The way a bank works is that it borrows short to lend long

The biggest problem is that your depositors might all ask for their money back tomorrow, and you might not be able to get the money back from your borrowers for years. 

This problem is known as a “bank run” and is famous from, you know, the Diamond-Dybvig model that won a Nobel Prize last year, or from It’s a Wonderful Life.

Banks don’t always like mark-to-market accounting.

One crude way that the actual US banking system deals with this problem is by letting banks account for their held-to-maturity bonds at cost on their balance sheet, but then making them explain, somewhere in the footnotes to the financial statements, their current market value. 

This feels like in some ways a fair compromise. On the other hand someone might read the footnotes! I mean, not most people. But someone might, and they might explain the footnotes in a readable way — they might say something like “on a mark-to-market basis, they were broke last quarter”  — and people might read that and think “huh that’s bad” and withdraw their deposits. Causing the bonds to be sold, causing insolvency.

Matt Levine Bloomberg 13 mars 2023

The risks of duration-mismatching your assets and liabilities has always been how you make real money in banking. 

No one ever earned a living taking in free money from depositors and stuffing it in the bank vault. And while it seems that some of SVB’s risk managers might have better spent their time investigating hedging strategies rather than promoting social justice, it’s not as though they were funneling depositors’ funds into the accounts of distressed Nigerian princes or prospectuses for tulip bulbs. 

Imprudent bankers weren’t the only ones who believed the high financial tide was permanent.

Who knew that 10-year Treasurys would be such a high-risk bet?

Gerard Baker 13 March 2023

Englund: In hindsight almost everyone.


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