If you know little about the impact on a bond’s price due to changes in interest rates like what you’re seeing play out inside the coffers of [failed] Silicon Valley Bank of California, [SVB], then deciding to proceed past “Go, and collect $200” was pure suicidal on this bank’s part. It’s all a game of Monopoly but only for those in the know of exactly how the game is played. One needs a tremendous amount of financial education and fortitude when deciding to make a large bet on long-term bonds while interest rates are being orchestrated higher by the Federal Reserve. Eventually, and even given our current Fed Chair, Jerome Powell, who completely lost all credibility with our investing public a while back, even given all of this, understand that the Fed might be obligated to continue a “peddle to the metal” approach to raise rates rendering a large bet like the one taken inside SVB to be a deadly mistake. This bank is now a zombie institution, a walking dead complete collapse. But after all it is the year 2023 and how could this happen? One lady I spoke with this morning in my Pilates Class says there’s so much federal oversight in the banking industry that regulators must have known and just decided to look the other way. I corrected her, she was correct about regulator oversight on steroids inside banks and brokerages but what she didn’t understand is that it’s not illegal in this country to make really bad decisions with money, even when it’s a depositor funds. Stupidity is still legal [at this print anyway] so Bank Regulators didn’t have to overlook or allow anything. As long as a bank can show that they have the required amount of reserves there’s no issue. Where the issue began is when customers of the bank requested withdrawals of their deposits and the money wasn’t there to accommodate their requests. It had disappeared even though it was parked inside an otherwise considered “safe” government security, a U.S. Treasury Bond. I’m going to demonstrate to you how management @ SVB disappeared their depositor’s money. 🙂

There are a couple of concepts that are helpful to understand when investing in fixed income securities, one is the impact of changes in interest rates on a bond’s price and the other one is the concept of “duration”, or price sensitivity to changes in interest rates. Most people who make a living outside of the financial world wouldn’t run into these topics very often, so here goes. When interest rates rise, bond prices fall – thus an inverse relationship exists between a bond’s price and changes in interest rates, in either direction. Why is that? The reason for this is that a bond’s coupon rate, the stated rate they are obligated to pay the holder periodically in the form of interest payments until the maturity date remains fixed. [This is true for most bond offerings out there]. So for example, if a bond is sold @ par [$1,000] and pays 5% interest annually, or $50 each year to the holder, that coupon remains fixed until the maturity date. And bonds trade on exchanges everyday. If interest rates were to rise to say 6% on that term paper then in order for that [already issued] paper to be attractive/competitive to any new buyers its price must adjust [because the coupon remains fixed] so that it actually yields 6% instead of 5%, get it? To orchestrate that, now the price of that bond must be adjusted downward to reflect the rise in interest rates and make it attractive for any potential buyer when compared to the newly issued paper out there –

Here are a couple examples of how a bond’s price will adjust to changes in interest rates:
1) Bond issued @ par for $1,000 paying a 5% coupon over a 30-year maturity
Long-term interest rates rise to 6%, this bond’s price will adjust to $846.28. So for holders who paid $1,000, their unrealized loss [on paper anyway] is -15.37% or ($153.72) per bond they hold. [A scenario where interest rates rose after this bond was issued.]

2) Bond issued @ par for $1,000 paying a 5% coupon over a 30-year maturity
Long-term interest rates fall to just 3.3%, this bond’s price will be adjusted to $1,507.29. So for holders who bought in @ par, their unrealized gain on this paper is now more than 50%, or $507.29! per bond they hold. [A scenario where interest rates declined after this bond was issued.]

Next we have the concept of duration. Duration is the average time that a investor can expect to break even in a bond holding. The calculation is complicated and takes into account the concept of “total return”. So by adding up all the interest payments along the way and a return of principal this calculation determines the amount of years [or months] on average that an investor can realize a return on their investment. Duration of a bond portfolio will fluctuate as well with changes in interest rates. As a general rule, the longer an investor goes out on the yield curve the more sensitive a bond’s price will be to changes in interest rates. 30-year paper is going to be way more sensitive to a change in rates than say purchasing a shorter term bond. That’s why the concept of duration becomes important. [If you’re ever looking to invest in bond funds you should always ask your advisor about the duration of any portfolio. This number is usually available, if not I wouldn’t invest in it since the longer the duration the more risk is involved in holding that portfolio.] Also understand that a bond portfolio consisting of an overweight in long-term paper, say 20 to 30-year maturities is going to see a lot of price fluctuation as interest rates change during that span of time. Professional bond portfolio managers know all this and manage their risk accordingly by including paper of varying qualities, maturities, and coupons. During times of rising rates a bond investor can expect to see their holdings [at least on paper] decline, the opposite being true under a period of falling interest rates. One way to combat falling bond prices is by being able to hold the bonds to maturity and collecting back the principal. As long as there is no incidence of default then the investor will be made whole again. But, in the presence of inflation and/or re-investment risk their investment may not have been optimal.

Bond prices will tend to converge on their original issued par amount as they approach maturity, there’s some calculation for this though not included here so you’ll need to take my word for that. Returning to the case of SVB, management did not have the luxury of waiting for their long-term holdings in U.S. Treasury bonds to approach maturity. Depositors wanted their money when they wanted it. Imagine being able to afford something but not having the ability to get cash back out from where you parked it. Not good. All I’m hearing is about how the federal government is going to make sure that depositors @ SVB will get their money. Why is no one talking about how this happened in the first place? I’m betting somehow that this mindless Woke Movement in California made hiring decisions based on someone meeting some far-left agenda – in other words employees hired by SVB were not qualified for the job of overseeing a portfolio of this size. Instead, they were hired because they met some quota [criteria] – LGBTQ -ABCSRDXYZ! They were never qualified for the job! A thorough investigation needs to be made immediately to find out how this happened – was it a committee decision to destroy their customer deposits or was this a decision made by one individual? When employees of a bank make really bad decisions like this one – essentially destroying lives, bank management needs to be HELD ACCOUNTABLE – NOT BAILED OUT!