A closer look at the latest US banking crisis reveals a surprise to anyone still thinking in terms of the crash of 2008. Unlike the problems of 2008, crummy and then triply securitized loans aren’t what sank Silicon Valley Bank and put stress on the entire banking system. It was a stash of what many of us think are the safest securities on Earth: US Treasuries.
- While US Treasuries are the safest securities, a rising interest rate environment has contributed to major losses and was a key factor in the failure of Silicon Valley Bank
- In 2022, Treasuries posted their worst losses since the early 1970s with the longest-dated ones tumbling almost 30% in value
- Individual investors should treat fixed income as the safe haven of their portfolio
- Remain committed to the tried-and-true benefits of diversification to achieve a balanced portfolio
US Treasury loans were, and are, the safest securities in one very important sense. Barring an unthinkable, self-inflicted debt ceiling disaster, the US government is going to repay its debt. This is what’s known as credit risk. When it comes to getting our money back from an investment, US Treasuries are still the safest game in town. But the final repayment date of many US Treasuries is decades away, and what happens to their price in the meantime can have huge impacts on individuals, businesses and economies alike. We call this interest rate risk.
What Led to SVB’s Collapse?
It was interest rate risk that absolutely crushed Silicon Valley Bank. For a reason which I assume we’ll know someday but today is unfathomable, the risk management department at SVB fell asleep. Loading up on long-dated Treasuries left them incredibly exposed to the jump in interest rates we saw last year. When depositors, many with balances well in excess of the FDIC insurance limits, saw the paper losses those long-dated Treasuries incurred, they got scared and pulled their funds. From there the run was on and the bank was doomed. There are a couple of takeaways in these events for all of us.
Treasuries Suffering Losses, but Those Losses Won’t Mimic 2008 Crisis
First, the fear of bank contagion isn’t going to go away. Last year, Treasuries posted their worst losses since at least the early 1970s, with the longest dated ones tumbling almost 30%. This, however, does not mean that we are in a 2008-like situation. Banks are far better capitalized today than they were back then. Further, the losses suffered in the equity and fixed income markets last year priced in much of this information. For markets to move in the future, something new will need to come to light. Remember, equity and fixed income markets are incredibly efficient processors of information and everything that is known is already priced in.
Treat Fixed Income as a Safe Haven
The second important lesson is that for individual investors, fixed income must truly be treated as the safe haven of their portfolio. Taking on what seems to be only a bit more risk in the safe part of our portfolios to get only a little more return will eventually backfire.
Purchasing even safer investments with maturity dates far in the future is one way people will try to get a higher yield. This is what SVB did. Other seemingly innocuous ways of increasing yield are investing in high-yield bonds, corporate bonds, auction rate securities, etc. This can work just fine until we actually need those investments to provide the safety they’re supposed to. Times of economic and financial stress are when we need our safety to be safe. As Warren Buffett is fond of quoting: “We see who’s swimming naked when the tide goes out.”
If, as a Claris client, you were wondering what you were wearing prior to the tide going out, last year should have been very reassuring. On average, the equity portion of our portfolios held up much better than the standard S&P 500 focused portfolio. We didn’t time the markets or predict what was going to happen. Rather, we remained disciplined to the tried-and-true benefits of diversification. The same was true on the fixed income side of things as our focus on the highest quality, short-term fixed income dramatically outperformed the broader bond market.
Contact Claris to see how our investment approach is designed to help you understand, invest and relax.