This March, misery loves company. Along with broken NCAA basketball brackets, investment portfolios are taking it on the chin as the banking sector struggles with the detrimental effects of rapidly rising interest rates on their balance sheets.
So what’s wrong with rising interest rates? Not much if your investments are short-term maturities that you can roll over into higher rates. But if your investment assets are locked in for longer time periods at low rates, and you need that money short term, you end up selling those long-term bonds at a loss to pay your bills.
Since last March 2022 when the Federal Reserve began raising rates to fight inflation, both stocks and bonds have experienced losses. There was a brief recovery in January 2023 in both markets. But then, in March, brackets were busted with the announcement of the failure of Silicon Valley Bank (SVB), which had a mismatch of assets (long-term bond investments) and liabilities (money owed to depositors on demand in the short term). SVB had experienced large inflows of deposits during COVID when interest rates were held low by the Federal Reserve and invested those deposits in long-term bonds. Then when depositors needed their money during this recent economic downturn, SVB was forced to sell those low-interest-bearing long-term bonds at a loss to meet the demands of their depositors.
It reminds me of the kitchen table discussions I heard between my mom and dad when I was young. My mom loved the safety of CDs. My dad preferred to take the risk of loss in the stock market for the potential of higher future returns. My mom watched interest rates like a hawk, locking in long-term CDs when rates were high and going short-term when rates were low.
SVB could have learned a lot from my mother. A big part of bond investing is math. When interest rates go up, the value of those bonds purchased at lower rates goes down. Lesson learned: don’t stretch out maturities of bonds held for investment when rates are low, just to get a little more interest, if you will need that money in the short term. Your bracket will be busted!