Originally posted on Quora April 7, 2023
The boom-and-bust cycle of the housing market is not contained to the value of real property but spreads to the rest of the economy and even affects the value of bank assets, such as MBS, as well. As a recent white paper out of NYU notes, the downfall of SVB is attributable not only to the fact that 96% of their deposits were uninsured but also that they had $80 billion (out of a total $200 billion in assets) invested in MBS that tanked in value as mortgage rates increased and property values stagnated or declined slightly from last year. As of December 2022, U.S. banks held $2.8 trillion in MBS, a position that could make them extremely vulnerable to an impending housing market correction.
How We Got Here: Pandemic Speculation
Simply put, during the lockdowns the real economy (i.e. the production of goods and services) contracted while M1 expanded by $5 trillion in a year’s time. For banks, who received almost $5 trillion in deposits representing a 36% total increase over two years, this means deposits far exceed demand for loans. A red-hot realty market, which was primed by near zero overnight rates that encouraged investors to buy or refinance property, made MBS an attractive alternative to business loans that along with fixed rate treasury bonds is where the bulk of deposit inflows were invested during the pandemic.
Where We are Headed: The Impending Bank Failures
One trillion in deposits was withdrawn from US banks in 2022. Half was put in money market funds and half were deposited in large national banks. This year in one week of March ending on the 15th almost $100 billion was withdrawn from US banks. However, the burden was shouldered almost entirely by smaller banks. While small community and regional banks saw outflows of $120 billion, large national banks actually saw inflows of $67 billion in deposits.The week after ending on the 22nd, another $126 billion was withdrawn from US banks but this time $90 billion of it was withdrawn from the 25 largest banks. Across the country deposits have fallen nearly 4.5% to the lowest level in two years and banks have incurred $780 billion in unrealized losses since 2022 equivalent to 36% of total bank equity.
A recent study published by the National Bureau of Economic Research has found that 10% of banks have larger unrealized losses than SVB and Signature. Overall, the market value of US bank assets are $2 trillion lower than their face value with ETFs for commercial MBS declining 10%, ETFs for residential MBS declining by 11% and 10–30 year treasury bonds losing as much as 25–30% of their market value. Across the industry, bank assets have declined 10%. An additional 186 banks are at risk of insolvency if only half of uninsured depositors decide to withdraw which would also put $300 billion in insured deposits (out of $10 trillion) at risk. This crisis will continue to grow as savers desert traditional banks that pay next to nothing in interest and look for higher interest-bearing accounts.