Taking a bit of a longer term view into why this happens, I feel the Fed (and Treasury/FDIC/OCC) needs to do quite a bit of soul searching:
1) After the crisis the new Liquidity Coverage Ratio (LCR) regulation required banks to hold a lot of "high-quality-liquid-assets" (HQLA) for every dollar of deposits they have. Kinda like reserve requirements...
2) HQLAs include liquid assets (cash, Fed reserves) plus treasuries and agency bonds. Well cash pays zero so of course banks will be investing in the juicier long dated assets. This is the first mistake by the Fed (and Basel) who took the approach "treasuries have absolutely no risk" which ignores interest rate risk.
For instance; say you bought a ten-year zero-coupon treasury when rates were 1; that's valued at 1/1.01^10 = 90.5 cents on the dollar. But if rates are now 5% that's worth only 61.3 cents of the dollar (!) but you are allowed to ignore this loss...
3) The way we allowed banks to hide these losses in the now popular Held-to-Maturity (HTM) category instead of Available-For-Sale (AFS). Any security put there can be valued for capital regulation purposes at the amount you paid for it, instead of it's actual value (i.e. market value). So in other words, we first incentivized banks to invest in these risky securities and then provided a way to hide the risks from capital regulations.
4) To make it worse, if you as a bank realize that "oh shit I have too much of this crap" there's another regulation disincentivizing you from fixing things. If you even sell $1 of the HTM bucket then ALL the assets of that class move into AFS and you are forced to realize all the losses. So you will only sell HTM at the very end, as SVB did.
5) Lastly, the govt flooded the markets with cash over the last years (zero interest rates) so everyone (firms, households) had lots of deposit. Lending opportunities were much lower than deposits so they had to put the money into these securities.
6) But central banks did QE, which drove the price of these assets very high (and thus the yield very low). For instance, SVB had agency bonds with 1.5% yields. So, to recap, banks were incentivized strongly to buy these securities which the govt made sure had terrible yields.
7) Then, once COVID ended and inflation started it was time to do quantitative tightening (QT) where the govt became a net seller of these securities, driving their price to the ground, creating huge losses for banks.
And that's where we are now. Most banks have HUGE HTM positions of mostly long-dated bonds, with huge losses, not because they are all idiots, but b/c that's how the incentives were aligned. And now we are paying its cost, including the cost of QE/QT.
1) After the crisis the new Liquidity Coverage Ratio (LCR) regulation required banks to hold a lot of "high-quality-liquid-assets" (HQLA) for every dollar of deposits they have. Kinda like reserve requirements...
2) HQLAs include liquid assets (cash, Fed reserves) plus treasuries and agency bonds. Well cash pays zero so of course banks will be investing in the juicier long dated assets. This is the first mistake by the Fed (and Basel) who took the approach "treasuries have absolutely no risk" which ignores interest rate risk.
For instance; say you bought a ten-year zero-coupon treasury when rates were 1; that's valued at 1/1.01^10 = 90.5 cents on the dollar. But if rates are now 5% that's worth only 61.3 cents of the dollar (!) but you are allowed to ignore this loss...
3) The way we allowed banks to hide these losses in the now popular Held-to-Maturity (HTM) category instead of Available-For-Sale (AFS). Any security put there can be valued for capital regulation purposes at the amount you paid for it, instead of it's actual value (i.e. market value). So in other words, we first incentivized banks to invest in these risky securities and then provided a way to hide the risks from capital regulations.
4) To make it worse, if you as a bank realize that "oh shit I have too much of this crap" there's another regulation disincentivizing you from fixing things. If you even sell $1 of the HTM bucket then ALL the assets of that class move into AFS and you are forced to realize all the losses. So you will only sell HTM at the very end, as SVB did.
5) Lastly, the govt flooded the markets with cash over the last years (zero interest rates) so everyone (firms, households) had lots of deposit. Lending opportunities were much lower than deposits so they had to put the money into these securities.
6) But central banks did QE, which drove the price of these assets very high (and thus the yield very low). For instance, SVB had agency bonds with 1.5% yields. So, to recap, banks were incentivized strongly to buy these securities which the govt made sure had terrible yields.
7) Then, once COVID ended and inflation started it was time to do quantitative tightening (QT) where the govt became a net seller of these securities, driving their price to the ground, creating huge losses for banks.
And that's where we are now. Most banks have HUGE HTM positions of mostly long-dated bonds, with huge losses, not because they are all idiots, but b/c that's how the incentives were aligned. And now we are paying its cost, including the cost of QE/QT.