How can you lose money on a treasury bill?
A reader writes, citing a scary article which is an opinion piece and a bit of fear-mongering. "The Fed says everything is OK but why should we believe them?" What is this saying - that the Fed is lying to us? Or are they saying the Fed is clueless that they have no idea what is going on? Either way, I am skeptical. Yes, shit is happening - HELLO? RECESSION ANYONE? But the end of the world as we know it? You'll never go broke selling bad news. And in terms of news, bad is the only kind they have in the media.
There are differences, however, between bank failures in 2008 and today. Back in 2008 it was overpriced real estate (Hmm.... maybe that will be true in 2024 as well) that drove a lot of banks under. People got funny-money mortgages on overpriced houses and everyone acted shocked when they defaulted on "liar's loans." These loans, bundled as securities, were on the balance sheets of many banks, along with derivatives of these bundled loans - something called a "credit default swap" which was supposed to make these "investments" bulletproof, but in reality was like an extended warranty on your car from a fly-by-night "warranty" company that has an empty office in Boca Raton and a phone number that just rings and rings.
As I understand it, the problems these banks are facing are related to the recent dramatic changes in interest rates as well as "Mark-to-Market" economics. You may remember Mark-to-Market during the Enron debacle. The folks at Enron, in addition to keeping massive debts off the books by spinning them off (illegally) to shell companies named after Star Wars characters (I kid you not) also used "Mark to Market" to record the overall projected value of an energy contract at the time the contract was signed. So they claimed that a contract worth $10M over a period of ten years, was "worth" $10M right now, even though energy wasn't even delivered yet.
Of course, in the volatile energy business, prices fluctuate wildly, so it is sort of specious to claim that a contract is worth $X today, when you have no idea what conditions will be like down the road. The fourth dimension of time rears its ugly head.
This time around, Mark-to-Market isn't being used to over-state assets, but perhaps understate them. Many of these banks that failed, had money invested in treasury bills, which were paying very low interest rates. When rates went up, these bills were worth less - the market value of an un-matured t-bill is what the market will bear, not the face value or whatever. You can calculate down to the penny the future value of money based on prevailing interest rates and other opportunities that have a higher rate of return. Yes, this is an example where opportunity cost legitimately enters into the picture.
There may be other factors. For municipal bonds or corporate bonds, the solvency of the underlying entity may be a huge factor. I could have bought those Mohegan Sun Casino bonds and made over 200% interest in a matter of weeks. But the thought of the place going bust scared me (and a host of other investors) to death - which is why they were trading for so little.
So these banks are stuck with T-bills, which, if they held them to maturity, would be worth the face value. They haven't "lost" money on them. But, if they had to sell them today, they would have to discount them significantly, as interest rates are far higher today.
Let me give you a real-world example. I bought this 30-year treasury bill with an interest rate of 3.87% and a face value (upon maturity) of $2000. I paid $668.62 for it, and today, it is "worth" $945.58 which according to my compound interest calculator, is about what $668.62 would be worth after 13 years at 3.87% interest. By 2040, it will be worth an even $2000.
Now, if I wanted to sell this bond, I could - to another investor. What they would pay for it might not be $945.58 that Merrill says it is worth. Another investor might want a higher rate of return than 3.87% and thus would demand a discount in price. On the other hand, if long-term rates have gone down (and they have, to about 3.5%) then maybe my T-bill may be worth more than its face value.
For shorter-term bills with even lower rates, the problem is dramatic. Rates for three-month treasuries last year were 0.8% and today they are 4.95%. Weirder still, the long-term rates are actually lower than short-term, this "inversion" they talk about that signals recession. Hello?
Now, if I keep the T-bill until maturity, it will be "worth" $2000 and I didn't "lose money" except perhaps to inflation. I could have used that money to invest in something with a higher rate of return, and made more money. That's why I only threw $2000 at this investment - I realized while it was safe, there was a risk that if rates went up.
So, as I understand it, that is the problem facing these troubled banks. They have money tied up in bonds with low interest rates. If they hold them to maturity, they get all their money back and then some. But if they had to sell on a moment's notice, they get market value for the bonds, which might be even less than they paid for them, if they are very low-rate notes. So if you do a balance sheet and put the "Market value" of these assets on one side, the balance sheet may go negative, even if the bank has a profitable loan portfolio and a hefty amount of deposits from depositors. The bank is solvent, and then again, it isn't.
What is interesting is that other banks are keen to snap up these "failed" banks, and acquire the deposits and loan portfolios. There is still a
there there, particularly when offered at a discount price. It isn't like these bundled mortgages, which are worth almost nothing - trying to foreclose on thousands of houses is an expensive and time-consuming process. Remember the "robo-signing" controversy? And since the market was flooded with foreclosures, prices went though the floor.
I recounted how, in Cape Coral, we went on a "foreclosure tour" and found houses that a year or two earlier were selling for $475,000 were now selling for under a hundred grand.
How do you think I made money in real estate? Not by buying at the peak, that's for sure!
So I am not sure we are facing the same level of insolvency this time around - although a real estate recession is definitely a possibility. The difference is, I think, that this time a lot of people are cash buyers or made large down payments. The "liar's loan" is history - or should be. We see people, mostly retirees, paying crazy prices for houses here on the island, with cash. If the market tanks, they may lose money personally, but no bank will get hurt.
Of course, other factors could come in to play. Silicon Valley Bank had a lot of loans to tech companies - a very cyclical business. A company goes bust, maybe those loans are not worth anything. That could change the picture quite a bit.
But whether this is a systemic problem affecting every bank, or just a quirk of "mark-to-market" on the balance sheets, remains to be seen. One problem is, of course, that if people get nervous and think their bank is going into default, they may try to withdraw all their money at once. And as a another reader pointed out, many of these silicon valley companies, as a condition of their loans, had to keep their money at the bank issuing the loans. So they had large, uninsured balances, that they needed for day-to-day expenses - to make payroll and keep the lights on. Their companies were solvent, but would become insolvent, if their deposits were wiped out.
I noted how a similar thing happened in 2008. The Fed required banks to have more cash-on-hand and as a result, they called loans ("
Callable Notes") which
pushed many small companies to bankruptcy - even companies that were making money and current on their loans. Fortunately, the Fed stepped in and backed-up deposits, not to save the bank, but to save the depositors.
Whether they can do this again and again, remains to be seen. But fear and panic really never serve anyone well - but they often work to the advantage of those sowing fear and panic.
Other than stuffing money in your mattress, three isn't much you can do, anyway. So why worry?
Shit is hitting the fan. Your house will go down in value. The labor shortage, such as it was, is over. Your stock portfolio will decrease in value as well. But people will still get up in the morning and go to work and pay their bills, and over time, it will turn around.
I've been through this four times, now.
And the previous three recessions I have been in, fear and panic never made things better, but in fact, far worse.
