Dear Reader,
“Banking is very good business if you don’t do anything dumb,” cracks Omaha’s sage, Mr. Warren Buffett.
Bank of America did something dumb.
The bank’s quarterly earnings report came issuing yesterday.
What did it reveal? That the bank had loaded up, dumbly, on government bonds when interest rates were guttering.
It neglected to consider that interest rates might one day leap from the gutter.
When interest rates did — leap from the gutter, that is — over half its balance sheet was reduced to sawdust.
Worse Than Atrocious
Bank of America’s balance sheet is presently burdened with $112 billion of unrealized bond losses.
The $112 billion enormity constitutes some 57% of its tangible common equity.
Tangible common equity (TCE) is a barometer indicating a bank’s ability to absorb potential losses.
“To say this is atrocious would be a massive understatement,” says macroeconomist Peter Schiff, in gobsmacked stupefaction.
He adds:
- Bank of America is the poster child for the looming problems in the US banking system…. This is not a problem isolated to Bank of America — their losses just happen to be the biggest.
It All Started in 2023
How did Bank of America arrive at this perilous pass? For answers we must return to the banking wobbles of 2023.
Beginning that year a score of regional banks sank to their knees… and plunged into receivership.
Do you recall Silicon Valley Bank? Signature Bank? First Republic Bank?
Like Bank of America — and in defiance of Mr. Buffett’s sage counsel — they had done something dumb.
They had loaded their portfolios with long-term Treasury bonds. The banks purchased these “safe” bonds in a climate of severely depressed interest rates.
Gee, It Seemed Like a Good Idea at the Time
In a climate of severely depressed interest rates, bonds maintain an elevated value. They constitute lovely jewels upon the balance sheet.
That is because bond prices and interest rates exist in antagonism… as the polar ends of the seesaw exist in antagonism.
When interest rates take to the downswing bond prices take to the upswing. When interest rates take to the upswing bond prices take to the downswing.
When you imagine a seesaw in active operation you imagine the price/rate relation.
Thus these bonds sparkled in the pre-2022 climate of severely depressed interest rates.
These banks expected this climate of severely depressed interest rates to run and run.
Yet this climate of severely depressed interest rates did not run and run.
Heavy Weather
In 2022 heavy weather barreled in.
Inflationary deluges ran in rivers, cresting at 9.1% in June of that year.
The Federal Reserve organized its flood response team… and undertook the most aggressive and dizzying interest rate raisings ever.
In March 2022 the Federal Reserve’s target rate squatted between 0.25% and 0.50%.
Within 14 months the Federal Reserve’s target rate scraped the sky between 5% and 5.25%.
Thus the bonds that were oaken assets in the climate of severely depressed interest rates… turned to sawdust assets in the weather of rapidly elevating interest rates.
Hence the subsequent bank drownings of 2023-24.
Storm Clouds Gather
The calendar has scrolled to 2025. And thick gray clouds gather on the horizon.
Bank of America had best have its waders readied. Mr. Schiff:
- Bank of America did the same thing (as those smaller regional banks): they bought up hundreds of billions of dollars worth of federal bonds during the pandemic when interest rates were at all-time lows, i.e. when bond prices were at all-time highs.
- Interest rates are now significantly higher than they were in 2020/2021. And as a result, the value of Bank of America’s bonds has plummeted by a whopping $112 billion.
Yet Bank of America does not stand alone. For many other banks did the identical dumb thing it did — pile into Uncle Samuel’s bonds:
- Back in December, the FDIC estimated total unrealized bond losses across the entire US banking sector to be roughly half a trillion dollars.
- Given that bond yields have risen sharply since then, the unrealized bond losses across America’s banks have only become worse.
Please, St. Jerome, Lower Interest Rates!
Thus these banks sink to their knees… and pray St. Jerome will deliver reduced interest rates.
Depressed rates would elevate bond prices — recall the swinging seesaw:
- Dozens and dozens of banks in the US, big and small, are quietly panicking… and praying for lower interest rates.
- Lower interest rates would solve the problem for them by increasing the value of their bond portfolios, reducing the unrealized losses, and forestalling a capital crunch or even insolvency.
Yet how can the Federal Reserve depress interest rates while inflation remains a menace?
It stands damned if it does — and damned if it does not.
The Fed’s Lost Control
Mr. Schiff fears that the Federal Reserve has lost command of the bond market.
The bond market has put out its tongue at Mr. Powell and mates, placed its thumbs in its ears… and wagged its fingers at them:
- Unfortunately for the Fed, and for these troubled banks, the bond market isn’t listening.
- In September, when the Fed began cutting rates, the yield on the 10-year Treasury was as low as 3.59%. Since then, even though the Fed has tried to cut rates three times, bond yields have surged, reaching a high of 4.89% just a few days ago.
- So it’s obvious that the Fed has completely lost control of the bond market.
‘Twas not always thus:
- There was a time that the Fed was able to move markets with a few well placed words in an otherwise boring speech. Alan Greenspan, Fed chairman back in the 1990s, was legendary for his cryptic messaging which could send both stock and bond markets swooning.
- But it’s clear the Fed just doesn’t have the same pull that it once did… the market is simply not following along.
- And that’s a huge problem for these troubled banks.
A Banking Crisis Can Spread Fast
I hazard it is a huge problem for these troubled banks… or at least a potentially huge problem for these troubled banks.
In justice — in justice — Mr. Schiff does not believe all banks did something dumb.
JP Morgan, for example, boasts a sturdy balance sheet of good, hard timber.
It lacks substantial exposure to the United States Treasury market.
Yet dozens and dozens of banks suffer substantial exposure to the United States Treasury market.
In the banking world the foot bone is connected to the leg bone is connected to the knee bone is connected to the thigh bone is connected to the hip bone is connected to the backbone is connected to the neck bone.
Thus a rumpus in the foot bone may soon have the neck bone in siege.
Will Bank of America prove the foot bone?
Regards,
Brian Maher
for Freedom Financial News