Global Financial Crisis 2.0? Part 2

Chapter 2: Why government bonds are now a ticking time bomb

In my previous article on the Silicon Valley Bank collapse, I made a couple of bold claims:

1. I said that US Treasuries are the new “toxic security.”
2. I said that anyone who has purchased long-term government bonds — be it banks, brokerages, large corporations, state and local governments, or foreign institutions — they’re all sitting on enormous losses right now, and are at risk of failure.

But don’t get me wrong: it’s not ALL Treasury bonds.

It’s the ones that investors and institutions bought back in 2020 and 2021 during Quantitative Easing, when the Fed Funds rate was ~0%.

The 10-year bonds, for example, had a coupon rate of as little as 0.5% annual interest in August 2020, and have since been hugely devalued by all the rate hikes.

See, when interest rates go up, any new bonds that are issued will have a higher “coupon rate” that reflects the Fed’s hike.

Investors holding the old bonds have to reduce the price of those bonds on the secondary market, in order to get the yield on par to what the new bonds pay in interest and thus attract a buyer.

As an example: no one’s going to pay face value for a bond earning a 3% interest rate (yield) if the Fed funds rate is going up and they can buy a newly-issued bond paying a higher interest rate of say, 4%. In order to sell that 3% bond, you’d have to drop its price to less than face value until it too produces a yield of 4%.

Thus, bond prices and yields have an inverse relationship.

And that inverse relationship, and SVB’s failure to hedge against it, is what ultimately did them in.