Stocks Week Ahead: US Banks Sit on $620 Billion Unrealized Losses

New York (CNN) The collapse of Silicon Valley Bank last week sent panic on the backs of investors, as it exposed a larger problem in the banking industry: the growing gap between the value that major lenders place on bonds they hold and what they are actually worth on the market.

SVB’s downfall was linked, in part, to the fall in value of the bonds it acquired during boom times, when it received a lot of customer deposits and needed a place to park the money.

But SVB is not the only institution to have this problem. U.S. banks were sitting on $620 billion in unrealized losses (assets that have fallen in price but have not yet been sold) at the end of 2022, according to the FDIC.

What is happening: Back when interest rates were close to zero, US banks scooped up a lot of Treasuries and bonds. Now, as the Federal Reserve raises rates to fight inflation, those bonds have lost value.

When interest rates rise, newly issued bonds begin to pay higher rates to investors, making older, lower-rate bonds less attractive and less valuable.

The result is that most banks have a certain amount of unrealized losses on their books.

“The current interest rate environment has had dramatic effects on the profitability and risk profile of banks’ funding and investment strategies,” FDIC Chairman Martin Gruenberg said in prepared remarks. at the Institute of International Bankers last week.

“Unrealized losses weaken a bank’s future ability to meet unforeseen liquidity needs,” he added.

In other words, banks might find that they have less cash than they thought – especially when they need it – because their securities are worth less than expected.

“Many institutions – central banks, commercial banks and pension funds – are sitting on assets that are worth significantly less than what is shown in their financial statements,” said Jens Hagendorff, professor of finance at King’s College of London. “The resulting losses will be significant and will have to be funded somehow. The scale of the problem is starting to cause concern.”

Still, there’s no need to panic yet, analysts say.

“(Falling bond prices are) only really a problem in a situation where your balance sheet is collapsing quite quickly…(and you) have to sell assets that you wouldn’t normally have to sell,” he said. declared Luc Plouvier, senior portfolio. manager at Van Lanschot Kempen, a Dutch wealth management company.

Most major U.S. banks are in good financial shape and will not find themselves in a situation where they are forced to take bond losses, Gruenberg said.

Shares of major banks stabilized on Friday after plunging Thursday into their worst day in nearly three years.

— Julia Horowitz and Anna Coobin contributed reporting.

Should we increase unemployment to bring down inflation?

Last week, Senator Elizabeth Warren asked Federal Reserve Chairman Jerome Powell about US job losses as potential victims of the central bank’s battle with high inflation.

Warren, a frequent critic of the Fed chief, noted that 2 million more people would have to lose their jobs if the unemployment rate rose from its current rate of 3.6% to reach the Fed’s projection of 4.6%. by the end of the year.

“If you could speak directly to the two million workers who have decent jobs today, who you plan to fire in the next year, what would you say to them?” Warren asked.

Powell argued that all Americans, not just two million, are suffering from high inflation.

“Will workers be better off if we just quit our jobs and inflation stays at 5 or 6 percent?” Powell replied

Warren warned Powell that he was “playing with people’s lives”.

The discussion was part of a larger conversation about cost-benefit analysis that keeps popping up in the job market: What’s Worse: loss or high inflation?

CNN spoke with two leading economic analysts with different perspectives to better understand the debate.

Below is our interview with Roosevelt Institute Director Michael Konczal. Tomorrow you will hear from Laurence Ball, professor of economics at Johns Hopkins.

This interview has been edited for length and clarity.

Before the bell: Do we need higher unemployment to reduce inflation rates?

Michael Konczal: The demand for labor is so high that we probably have the ability to reduce the pressure on the economy by slowing certain measures of hiring – the quit rate or the job opening rate, for example – which would allow wages to slow down and cool the economy, but not necessarily put many people out of work.

Powell argued that high inflation could be worse for the economy and people than rising unemployment. What do you think of this cost-benefit analysis?

What raised my eyebrows was Powell who said that if he quit his job, inflation would stay at 5 or 6%. Inflation over the last three months hasn’t been 6%, depending on what you look at, it hasn’t really been 5% either.

Inflation has a high cost when it is at 5% or 6%, but when it goes down to 2.5% or 3%, I would like to know how urgent he thinks it is to obtain this last mile up to 2% inflation if it meant more than two million people were out of work. I think the dirty secret is that economists can’t really tell you what the downside is to inflation at 2.5% instead of 2% — there are winners and there are losers, but the net economic costs are less clear.

It’s going to be really brutal on the labor market to bring inflation back to that last mile, it could involve some incredibly tough trade-offs. I think it would be really devastating for so many people to lose their jobs for what is essentially a made up number (the 2% inflation target).

How serious do you think Powell is about meeting his 2% inflation target?

Powell doesn’t want financial markets to get frothy or financial conditions to loosen, so he has to appear hawkish, even if he doesn’t want to be so hawkish. On the other hand, they play with real bullets. It’s real, millions of people will lose their jobs if the Fed does what it says it wants to do.

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