Today your host Josh and co-host Michelle discuss the recent bank failures of Silicon Valley Bank, otherwise known as it’s initials SVB, and another unrelated bank called Signature Bank.
- Bonds have an inverse relationship with interest rates, i.e., as interest rates rise, existing bond prices tend to fall
- SVB was locked into $80+ billion of long term bonds, particularly mortgage securities with 10+ years of maturities, and the price of those bonds took a hit as interest rates increased
- Banks don't hold as much in cash reserves as you think. Most of their capital is loaned out or invested in other securities.
Segment 1 (Show Open):
Good afternoon everyone and welcome to Coasting in Retirement! I am your host, Josh Null, and I’m joined by my co-host, Michelle Lee Melton. Michelle, how are you doing? We are back with another great show today, recording yet again in our still new-car-smell Jubilee Studios in Daphne, Alabama! First, for those new to the show, little background on me. Again, my name is Josh Null, and I am a fee-based fiduciary financial advisor, I hold my FINRA Series 65 securities license and I am the owner of Gulf Coast Financial Advisors, an independent wealth management and financial planning firm based out of downtown Fairhope, Alabama that serves clients up and down our part of the Gulf Coast. You can find more information on me and Gulf Coast Financial Advisors by visiting our website gulfcoastfa.com or feel free to give us a call at 251-327-2124. We will repeat our contact info several times throughout the show!
So let’s get on with the show. As always, Michelle and I are here today to discuss financial topics relevant to those in or near retirement living their best life along our part of the coast. Today we’re going to discuss the recent bank failures of Silicon Valley Bank, otherwise known as it’s initials SVB, and another unrelated bank called Signature Bank. We going to dive into the similarities between these 2 bank failures, the 2nd and 3rd largest bank failures in US history, and more importantly we’re going to discuss how these bank implosions were tied to interest rates, bonds, inflation, and volatility, and what investors should be learning and doing from this unexpected and sudden news.
First, let’s talk about interest rates and bonds, and why what happened to SVB is important to regular investors. Bonds have an inverse relationship to interest rates. When the cost of borrowing money rises (when interest rates rise), bond prices usually fall, and vice-versa. Most bonds pay a fixed interest rate that becomes more attractive if interest rates fall, driving up demand and the price of the bond. Conversely, if interest rates rise, investors will no longer prefer the lower fixed interest rate paid by a bond, resulting in a decline in its price. Think of it this way: if you had 2 identical offers from, let’s say a municipal bond for one city, with one bond paying 7% interest, and one paying 3%, which bond would you pay more money for? That is the basics of how bond prices fall when interest rates rise – there’s more demand for the higher priced bonds, and with higher demand, you get higher prices. At least that’s what I learned thru my Economics degree at the Harvard of the Midwest, Missouri State University.
What SVB did was lock in a huge amount of money $80 billion into long term bonds, particularly 10 plus year mortgage securities, then got smashed by rising interest rates. The banks cash balance was high because they had taking in more money than they could loan out.
Signature Bank appears to have made some of the same mistakes but it was compounded by their involvement with cryptocurrency. Talk about Silicon Valley bank being a tech heavy California bank while Signature was a more New York real estate based, and arguably, more aggressive.
Now, why did those interest rates rise? That right, because the Federal Reserve decided to raise the Fed Funds Rate, which is is the rate at which commercial banks borrow and lend their excess reserves to each other overnight. The Fed did this to obviously tame our recent high inflation. But why did we have high inflation? Talk about the fed keeping rates artificially low over the past decade plus.
Volatility emerged by investors concerned that regional banks were going to fail. You also saw a flight out of equities to bonds, which is kind of amazing, because long term bonds were at the root of this panic.
Before we end out first segment, we’re going to pivot to an offer to our listeners today. We recently did a comprenshive financial plan proposal for a business owner looking to transition to retirement in his early 60’s. This plan included both a lot of specialized software offerings but also the expertise and experience of our team at GCFA, so I wanted to share it with you all. If you’re interested in having a conversation about working thru a similar plan, be sure to give us at call at 251-327-2124 or you can email me at firstname.lastname@example.org. Here’s the basics:
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The strategies we use are designed in part to help you with income production as well as inflation and longevity risks. Not only are we trying to match your risk tolerance with your investment holdings, we want to help make sure you don’t end up outliving your retirement savings. Again, f you’re interested in having that conversation, give us a call at 251-333-5151, or find us at gulfcoastfa.com. That’s gulfcoastfa.com.
Alright folks, coming up next - There’s always a lot going on in the world! Particularly the world of finance- this past week was certainly an example of big news in finance! Every week Michelle and I scour the interwebs for helpful financial articles related to our topic of the day, especially articles that pertain to those in or near retirement. Join us after the break to hear Michelle and I discuss this week’s relevant headlines in our “Michelle with the News of the Week” segment. Stay tuned!
Segment 2 - Michelle with the News of the Week:
Josh: “Welcome back to Coasting in Retirement, your host Josh Null here! As we discussed before the break, every week Michelle and I scour the interwebs for helpful financial articles related to our topic of the day, especially articles that pertain to those in or near retirement. Coasting in Retirement’s co-host Michelle and I are going to help you all understand and decipher the deeper meaning of those headlines, or at the very least, provide context. So with out further adieu, here’s “Michelle with the news of the week”!:
1. Michelle: Alright Josh, my first article is going to be about the bank failure that kicked off a crazy week: The Verge has an article titled “The tech industry moved fast and broke its most prestigious bank”. Of course, this article is referring to Silicon Valley Bank, or SVB because everything has to have an abbreviation. Anyhoo, this article does a great job of breaking down everything that led to SVB’s failure, including potential fallout to other industries, but I want to focus on the article using the movie “It’s a Wonderful Life” as a comparison to the run on SVB. So, Josh, why was there a bank run on SVB, and how does that compare to the bank run depicted in “It’s a Wonderful Life”?
Josh: Banks with $15.2 million to $110.2 million in transaction accounts must hold 3% in reserve. Large banks (those with more than $110.2 million in transaction accounts) must hold 10% in reserve. These reserves must be maintained in case depositors want to withdraw cash from their accounts. Banks use the rest to make loans. When the economy falters, and mortgages during Great Depression in Bailey’s Building and Loan example, or in SVB’s case, tech and crypto, the depositors can start to worry if the bank has enough cash on hand to give their money bank. And if enough depositors panic and ask for their money bank, you have yourself a bank run, which means what happened to SVB is very much like what happened to the bank in It’s a Wonderful Life. The difference is the means and speed of communication, and the obviously the size of the bank. Talk about how tech, particularly Twitter, led to the swift downfall of SVB. I think the primary difference here is I’m not so sure SVB had to go under. Yes, as we discussed in the opening, SVB make a bad bet on longer term mortgage securities instead things such as shorter term Treasuries, but it wasn’t like they were making some crazy bet on, I don’t, Russian bonds. They just got caught with their pants down when the Fed decided to raise rates aggressively.
2. Michelle: Ok Josh, so we’ve already established that the failure of Silicon Valley Bank was the 2nd largest bank failure in US history, right after the Washington Mutual way back in 2008. We also stated that we just saw the 3rd largest bank failure ever with Signature Bank failing over this past weekend. I found a great article on Barron’s simply titled “Why Signature Bank Failed”. It seems like there are a lot of similarities between the 2 bank failures, but this article goes into a little more depth about Signature’s ties to cryptocurrencies. We’ve discussed crypto at length in previous episodes, so tell me your opinion as to how crypto plays into this story?
Josh: Discuss how to find that previous episode on Spotify. Then discuss the FTX failure, and how that is still rippling throughout the financial industry. Digital asset clients made up about 20% of Signature’s deposits, and the Fed was taking a look to see if there was any money laundering happening. Signature also embraced a couple of crypto exchanges, one in particular by the Winkelvoss twins of Facebook fame, and then all of those exchanges started faltering, depositors in Signature became very concerned about it’s ability to give their cash back. So they panicked, made a run, asked for way more cash than Signature had on hand, and there you go = another bank failure.
3. Michelle: Let’s stay with Barron’s, why don’t we. I believe this article ties into our discussion about long term bonds, interest rates and inflation. The article is titled “How SVB Was Doomed by a Bad Bet on Mortgage Securities and the Fed Rate’s Hikes”. So Josh, when I see mortgage securities, I can help but think back to 2008 when mortgage backed bonds nearly broke the United State’s banking system. Is the same thing?
Josh: From what I can tell, no. The mortgage backed bonds from 2008 that you are referring to Michelle are CDO’s, short for Collateralized Debt Obligation. A CDO is a particular type of derivative because, as its name implies, its value is derived from another underlying asset. These assets become the collateral if the loan defaults. The problem with the CDO’s that nearly broke our financial system is that bond departments were putting a bunch of sub-prime mortgages into the CDO yet still getting an A rating form the various rating companies, like Moodys. From what I can tell, SVB didn’t necessarily make a bunch of bad bets on what would be called junk bonds, or worse, they just made a bad bet, to the tune of $80 billion, on mortgage bonds with 10+ year maturities. And up until recently those bonds would have had incorporated relatively low interest rates, so when rates shot up significantly and quickly, the current value of these bonds fell. Now typically you could just hold on to the bond until maturity and get made whole, but when you’ve got a bunch of depositors demanding their money back, and you have to fire sell the bonds at a loss, now you’ve got a problem. Which is pretty much what happened.
4. Michelle: Alright Josh, so now that we’ve introduced a few new websites to our show, let’s pivot back to an often referenced site: Investopedia. The have an article titled “The Inverse Relationship Between Interest Rates and Bond Prices”. To be honest, I get that the info in this article is important, but compared to the sensationalism of Barrons or the Verge, the article is a little…boring. So I’ll simply toss it to you – how important is this inverse relationship? Did it have anything to do with the 2 recent bank failures?
Josh: Bonds have an inverse relationship to interest rates. When the cost of borrowing money rises (when interest rates rise), bond prices usually fall, and vice-versa. Most bonds pay a fixed interest rate that becomes more attractive if interest rates fall, driving up demand and the price of the bond. Conversely, if interest rates rise, investors will no longer prefer the lower fixed interest rate paid by a bond, resulting in a decline in its price. Think of it this way: if you had one bond paying 7% interest, and one paying 3%, which bond would you pay more money for? So as we discussed with the article, SVB just didn’t have lower interest bonds, it had a ton of them - $80 billions worth – and it had them for long maturities at what is now considered low rates. As long as depositors didn’t know, or care, and SVB could hold on until some of those bonds started maturing, then they would have been fine. Bank borrow long but lend short, and unfortunately, SVB’s leadership took this to the extreme and got caught up in a good old fashioned bank run. For individual investors, the main takeaway is that sometimes it pays to look long at equities but short at bonds, especially in a rising inflation and interest rate environment.
Explain the basics in the article, and tie in why this matters to retirees in their own portfolios, probably more than it matters to the average investor to worry about with their regional bank.
5. Michelle: I’m going back to Investopedia again, so I guess let’s call this article “twin-sies” week. Hot off the presses is an article with an absurd amount of words in the title – don’t these people have editors demanding to trim this up? – anyway, the article is titled “U.S. Bond Yields Post Biggest One-Day Drop Since Financial Crisis as Investors Seek Safety.”Uhh, I’m so exhausted from reading this title that I don’t have the energy to ask a question, so I’m just going to throw it to you Josh.
Josh: Discuss how a flight to quality sometimes involves leaving equities for…bonds…which ties a perfect circle to what led to SVB and Signature bank collapses. Tie that part of the conversation up with a description of how all of this is a confidence game.
6. Michelle: Of course. I let you pick the last article for our segment this week, and you immediately jump to…Kiplinger. Does you love of 80’s hair metal lead singer Kip Winger know no bounds? (Hee hee). Alright, so in all seriousness, Kiplinger has an article titled “The Risk with Fixed Index Annuities”, and I feel that Kiplinger, as usual, does a good job of balanced and fair analysis. They do mention a particular feature of fixed index annuities that I think ties into our topic today, quote, annuities can be a “hedge against market volatility”. Well know that you’ve gotten me to say both Kiplinger and volatility in the same paragraph, what say you Josh about this article?
Josh: Talk briefly about how FIA’s work and how they may be an option for pre retirees and retires that are tired of seeing their account balances go up and down.
Josh: Michelle, great job as always with the headlines, these are all important pieces of information that impacts those in or near retirement! Listeners – if you have questions around the topics in our headlines of the week, or questions related to your investment strategy or financial plan, why don’t you give us a call at 251-327-2124 to have a conversation or set up an appointment.
Alright folks, coming up after the break, we get to have a little fun and I’ll probably get picked on a little bit by my co-host, Michelle in our next segment. We call it “Where Josh nailed it, where Josh was a little off”. As someone that has always had strong opinions, and often public opinions, I think it’s important to hold myself accountable for the things I’ve said that didn’t quite stick the landing. But to be fair we also discuss where my often skeptical viewpoints proved to be pretty accurate. Remember I am originally from the Show Me State of Missouri, so means, don’t tell me, show me! Stay tuned!
Segment 3 - Where Josh nailed it, where Josh was a little off:
Welcome back! So the point of Coasting in Retirement is to offer general financial guidance and education to those in or near retirement, which means I often give my professional opinion. And while I am proud of thought, care and due diligence I put into giving my professional opinion, both on this show and in my financial planning practice, I’m also human, which means I don’t always stick the landing perfectly. So each week I get to poke a little fun at myself by admitting to any thoughts or opinions I’ve put out there that weren’t 100% on point. BUT this segment has to be fair, so I also get to pointing to some of my thoughts and opinions that were pretty accurate. We call this segment “Where Josh nailed it, and where Josh was a little off”. Alright Michelle, what’s first?
1. Michelle: Josh, with the recent bank failures of Silicon Valley Bank and Signature Bank, the FDIC insured deposit amount of $250,000 is suddenly on many bank customer’s minds, particularly business owners. I did some research and it took the FDIC 28 years to make it’s last increase, going from $100,000 in 1980 to $250,000 in 2008. You’ve stated for the past several years that the FDIC needs to increase it’s coverage again, and figure out a way to separate business accounts from personal accounts with it’s coverage. Did you nail it on this opinion or were you a little off with this opinion?
Josh: I think I’ve nailed it and I think this is another example of why they need to raise it. Go into how there’s been both inflation and a huge increase in money supply since 2008, and it’s not that uncommon for someone to have excess of $250k at a bank, particularly if they are a business owner. Also discuss how not addressing this before hand puts the FDIC in a position where they have to make ALL of the depositors of SVB whole, and how this sets a dangerous and unrealistic president.
2. Michelle: Josh, you’ve stated on this radio show that the Federal Reserve was not doing anyone any true favors by keeping interest rates artificially low for so many years. Consequently they have had to raise rates at an incredibly quick pace that appears to have caused some chaos in the economy. You’re opinion is that the federal reserve did not do a great job with managing interest rates – nailed it or a little off?
Josh: Nailed it. I’ll give an analogy as being a Dad. Let’s say for years I put the cookies out on the counter and I look the other way any time the kids grab 1, or 2, or 3, or whatever. I just keep re-filling the cooker jar everyday. Then one day all of my kids are dealing with weight issues and rotting teeth, so I yank understandably yank the cookie jar off the table, and replace it with, I don’t know, kale I guess. But I then turn around and have the nerve to point at my kids and say, “why didn’t you just eat only 1 cookie per day?”. Expound.
3. Michelle: Josh, you were in real estate in the 2000’s, and if memory serves me right, you actually did business with a bank that was taken over by the FDIC. With that experience and with the Dodd-Frank act adding extra stress tests to banks, did you think that you would see more bank failures like we did this past week?
Josh: Little off, to be honest. I sure as heck didn’t think we would see the 2nd and 3rd largest bank failures EVER this past week.
4. Michelle: Josh you’ve gone on the record that cryptocurrency has significant place in pre-retirees and retiree’s portfolios. With some part of the recent bank failures being attributed to their ties to the crypto industry, do you feel you are still nailing it with your skepticism of crypto, or are you a little off?
Josh: This is a meatball pitch down the middle – nailed it. First – let me be fair to the crypto world – I don’t fully understand it, and from everything I’ve heard there could be an eventually use case for blockchain. Even so, I’ve always held that no strong sovereign nation was EVER going to let private citizens create their own viable currency, and that speculation in that space was not better than tulip mania from centuries ago.
5. Michelle: So Josh, using annuities as a hedge against potential losses and stock market volatility. What was your opinion in the past, what is your opinion now, and did you nail it or were you a little off with this opinion?
Josh: Use this part to describe how hard it has been to get gains in an investment portfolio the past couple of years, how most people are more concerned about not losing money vs having huge gains, and how your opinion has changed regarding annuities.
Well listeners, once again I didn’t totally nail it with all of my opinions, but I had valid reasons for being a little off. And I’m learning to be more open minded! Impressive maturity, one would say, right Michelle? Now, to our listeners that have more questions bonds, investments, inflation, interest rates, annuities, etc., we invite you to reach out to us. Call us anytime at 251-327-2124 to make an appointment or request more information.
Folks, that’s it for us this week here at Coasting in Retirement! I want to give a huge thank you to my lovely co-host, Michelle Lee Melton, a thank you to our awesome radio station 106.5, many thanks to the provider of our show music, local band Sloth Racer, and as always my sincere appreciation for all of your out there that have been listening and joining us on this journey. We would love to be a part of your journey as well. Until we talk again next Sunday, have a wonderful and productive week. This has been Coasting in Retirement with Josh Null!
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