From The Institutional Risk Analyst (also on blogroll at right), April 26:
Who Killed First Republic Bank?
Q: Who killed First Republic Bank (FRC)? A: Janet Yellen and Jerome Powell. Q: When did bankers and regulators first know they had a problem with QE and the banks? A: The middle of 2022.
Going back more than five years, The Institutional Risk Analyst described the existential market risk created by the Federal Open Market Committee’s massive purchases of securities. The recent movement of the bond market has reduced the visible unrealized losses on securities owned by banks, but the fundamental problem of mispricing of risk remains unresolved. Trillions of dollars worth of low-yielding assets are festering on the books of all US banks.
Ponder the remarkable idiocy of the Financial Stability Oversight Council, which just published a long list of recommendations for identifying risk among nonbank financial firms like Black Rock (BLK). The FSOC document never mentions the impact of quantitative easing or “QE” on financial institutions and markets. Chaired by Treasury Secretary and former Fed Chair Janet Yellen, one of the architects of the “go big” policy behind QE, the FSOC sees risk lurking in every corner but the one that actually matters.
It is clear today that the Fed's decision to start manipulating the bond market early in 2019 was a serious mistake, yet Fed Chairman Jerome Powell and Secretary Yellen are silent. The Treasury and Fed cannot admit fault for fear of bringing the whole house of cards crashing down, especially now that President Joe Biden has announced his reelection campaign.
How big is the risk created by Chair Yellen and her successor, Fed Chairman Powell, as a result of going “big” on QE in 2019 and then full throttle after March 2020? Let’s start with the data from the Securities Industry and Financial Markets Association (SIFMA), which shows that about $25 trillion in fixed income securities were issued in 2020-2021. If we adjust these securities by a conservative 12% haircut vs current pricing for say Fannie Mae 3% coupon MBS, you’re looking at $3 trillion in unrealized losses on COVID era securities.
The same price adjustment on trillions of dollars in whole loans priced during 2020-2021 gets you another couple of trillion in unrealized losses. We express the losses as a discount to par value, but the real problem for banks and other investors is the low levels of income coming from these COVID-era securities. Those Fannie Mae 3s issued in 2020 at 104 are trading at 89 today, but SOFR is just shy of 5% as are three-month T-bills.
Anyway we cut it, the US financial markets need to absorb about $5 trillion in securities losses to get clear of the cost of QE. This process of loss recognition must occur at the same time that banks and leveraged investors are forced to reprice their funding costs. As the process of repricing of liabilities moves forward, more banks will likely fail....
....MUCH MORE
