There Could Be More Bank Failures | Chris Whalen 

I believe SVB was making an effort to reorganize their bond portfolio. Yes, they would lose money if they sold their low-yielding bonds. But, they were trying to make up for it by repurchasing bonds on the open market at the higher interest rate.

Despite the economy's resilience thus far, the SVB scenario cautions that the effects of Federal Reserve rate hikes persist. During such periods, investors must remain alert to anticipate what comes next. It is not necessary to act on every prediction, so I recommend seeking the guidance of a financial advisor, which has been my go-to advice for some time now.

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What he doesn’t know isn’t worth knowing about

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Ouch. LOL That was a stupid announcement. I mean this guy is supposed to be smart. But in his defense,.. he made that announcment while he was going through a mentally unstable break down blaming the Fed for SVB's failure. And then proclaimed,.. this is it for rate hikes...The Fed has no more tools,... The Fed will be cutting from here on out.

Oh yeah, but isn't he Kissinger's son? 😉

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When it comes to investing in stocks, one of the biggest mistakes investors can make is throw in the towel right when we hit a bear market bottom and the indexes find support and start to surge. I've been in touch with a coach for awhile now mostly cause I lack the depth knowledge and mental fortitude to deal with these recurring market conditions, I nettd over $220K during this dip, that made it clear there's more to the market that we avg joes don't know

I've actually been looking into advisors lately, the news I've been seeing in the market hasn't been so encouraging. who's the person

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he appears to be well-educated and well-read. I ran a Google >>search on his name and came across his website; thank you for sharing..

Yes, and still gundlach said last week on the nbc that it was mathematically impossible to hedge (SVB), in contrast to the pecca-steno duo, and today the stripping whalen. Parallell universes, they live in.

45:40 and a few seconds brings up the chart for someone who can give an answer to this one.

I'm pretty sure it's how well you convert your already earned income to cash. So the Wells Fargo efficency ratio is high because they have high staffing costs. I believe this was the case off memory. Jpm metrics are all God tier. I spent days reading 10 years of reports, and when I got to jpm, I fell in love. Jpm is God's bank. They call it a fortress balance sheet for a reason.

It's a cost / income ratio. I know... It's really really stupid, and it's not the only formula we have like this in finance that is reverse intuitive

@@Tential1 Appreciate the explanation. Makes sense now;)

If they can get it at a discount,.. the yields could be high.

Great question, does Mr. Whalen think banks use real money for cc purchases. Look up episode 9 of "Free to Choose" where Congressman Clarence Brown brought up credit creation from credit card money as being a cause of consumer inflation! Milton Friedman didn't answer! He was famously shutting down the printing press at the Treasury! Credit Creation produces over ninety percent of money. Shhh! Even the bank of England admitted to credit money creation in 2014 same year Professor Werner published his empirical demonstration of money creation (Werner 2014)

"The creation of money always involves the extension of credit by commercial banks." Russell L. Munk United States Treasury

It's called a fractional reserve banking system. It's no secret. It's been around forever.

@@jcgoogle1808 never said it was a secret and FRT started in the thirties as a gentle nudge away from Credit Creation Theory. Today the dominant theory is banks as intermediaries, they take deposits and lend them out. This deflects from the harmful effect caused by injecting funny money into the asset markets, real estate and equities.

Calm doesn't generate the hype needed to draw eyeballs that sell the advertising space

You must have missed him the last time he was on this channel a month ago right after SVB was taken over by the FDIC. Whalen was a basket case. Oh,.. this is all the Fed's fault,.. blah,..blah,.. blah,.. NO it was Silcon Valley's and its own cutomers' fault.// the former for going too far out on the duration curve even though the Fed telegraphed for months it was going to raise rates,.. and the latter for telling fellow depositors to (needlessly since the government decided to guarantee the desposits) get all of their money out of Silicon Valley immediatley if not sooner. "The Fed Is To Blame For The Collapse of Silicon Valley Bank | Chris Whalen"

Because investors can choose where to put their money and they are choosing to move it to where it is appreciated the most (higher yield).

If the bank is paying you 0.1% per year in interest in a checking or savings account and you can get a treasury paying nearly 5% per year,.. where are you going to put your money?

Interviewer: Yes, what is a bigger headwind, Chris? Banks' unrealized losses have gotten smaller over the past month. Is it deposits outflows, cost of deposits, duration risk on the asset side, or commercial real estate credit risk? Speaker: Well, let's go down the list. The duration risk is basically a function of where the ten-year is. So if the ten-year is closer to three than four, the number is going to be better, it's going to be smaller. So whereas in the third quarter, your available-for-sale book and your held-to-maturity securities were probably a trillion dollars underwater, this quarter it's going to be half of that. That's not a great number, but it's okay. It's not as bad as people were worried about. The more profound question though goes back to your thought about those distressed assets. If you have loans made in '20 and '21 that have coupons of three and four percent, you're underwater. Most bond investors, most funds, for example, can't justify owning an asset like that unless they buy it at an extremely low price, a very steep discount. So I think in those cases, the cash flow is what's coming at us. This is going to be a second quarter, third quarter story. And I think if the bond is close to three percent, a lot of banks are going to take the pain and sell, Jack. They're just going to kick this stuff out, take the hit, you know, maybe a 10-point, 12-point loss on, say, a GMAC II, but you know what? If you can go out and reinvest at six percent, that's a good trade in the bank's set of capital and strong earnings. They're going to do that trade. The rest of it, I think, you know, it's gonna be a case by case. I hate to say it. Some banks, if you look at PNC this morning, came through very nicely, not much volatility in the balance sheet. Other banks are not going to be as lucky. First Republic is still trading at 10-10 cents on the dollar of book value. They may get bought, somebody may just take it off the table. But I think you'll see more consolidation as we push the liquidity out of the market. Credit costs are going to come back, and you're still going to have an issue about funding, but the banks are going to try and deal with it as they can. So, you know, I think credit will be the story by the end of the year. That'll be the predominant story for banks, the return of credit risk. What did you see today, not on the cost of deposits, but on the absolute level of deposits? I know it's JPMorgan. Their deposits actually increased quarter over quarter for the first time since the first quarter of 2022. Is that a good sign? People have faith in the banks or is that everyone is withdrawing money from regional banks and parking it with Jamie Dimon? So actually, it's good for the big guys, but for the regional banks, it's a struggle. In other words, the better the deposits look for the large banks, the worse it will be for the regionals. Or perhaps, but again, I would say it's a case-by-case kind of analysis. You can't just say, "Well, all small banks are in trouble" because it's not true. There are a lot of small banks that have very, very strong relationships with their business customers, which is what matters, and they're going to get through. But they're gonna have to pay for the money. That's the big caveat. So as we shrink excess reserves from the system as the Fed eventually has to start selling securities from their portfolio to hit their own benchmarks for runoff, then I think you're going to see this whole issue change, and you're going to see the banks much more focused on credit, and you're going to see a lot of commercial restructurings, buildings, you know, what have you. And the commercial side is going to lead this discussion as opposed to 10 years ago when residential mortgages were the big deal. It's going to be a different conversation this time. Yes, and I've noticed Wells put aside 643 million dollars for bad loans, and you know, that sounds like a large number, but compared to the size of Wells Fargo, it may not necessarily be large. What are you seeing there? It's just a gradual build. The numbers for defaults are still very low, historic lows, and they have normalized for multifamily and for autos and credit cards. They haven't normalized yet for one to four-family or HELOCs. That's going to probably take most of the year. I think the way I would put it is the individual banks are going to have to make some decisions about a lot of things on their books that looked fine two years ago but may not look fine now. Now, you know, Jamie could get his bank down to two trillion dollars tomorrow instead of being close to three. He would do it because he'd have higher equity returns. These big banks are not really making that much money. They'd do better smaller. JPMorgan makes a fair chunk of change, but what they are, the top-line number is great, but just watch. Just watch the funding costs because that's going to affect capital, and the next thing is that provisions expense is going to get larger over time as charge-offs grow. The regulators are going to make them build credit reserves, and the assumption we have a recession, maybe shallow, whatever, watch Citi, you know, Citi because they're a subprime lender. They're vulnerable. Watch Capital One. If you watch those two, it'll tell you what's going on because they have a higher default rate, they have a lower quality customer, if you will, and the assumption is that they're going to get more defaults on that book. That's why they charge more. You know, the gross spread at Citi's in the teens. The gross spread at JPMorgan is six, right, different business, yeah. And that's how bank accounting works. Banks take the losses before they actually happen before people stop paying on their loans. Banks are, well, supposed to build for those losses, and that's why they took all these losses that were really paper losses in March of 2020, April 2020, that then when people actually paid back their loans, it was a huge, you know, money coming out of the credit reserve that's basically making money. And, you know, that's why, Chris, the financial system, the way banks make money, because it is all based on assumptions. It kind of seems to me a little funny, I should say when people say JPMorgan's revenue is, you know, up 48% in 2020, it's not as if, "Oh, we're selling 100 cans of Coke and we sold 120 this year so it's up 20%." It's based on all these assumptions, you know? That's right. It's what we think revenue is, subject to revision. And you know, look, I'll give you an example of why they do this. Let's say you're a business customer and you're 60 days behind on your line of credit, but you get things together, you catch up, and the next month you're current again. They don't want to necessarily charge that loan off because you were 60 days behind. There may be some reason why you were late. That's why you have a bank, right? So the banker works with you, gets you back on track, no fuss, and off you go. Now, if they have a default where there's no security, let's say it's an unsecured loan, 90 days plus, no payments, they charge it off. They write the whole thing off. If they get a recovery subsequently, great, it's just found money, right? If you have a secured loan, what they normally do, say a mortgage, they'll write it down to fair value. They'll say, "What's this house worth? If I have to foreclose, what am I likely to get as a recovery on the loan?" And then they'll charge off part of it against the provisions you were talking about. That's what the loss is for. But they might make a full recovery, you know, no. So it could take years between when the customer goes delinquent and when they finally resolve the asset, and that's why you have all this funny accounting that kind of estimates loss, kind of estimates revenue, but subject to revision. But so Capital One, you said they are like Citi. They're in a position to be the first to see credit losses because they lend more subprime, so higher rates. Actually, they did the best in the crisis that we had a month ago, of a duration crisis because, you know, First Republic was making mortgages at 3%. And if you're a credit card company that lends at 20%, you don't care if the interest rate went from 0% to 4%. You're a new literature book in a very different way because if you're in the credit card business, you're funding those liabilities with market deposits. You can use broker deposits at Citi to fund your credit card book because the spread is 15%, 16%, 17%. So you have plenty of room. What's interesting to me, Chris, is even though it may seem silly to use that expensive deposit as opposed to a core deposit checking account, which is still less than one percent today, it gives them more flexibility because that book can come and go, and you can sell assets, you can buy assets. So the credit card businesses are very much capital markets, mark-to-market every day kind of business. It's not like the lending business at, say, Bank of America, where they keep 30-year mortgages forever, they literally make the mortgage and just stick it in the portfolio, keep it, no hedging, by the way. So, you know, that's a very different world from a bank that has to be cognizant of market rates, and even the Goldman Sachs, Morgan Stanley, Citi to some degree, they all have to borrow money in the marketplace every day, and that's a very different discipline. It's more like a broker-dealer than a bank. Interviewer: Thanks, Chris. I want to put a pin in the "Is the banking crisis moderating? If so, why?" discussion because I definitely want to ask you about that. But I just want to make a comment that a little over a month ago, it was like today, a Friday, Silicon Valley Bank failed.

Two days later, Signature Bank was taken over on a Sunday. At the same time, the Fed rolled out the BTFP on that Friday. Chris, you, like many in the markets, were quite agitated, and you had a lot of concerns about the health of the banking system. Today, now that big banks reported earnings that, at least on the face of them, appear quite good, you are much more measured and maybe perhaps less concerned. Is that accurate to say? And if so, why? What has happened over the past four or five weeks that makes you say, "Hmm, maybe this crisis we're in, maybe it's not as bad as I thought it was?" Speaker: I think the concern a couple of weeks ago was a surprise when people were surprised, and a default event occurred that they did not anticipate. That has ripple effects throughout the market. So I think a lot of people were rightly concerned when we saw two banks go down in less than two weeks, and in both cases, FDIC clearly had no warning. They couldn't even get a sale process underway. So that is a concern. We do not need to see that, and it's frankly a pretty severe indictment of the Fed because the whole point of going big and providing massive amounts of liquidity to the market was to avoid precisely these sorts of problems. So today, in my calmer, yes, the Fed threw more money at it, and we calmed down the problem for the time being. But it doesn't change the fact that quantitative easing and now quantitative tightening, as we call them, have put a lot of unnecessary stress on the system. And there's a disconnect between what the Fed governors are saying about inflation and what we can see in the market. Let me give you an example. At the end of the third quarter, the banking system's dependence on what we call non-core funding, hot money, doubled in a single quarter. And yet, at the same time, lending didn't grow. There wasn't much going on. It was a fairly pedestrian quarter. The Fed missed this. This was a real flashing red light that said, "Hey, you have a problem. Your banks, your 132 largest banks in the country, were all looking for hot money. What do you suppose that is?" It's because of what we're talking about, Jack. There's a structural change going on in the markets, and that still worries me. That tells me that we could have more bank failures ahead, and it will be the outliers that fail, not the mainstream banks. It's going to be the ones that have a business model, which for some reason or another, is not going to do well in an environment where we're taking reserves out of the system. And keep in mind, the folks at the Fed don't know how to calibrate this process. They don't know, or you know, if a 1% move in Fed funds is equal to X amount of market runoff. Okay, they guess about these things, and these are dangerous things to guess about. After last year's interest rate surge, VanEck Income has made a comeback, and VanEck has the ETFs to help bring income to your portfolio. You can check out VanEck's wide range of income-focused ETFs using their Income Investing Yield Monitor, where you can search by yield, duration, and expense to find the ETF that fits your Speaker: That fits your needs. With the Yield Monitor, you can effortlessly track monthly fixed income, ETF category flows, yields, total returns, and more. To access VanEck Income Investing Yield Monitor, go to VanEck.com. For guidance, now the disclosures: Investing risk includes principal loss. Visit VanEck.com to read a prospectus before investing. VanEck ETFs are distributed by Van Eck Securities Corporation, a wholly-owned subsidiary of VanEck Associates Corporation. Thanks, and let's get back to the interview. Interviewer: There's a slowdown in lending, and when there's a mini-banking crisis, people guess about how much of a hike the credit card should be. "Oh well, the banks will stop lending. That's equivalent to a 25 basis points increase. Now it's 50 basis points up. It could be a hundred." It's just people, you know, there's no way to be proven wrong. Interviewer: But why did people see a kind of slowdown in lending at the end of that first quarter? Is it because banks stepped back? Speaker: Yeah, they were trying to maximize cash. Now, how do you do that? You throttle back lending. You let more of those loans that are coming due redeem; you stick the cash in the bank. Yes, and so I just want to ask you about hot money. I think that's money that goes in and out. It's not loyal, whereas the stable money is something that is going to stay there. What would be an example of hot money? You said that the banks are increasingly relying on it, and you know, what conclusions can we draw from the fact that they need to be tapping this hot money? Interviewer: Hot money, the definition of it, has expanded quite a lot. It could be large high net worth investors who are putting, you know, $250,000 in multiple banks using CDARS or one of these other networks. It could be business customers who are looking to maximize yield on their treasury balances. So there's a whole variety of different types of use cases that we didn't have a few years ago. Now everybody's looking to get paid something on their deposits. So if you're a big business customer of XYZ regional bank, you call your account officer and say, "I'm thinking about moving our payroll into T-bills this quarter. Could you help me with that?" And they go, "No, no, how about, you know, we offer you 2% on your escrow balances and your payroll?" So banks are having to become very innovative about how they retain liabilities and how they also retain the asset side of the business, right, because you want to lend these guys money. That's the struggle all the banks are going through, and they're fighting the treasury. They're fighting J.P. Morgan.

Interviewer: Your idea, your thesis about how quantitative easing and quantitative tightening, the relative expansion and reduction of the Fed's balance sheet, that's very disruptive to the commercial banking system. It's, I'm still processing it, and it's, you know, I feel like it's really complicated. So it would be great to dig into that a little bit. Why is quantitative easing and quantitative tightening so disruptive to the banks? Speaker: Well, quantitative easing was a way for the Fed to change investor preferences. How do you do that? You take a lot of low-risk, quote-unquote, Treasury bonds and mortgage-backed securities out of the market. You stick it on the Fed's balance sheet. Now, unlike banks, the Fed doesn't trade those balances. They don't hedge them. It just sits there sterilized, as the economists term. That puts downward pressure on interest rates because investors now have to go invest in something else, right? By definition, there is a shortage of duration. So if you look at when the Fed bought those securities back in 2021, let's say the notional amount, the top was $3 trillion, and Fannie, Freddie, Ginnie mortgage-backed securities. But since they raised rates, the maturity of those securities has gone from a couple of years' average life to 15 or 20 years because nobody's prepaying the mortgage. Speaker: The extension of the duration of these securities, the extension of the maturity because nobody's prepaying, right? They're just sitting there. Every month they pay interest. It forces long-term rates down. So the worry I have is that if the Fed doesn't accept that they have to be a seller, now this is - they were a buyer in 2020 and 2021 - in order to have some symmetry in terms of monetary policy and how we unwind this, then long-term yields for banks are not going to rise, and eventually, they're going to get crushed because the cost of funds is going to go up. We know that. But if yields on loans don't go up as well, if yields on securities like the 10-year treasury don't get up above 4%, I don't think the banks are going to have a very easy time with that, Jack, because their net interest margin is going to be compressed. The Fed is playing God with the bond market, and they need to understand that there has to be some symmetry in how they unwind the policy, much the way they put it together in the first place. Right? They dropped target rates. They bought a lot of securities. They should tell the Fed in New York every time that ten-year gets anywhere near 3.5%, keep selling until you get to the cap. And I don't think that's such a revolutionary idea, but apparently, it's a big deal for the Fed. Interviewer: Chris, help me understand that. So when the Federal Reserve, a central bank, moves interest rates enormously in a very short period of time, 450 basis points in a year, that imposes drastic losses on holders of duration securities, treasuries, mortgage-backed securities, and those can be hedged. But if I own a lot of treasuries or mortgage-backed securities and I hedge my risk to you, I've just transferred the risk to you. So that's a whole hedging thing that we can get into later. Of course, as you say, the Fed doesn't hedge, but if you're holding onto something, if you're buying an asset on credit, in other words, you like the asset, you don't hedge it, why be with you? You might as well just stay in cash. Okay, let's get into the hedging point now. That's, I'm like, that makes no sense to me. Yes, if you buy a 10-year treasury, oh, but I hedged it with a swap. So now you just have a swap spread risk, you know that's us, but the hedge ratio for a Ginnie Mae II is a lot higher than a 10-year treasury. Why? Because the Ginnie Mae II is a little less liquid than a treasury, number one, number two, the cash flow is all back in. So let's say you have no prepayments, you're at 6%. So for today, nobody's prepaying their mortgage. You're getting 2% annual off of that security, your cost of funds could be 5%. So by definition, these securities are underpriced. They were manipulated when the Fed created them. And keep in And keep in mind that as you raise rates on these securities and their maturity is extended, the weight of them exerts enormous pressure on interest rates in the long end of the curve. So we won't see a normalization of policy until the Fed accepts that they'll have to tell the New York Fed to sell mortgage-backed securities. I think they should do this opportunistically; you don't want to be a seller when the market is retreating, but if they're anywhere near 3%, I want the desk to be selling every day. They could sell cash or forwards, it's up to them. But I think the only way to normalize this market is to get that duration, with a nominal face amount of two and a half trillion dollars, back to the private market. They need that paper. Speaker: I thought the problem was precisely that there was too much duration in the market because it took on too much duration risk when interest rates were so low. You know, if Silicon Valley Bank owned over 80 billion, or even over 100 billion in Ginnie Mae securities, if the Fed had dumped all those securities, they would be trading even lower. This problem of a bank's book value being impaired by the rise of high-interest rates on treasuries and mortgage-backed securities - wouldn't that be exacerbated by selling a little bit? But the volatility would come down because if all of a sudden the securities are in the market, guess what's going to happen to them? Those low coupon bonds are going to trade at a discount to the On The Run paper, the fives and the sixes that we're writing today. People are going to restructure those bonds. They're going to take all those low coupon securities, basically strip them into an interest and principal-only piece, and then weigh and securitize them, and send them to insurance companies. So that, to me, is an excellent outcome because then you will essentially satisfy the shortage demand for duration in the market. There has been a shortage since 2008, and you would think, "Well, gee, Chris, the deficits are huge. How can there not be enough paper out there?" Because you can see it in the swap bucket. Since 2008, swaps for dollar-floating fixed transactions have been at a discount. The rest of the world operates at a premium. Why? Because people were hiding in dollars. They wanted risk-free assets, and they still do. So the bid for a risk-free U.S. currency asset is still off the scale. That's where the Fed should be a seller, be a seller opportunistically, get this stuff out of it, and that I think would help a lot of the volatility we saw in the first quarter, which was stunning, right? You can't have a mortgage-backed security move half a point in yield every day, both directions, by the way, and expect people to make money. I'm sorry, that's not going to happen. You cannot hedge this. You cannot model this, right? So the agency mortgage backs, they have two. I mean, I'm sure they have more, many more, but let's say interest rate risk, convexity risk, but then the spread between the treasures, that's sort of risk. If the Fed stops hiking and, you know, I mean, it seems like it could be the case that the Fed will do 25 basis points at next month's meeting, and then they'll be done. Interest rate volatility on the upside is already gone. On the downside, sure, they can cut, but if the Fed hiking cycle is over what do you work on? You put that paper back in the market to get rid of the volatility. That's what you have to do, and the Treasury, remember, could be refunding. Now that the Fed's not buying paper from the Treasury, they're going to have to go out and refund these assets. So we'll have supply there too, but at least they'll have correct coupons. Interviewer: Chris, to what degree have your fears and the fears of the market in the banking community regarding the recent rally in bonds helping bank book value been allayed by the fact that as interest rates have fallen and mortgage-backed securities have rallied, bonds have rallied because there's a bid for safety? What banks own has actually increased in value, so all these negative equity, market-insolvent positions are looking a lot better. They're certainly looking better than the third quarter. But you know, again, if the ten-year trades off, if we go back to a 4 percent yield, you're right back in the same problem. That's why I think you'll see some of these banks selling when they don't see the 10-year going down anymore in yield; then they're gonna kick out some of this paper and take the pain. Because if you can reinvest at twice the yield, it's worth your money if you have the income and the capital. So, the regulators aren't going to get fussy with you. Do it, kick it out there, go buy some of the current maturity paper, which is gonna perform reasonably, and it won't have excessive prepayments. But I think that, to me, is the way out of this. Otherwise, you know, we have a half a pause, which is just changing targets and focusing on the balance sheet.

You can't do that; that's not a credible policy on the part of the Fed. So how big of an issue are the securities on the banks' books that they bought at 2 percent, 3 percent treasury, all the duration risk? How worried are you that, right here, flow-wise, it's still a significant problem for the industry? If they hold onto those securities, it will impair earnings for years. That's really a medium-term problem. And then low credit, those are the two real concerns coming down the road. The mark-to-market was mostly about disclosure. Now that people understand the issue and they are not surprised the way they were about to go, I think it's going to be far less of a concern. Let's remember the definition of systemic risk is when people are surprised. You go, "Hello, it's the default you were unexpecting," and that really unsettled people. But having said that, you know, I think people, with anything, want to go buy these stocks. I'm not sure that's a great idea, but you know, I still prefer the mostly long position. I bought some New York Community Bank, I bought some Sterling Alliance. Do not take me as an example, though. So yeah, nothing you say is investment advice, no, but I'm accumulating these on a long-term basis because I like the business model. Banks are going to get punished this year, okay? Well, that's because interest rates rising and credit costs are bad for book value and stock value. They taught me years ago, so remember that. These stocks are unlikely to perform well as long as we're worried about credit. So until the Fed really signals we're done, and maybe we could even see rates go down with a few more good inflation numbers, you know, the Street's going to be squawking for this. Unless you can imagine- I'm just trying to understand what has improved for the banks' equity position in terms of their book value. On the whole, the majority, other than interest rates having gone down, what has changed? Yeah, the market's less ugly, but in terms of their overall capital position, I think nothing has changed. They're still likely to give back equity over the next couple of years much the same way many of them accrued new equity during 2020 and 2021. Give back equity as in their valuations go down. No, no, and that's natural. We had a long period where credit had no cost, almost 10 years. So now that the Fed has stopped buying bonds and stopped forcing asset prices up, you're going to see the real cost of credit come back. We've been only waiting for 10 years. Well, come on, how long can credit guys wait? You know, we have to have our fun too. Yeah, because of what? So, you know, when we spoke in March, we said there were a lot of banks where if they were marking their securities and loans to market based on interest rate risk, their liabilities would exceed the value of those assets. Otherwise, they would be marked to market insolvent. That has improved in some cases dramatically as interest rates have fallen over the past month. But if it was such a problem, then why is it not a problem now? I mean, because it's less of a surprise, more people have dug into it and they understand it, and the banks have said, "Well yeah, I've got a big mark-to-market position, but I still have tangible equity." And that's most banks. There are some out there that were playing games and may have been playing for an early pivot and decided to go long too early. You know, the time to change from long to short duration, or excuse me, let's say you were short, you wanted to go long, was the third quarter when the disclosure on that mark-to-market was really ugly. That was the time to flip, but a lot of people were unwilling to do that trade. They were afraid. By the time you got to the end of the fourth quarter, it was very clear watching the 10-year that we were seeing a short-term rally. By the time you got through February, even more so, right? So, the mark-to-market was getting better that whole time, but then you had Silicon Valley and Signature go sideways, and that threw everything out the window. So, I think since then, people have come to understand the problem, and they're a little more comfortable that the Fed is going to do something like lending on securities without a haircut and that sort of thing. But it doesn't change the fundamentals, which is you still have trillions of dollars in securities and loans and commercial mortgages that were priced during 2020 and 2021 priced too low. And if you refinanced those assets today, they'd have twice the yield or more. Chris, now I want to bring up the issue of hedging, which I know you have strong thoughts about, and I do as well. People can say, "Oh yes, the banks bought these duration securities and they have these risks, interest risks, but they know that and they hedged their book accordingly." They're interested, people love to, you know, mention that word hedge and then change the subject. Um, you don't hedge an asset that you're going to keep in the portfolio, what we call hold-to-maturity. Why? Because you buy that asset on credit, you like the credit, therefore you own the asset. Why would you spend most of the coupon hedging it? You might as well just keep reserves at the Fed and send everybody home, right? Fire most of your employees, put all of your assets at the Fed, and go play golf, right? So, the book for hold-to-maturity is really about credit, and you want to maximize the return, which is maximize the coupon. And you're not going to spend on a hedge, right? Um, your available-for-sale book, that's different. You essentially have to hedge it. You're guessing, you're trying to say, "Where's the 10-year going to be at the end of the month?" Okay, so Jack, tell us where's the 10-year going to be at the end of the month? You have no idea. Yes, okay. So, each month, each quarter, shops that have a large chunk of their assets in available-for-sale have to figure out how to guess how much hedge to put against that position so it doesn't go one way or another too much. The classic example is if you're a big lender, you're short in terms of loans, you want to sell on the market next month, you close mortgages, you deliver, that's how you make money. Hopefully, the spread is positive. Same thing with securities, stuff you've been working on this month. Yeehaw, the 10 years going up, the yields going down. So, the stuff you've got in the pipeline, you're actually going to make more money on this month than you might have otherwise. Again, you hedge your rate risk, but you're not hedging the full economic risk of the transaction. Otherwise, you might as well be selling flowers. So, you hedge the rate risk, you mean the interest rate risk, duration risk of the available-for-sale securities. It's somewhat not a hundred percent. You try and cut the ends off it because remember, these are assets with cash flow, but typically, they're agency or government securities. So, it's not like they're distressed. You don't need to hedge a hundred percent of the economic value of the portfolio. But a lot of people who use that word, especially members of Congress, love to say the word hedge like it implies something. It doesn't necessarily mean anything at all. So, that's the issue. A lot of lenders in the last year, because of all the volatility in the market, was so hard, they stopped hedging entirely. As soon as they close the loan, they sell it. They don't even try and hedge the book. That's a very primitive way of working the market, but it's low risk, and it gives you commissions. Today, I think it's the right choice. I'm talking about big lenders who just said to hell with this. I can't possibly guess what this market is going to do because of the Fed.

Therefore, I'm going to simplify my operations. Yeah, I'll sell it quickly, assign the trade to another counterparty. Whatever, just get it out. Because time is risk. Remember, the longer you have that asset sitting on your book, it's all risk, and you don't know which way. Yes and no, there's no magic formula. They don't send you, you know, an envelope every morning. Yeah, and Chris also could correct me if I'm wrong, but bank deposits, demand deposits can be called overnight, but they often aren't, you know. Many bank deposits have been there for 50 years, so even though they have the option of being called overnight, the duration is not one day. So banks assign a duration to that, four years, seven years, but then when there's a bank run, the duration is actually one day because everyone pulls their money. So by definition, there's a - there's a - regardless of hedging. When she describes what happened to Wachovia and how the big institutional investors showed up and demanded early redemption on their bonds, we're not even talking about deposits now. There was already a deposit run at that bank, and it was large institutional customers coming and saying, "Hey, we really would like our money back." Well, what's the duration of that? So, yeah, I mean, there's an emotional aspect to liquidity, and there's a legal contractual aspect, right? The contractual aspect is, "I probably have a penalty if I withdraw early, okay, but if the difference in yield is bigger than the penalty, well, screw it. I'll take the penalty and just reinvest." That's where we are now. But when Uncle Sam is paying 4% for T-bills, well, hell, what's the penalty, right? Doesn't matter, right? And so banks can hedge their book, not just with swaps, but there's also mortgage servicing rights, which retain value as interest rates go up because people aren't refinancing. So, give me, like, a natural. That's the best way. The ideal book is a decent portfolio of mortgages, commercial or residential, and then a big service income, so that when rates go up and volumes fall, you have cash flow. I think it's ironic that one of the highest-quality cash-flowing assets is attacked by the regulators, which are mortgage servicing rights, and then meanwhile they tell everybody to buy the most dangerous securities of all, which is mortgage-backed securities, which is what Silicon Valley Bank had, you know, some of the other books like S&P and Palmer. You know, I wrote this up in the blog, but think about 2019, 2020, 2021, 2022 for a Silicon Valley Bank when they're running that big book and half the book was pre-paying every year. So they have to go buy more. In fact, they bought a lot more, and each time they went into the market, they were replacing securities that prepaid. The new securities have much lower coupons and much lower duration. So by the time they get to the end of 2021, the bank's dead, and they didn't know it. The bank was dead. Yeah, they had so much price risk on their book from the mortgage-backed securities anyway, right, right? Chris, let's talk about a tale of two banks with regards to duration risk and interest rate hedging. One is JPMorgan, who reported today, and the other is Bank of America. JPMorgan, despite its enormous size, parked most of its securities in the one-year to five-year securities. They didn't buy a ton of that, you know, super long duration mortgage-backed messy things, and they also did a lot of hedging. Bank of America hedged, and again, we're not saying that the large banks are not aware of these risks, but we're not saying that they are not competent in hedging them if they want to or if it is economic for them to hedge them, and available-for-sale securities. Bank of America did, but they had so much in the held-to-maturity bucket, over 100 billion dollars in losses, and where's the hedge, Chris? Where's the hedge? A totally different approach. Bank of America keeps everything. They have very, very secure core funding, and they're happy, basically, sitting with the book, not hedging a lot of it. They do hedge some of their interest rate risk, but basically, it's a very old-fashioned, almost community bank kind of model. I've always had some issues with their performance and also their disclosure. Jamie Dimon, you know, and think about this, the weighted average maturity for Bank of America is probably close to 20 years. JP Morgan, the weighted average maturity of their whole balance sheet is probably less than five years. Wow. I didn't - what that tells you is that Citi, JP, Goldman, you know, these firms have big capital markets businesses, so they tend to watch duration very carefully, and they want to keep it short because it allows them to manage it effectively, right? If you're a Wells Fargo or Bank of America, or you keep a lot of stuff on your book, uh, and that tends to make your duration much longer, so it's a management choice. I don't know that it's going to be fatal for Bank of America to keep all of that paper, but I think it'll hurt their earnings. It's certainly going to impair their earnings going forward. Yeah, I mean, people are getting very emotional during this whole episode. I posted something on Twitter about the losses at Bank of America, over 100 billion dollars in securities. People accused me of trying to start a bank run on Bank of America. I'm like, "The biggest bank in the world, or one of the biggest. Are you kidding me?" No, what they're about is just basking in their mediocrity. What can I say? The Bank of Brian is just endless, to say the least. But, you know, having said all that, you raised the right issue, and it's not that the bank's gonna fail, but people are very emotionally attached to Bank of America. There are a lot of managers out there who are determined that that bank should be the best performer among the top five, and the answer is not self-serving beliefs because, you know, you can't look at their performance and say, "Well, this is great. It's not." U.S. Bank and JP are the leaders in the group. The next benchmark after them, ironically, is the average for the top 132 banks, which are mostly smaller. So think about it. Bank of America, Wells, and Citi, they're all trading below their peers in terms of their operating performance. It's not great. You know, Brian needs to shave five points off his expenses and get down to where JP is in the low 60s in terms of efficiency ratio, and the same with Wells. I don't think Wells is credible, at least not yet. Until they get their operating efficiency under control, and you can say the same thing for Citi. Citi still has too much overhead. Their overhead number needs to start with a four, not a five, all right? Because look, they're half the size of JP Morgan, but they have overhead that's just too high. That's the only way they're going to get in the game in this market. The banks that are going to thrive and survive, frankly, are the ones with the best operating expense control. Jamie knows how to do that. Think about it. His bank is right next to the peer group for all these little banks at 59. That's pretty good for a bank with almost three trillion dollars in assets.

There isn't a subprime loan problem,.. unless it's in used cars. Most homeowners who bought or refinanced when they could get 3 to 4 % fixed are doing great. They are the ones benefitiing from paying loans back with cheaper dollars. And why housing sales are way down, while prices remain subbornly high. The impending crisis is in the regional banks who have trillions of commercial real estate on their books, particularly office buildings that are still half empty and up for refinancing over the next year or two. Residential should be fine.

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Why?

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