Could unrealised losses on bank balance sheets be the elephant in the room triggering another banking crisis, potentially worse than the 2008 financial crisis and the 2023 treasury bond market crash?
All banks passed the Fed’s February stress tests for banks.
So there is no need to hide it under your mattress, according to the Fed’s latest stress test for banks.
But here is the caveat;
They did not test for stagflation, the most adverse scenario where interest rates go up in a recession.
Rising inflation could mean another treasury bond market rout and more unrealised losses
So maybe that is why FDIC Vice Chairman Travis Hill noted in his
quarterly report on the FDIC-insured banks that the FDIC would no longer disclose, as of February 26, the total assets on its Problem Bank List.
The list previously showed total assets and the total number of banks on the Problem Bank List. As of March, it only shows the total number of banks, omitting the total assets of problem banks.
So we now only know that there were 66 banks on the Bank’s Problem List in Q4 2024, according to the FDIC.
Hiding unrealised losses
By failing to disclose total assets on the distress list, we no longer have insights into whether the banking stress is across the sector and potentially a systemic crisis or a passing problem.
During the 2008 peak financial crisis in the subprime mortgages, the total assets of distressed banks ballooned from under 50 billion USD in early 2008 to approximately 850 billion two years later.
A sharp rise in the total amount of distressed assets could imply contagion in the system, leading to more distressed larger banks, as it did in the 2008 financial crisis.
So the number of banks on the problem list 8 Xed from 100 to 800 problem banks, during 2008 and 2010. Indeed, the big banks were also in trouble. “I Need $30 Billion By Tonight,” said Jamie Dimon, CEO of JPMorgan Chase, in 2008. The 2008 subprime mortgage meltdown and subsequent global financial crisis took down more than 500 banks between 2007 and 2014, with total assets of nearly $959 billion.
A decade of Quantitative Easing QE, QE1, QE2, and Operation Twist followed with central banks creating currency and expanding the money supply to buy distressed toxic assets.
So, the financial crisis of 2008 was a debt problem in subprime lending, papered over with even more debt.
Fast forward to 2023, the worst treasury bond market crash in history, which collapsed five banks.
“There has been no market for the trillions of dollars of 10-year treasury bonds when it yielded 2% at today’s inflation rate.
The only buyer would be central banks, but that means printing more currency to buy toxic debt, which further debases the currency, causing inflation and creating a hyperinflationary money printing vicious cycle, Darren Winters noted in a piece entitled, “Banks’ unrealized losses,” dated March 2024
“Banks could be staring down the double barrel of unprecedented, unrealized losses on their bond portfolio,” Darren Winters added.
Treasury bonds have the lowest default risk, as the Fed can create dollars to pay bondholders on maturity.
However, there are maturity risks due to inflation on holding bonds.
Thirty years ago, in 1995, a small car cost 12,000 USD, and today, you can expect to pay more than double for a similar car.
In the past decade, average new car prices have increased about 60%.
So banks that piled into 10 and 30-year treasury bonds issued not long ago with yields of less than two per cent could be sitting on massive unrealised losses on their balance sheet.
Those unrealised losses could be even worse if bond investors used leverage to make those investments.
Darren Winters remembers vividly when the Fed fund rates were 0.25% during the 2020 global pandemic lockdowns, a bond investor was bragging about how smart he was leveraging his bond investment with near-free money and piling into treasury bonds yielding 1%.
Picking up pennies in front of a steam roller?
Investors perceived treasuries as a risk-off asset representing a flight to safety and security.
Few investors predicted that inflation would ever rise and that interest rates would be near zero for generations. Few understood the maturity risk of holding bonds if inflation was ignited and spread.
Hiding the total amount of distressed assets and potential unrealised losses will not make the Problem Bank List look better.
The FDIC’s decision to cancel reporting total assets on the Problem Bank List could create more fear, uncertainty and doubt (FUD).
Could the total assets of problem banks be so bad that the FDIC is worried about creating public panic, leading to a disorderly bank run?
However, the Federal Deposit Insurance Corporation (FDIC) insures deposits held at that bank up to a specified limit, protecting depositors against losses in the event of a bank failure.
Not enough life rafts?
Unprecedented unrealised losses, so do you have non-debt assets?
Treasury bonds have been perceived for generations as a safe haven asset, with the most conservative investors, banks, pension funds and insurance companies piling in, believing treasuries as a risk-off investment, generating yields.
When that narrative flips, it is a paradigm shift and a potential systemic crisis.
If this crisis of confidence amongst bond investors does not abate, yields and interest rates are likely to head higher.
Yield suppression as a central bank policy means currency creation, ultimately leading to further monetary inflation and calamity in the bond market.
If history is anything to go by, the end game looks like a currency crisis where cash and bonds are trash.
Leveraged assets, purchased through the availability of cheap credit, could also be a dangerous place for investors. Precious metals, cryptos, and alternative investments could do well.
Even some stocks do better than cash in a hyperinflation scenario.