs. Any investment advisor that tells you different is plain wrong and probably has a second agenda.

You can also save yourself time. I see so many people use enormous amounts of time reading headlines about companies and consuming videos about the economy and all that jazz to stay up to date and make "informed trades". But in the end a lot of that time is wasted. And you might say that's ok if that is their hobby, but lets be honest, the reason people do this is because they got sold on the idea that they can get rich from it.

If everyone invested in index funds, then there would be a lot of money to be made from you alone looking at the market. There are often companies that announce some new product that will (at least for a few years) outsell their competition. Index fund have no way to know that the company will thus be worth more money than their competition, but you do.

The problem is the above is similar to a zero sum game in that there is a fixed total profit to be made in that way, and that money is shared between everyone who is correct (including index funds!). Since there are a lot of people trying to make the above trades the total profit you can make is reduced as they have already moved the price above what a pure index fund market would have it at. (a true zero sum game every winner is paired with a loser, while the above doesn't actually have losers in the same way, but I don't know any other way to explain it)

I concluded long ago that if I made studying the market my full time job and hobby I could make a good income doing it. However reading all the reports is boring, while writing code is fun, so I just invest in index funds.

> I concluded long ago that if I made studying the market my full time job and hobby I could make a good income doing it

I'd be curious how you reached this conclusion. The outside view (lots of academic papers on this) is that nobody beats the market over a long time frame. I've often thought this assumes scale-invariance; as I look to make lower volumes of money, I'll see things that aren't worth a real trader's time. Another way I can see this as true is if you don't need to have the money invested all the time - if you strategically pick 1 investment every 5 years, can I expect to beat the market by picking the absolute best trade?

Despite those ideas, I concluded long ago that nobody can beat the market over time, with maybe 1-2 exceptions.

There are a handful of people - Peter Lynch, Warren Buffet... That over the years have proven that thesis false. The vast majority do not beat the market, but the vast majority are investing on emotion and fads.

I would have completely missed amazon and google, but there were other companies that would for a while grow at better than market rates that I would have found (or so I think!), and would have been able to get out of in time (this isn't hard because I don't need to call the top, I can be off by many months and still have a nice return). These companies carry much less downside risk vs dot coms - most of which failed, and part of doing well long term is ensuring that your losses are not good because you will have them from time to time.

Note that you don't have to beat the market by much to pull this off so long as you live cheap those first years.

> nobody can beat the market over time, with maybe 1-2 exceptions.

Apologies for the poor wording. Agreed there do appear to be a few people who beat the market regularly. My perspective is those people are not using the same tools available to even elite traders - Buffett gets really good deals because of who he is. That kind of thing isn't available to anyone else and in the context of "could GP beat the market if they worked really hard and were really smart", it rounds to "nobody can beat it".

I haven't read those academic papers you mentioned so I might have missed some insights, but after thinking about it on and off for a while my thoughts on it are:

1. Many people trading on the stock market are professional traders who do it as a full time job, and they have access to information and tools that you don't. So unless you expend similar amount of time in studying the markets, it's highly unlikely you'd beat them.

2. Even the best traders generally beat the market by a couple percent on average. So in order to compensate for time cost of equivalent to a full time job on studying the markets, the fund you're investing needs to be: (your salary / x%) -- Let's say you expect 100k salary, and somehow you can beat the market by 5% if you put in the time, then you need a fund of 100k/0.05 = 2000k for the enterprise to "break even" so to speak.

3. Most people don't have 2 million to invest. And even if they do, they don't want to spend 40+ hours a week studying the stock market. So, since trading is basically a zero sum game, most people who invest small amounts of money perform worse than the market.

This doesn't even go into the tricky details of determining whether your performance is due to skill or luck (or lack thereof). The 5% is subtle enough, but not having any degree of certainty at all makes reviewing your decisions and trying to improve your trading skills even harder.

That said, there's probably more than a couple people besides the big names who can pull this off. It's just that even if you consistently beat the market, it takes a long time for people (including yourself?) to notice, because the effects are so subtle at first. In a sense Warren Buffet owes his fame not only to his skill but also to his age, and his willingness to engage in the activity even when he has all the money in the world. I suspect most other people find other interesting things to do once they earn a hundred million or so since it's more money than they ever need...

This is a reasonable summary of mutual funds not beating the market. I think it's maybe a single-digit number of individuals can do it, but the reasonable default should be something like "a number that rounds to 0% of money managers in any format are able to beat the market over a long time frame".

https://www.nytimes.com/2022/12/02/business/stock-market-ind...

> If the market always knows best then why do I need traders except for market making purposes?

You may not. It doesn't follow that the market doesn't. Long term US stock investment isn't the only reason people use capital markets. And even for passive etfs, your counterpart is likely hedging their exposure with someone who you didn't buy the etf from.

Seems to me you're missing the forest for the trees.

"The Market" is the spontaneous order generated by millions of individual transactions seeking equilibrium.

Individual traders can fail, be greedy, or succeed, and the market as a whole still balances out.

Think of it like a biotope pond, which exists and naturally adjusts to all sorts of conditions, and think of the Federal Reserve and Banks lending practices as a corporation dumping 40 metric tons of mislabled organic fair-trade ketchup into that pond.

Too much of even a good thing, still poisons the system.

I thought the market knows best was kind of a joke. As in all your best reasoning and prayers, but it can still go against you, the market knew best. Is it in the same vein as a wizard being neither early or late, he arrives precisely when he means to (nothing’s ever priced incorrectly)? Or, like a loving mother who beats you (you didn’t properly factor in jupiter)? Depends how you’re feeling, but the market always knows best.

That is not what is meant, and you should stop thinking that.

> But for those they would have to pay a premium.

Wouldn't that be equal to holding short-term treasuries. In that case, they'd be sitting at billions of "worthless" money. Question is, who is the other bank that took that risk. Because of the nature of the market (ie: competition) they had to produce yield comparing to their peers.

So either their peers were smarter or the big unfolding is yet to happen.

Their exuberance at the state of the economy in 2020 and early 2021 can be seen in their interview with Bloomberg. They expected the growth of tech to continue to grow at the rate that it did with the start of the pandemic and that that was going to be stable afterwards.

https://www.bloomberg.com/news/videos/2021-05-20/innovation-...

> the market always knows better than you

If humans could predict the future, we wouldn't have gambling.