Banking in very uncertain times

From the blog post:

The thing killing banks is a very simple idea with profound consequences. It is not a secret: when interest rates rise, all asset prices must fall. This is both almost a law of nature and also perpetually underestimated in how much it affects the world outside of asset prices.

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Every bond and instrument created on top of bonds has a “duration”, which you can round to “how much time left in years until we expect this to be paid back?” And every bond and instrument on top of bonds has its market price move down by 1% per year of duration if interest rates move up 1%, and vice versa. (There is better math available but this is math you can trivially perform in your head, and is close enough to blow up large portions of a financial system.)

So if you held ten year bonds and interest rates went up 4% in a year, your ten year bonds are down, hmm, somewhere in the 35%ish range. This is true regardless of whether the bonds are good bonds. If you want to sell them today, the people buying them have better options than you had a year ago, and to induce them away from those better options you have to give them a 35%ish discount.

(The calculation here seems to be that the ten-year bonds have 9 years to go, 9*4 = 36, and round down a little to 35?)

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The three bank runs which already happened had idiosyncratic causes, but “if accounted for accurately, the bank is insolvent” is the sort of thing which, if one stipulates to it, one would suggest might generate bank runs in the near future. And so there was a policy response, which much commentary has assumed is primarily about the banks which no longer exist, and the satisfaction of their depositors, and which is actually much more about banks in danger which might yet be saved.

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The $620 billion in losses on securities and the concomitant loss on loans is not distributed evenly across the U.S. banking sector, but it is distributed across the U.S. banking sector. Every institution thanking its risk managers for them having a below-average amount of it implies that some other institution has more of it.

And so we are in a situation where some institutions, whose names are not yet in headlines but may be very shortly indeed, are under acute stress. And we are also beginning to understand a mechanism by which a handful of institutions fell off a precipice, where we understand the edge of that precipice to be eroding, because we currently believe interest rates will go up again. (That belief is shifting rapidly; the rapid decline in 2 year Treasury yields is a sign that the markets are adjusting expectations and beginning to doubt the forecast future sharp hikes.)

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When Rippling’s bank recently went under, there was substantial risk that paychecks would not arrive at the employees of Rippling’s customers. Rippling wrote a press release whose title mostly contains the content: “Rippling calls on FDIC to release payments due to hundreds of thousands of everyday Americans.”

Prior to the FDIC et al’s decision to entirely back the depositors of the failed bank, the amount of coverage that the deposit insurance scheme provided depositors was $250,000 and the amount it afforded someone receiving a paycheck drawn on the dead bank was zero dollars and zero cents.

This is not a palatable result for society. Not politically, not as a matter of policy, not as a matter of ethics.

Every regulator sees the world through a lens that was painstakingly crafted over decades. The FDIC institutionally looks as this fact pattern and sees this as a single depositor over the insured deposit limit. It does not see 300,000 bounced paychecks.

It does seem morally correct to say that employees of some arbitrary company somewhere shouldn't be punished because their employer picked the wrong payroll provider. Moral hazard isn't relevant here. It's just punishing arbitrary people for someone else's screwup.

But if we consider delivering paychecks on time to be a sacred duty, it seems rather irresponsible in retrospect for a payroll provider to transfer all the money using one bank? I wonder how many other payroll providers do that? And what other cases are like that?

Also, the money in a bank account that is way over $250,000 might actually belong to many people, so legally it's covered:

Many fintech products have an account structure which looks something like this sketch: a financial technology company has one or several banking relationships. It has many customers, enterprises which use it for e.g. payment services or custodying money. Those services are not formally bank accounts, but they perform a lot of feels-quite-bankish-if-you-squint to the people who rely on them to feed their families. The actual banking services are provided to those users by the banks, who are disclosed prominently on the bottom of the page and in the Terms and Conditions.

Each enterprise has their own book of users, who might number in the hundreds of thousands or millions, in a single FBO account at the bank, titled in the name of the enterprise or the name of the fintech. The true owners of the funds are known to the bank to be available in the ledgers of the fintech but the bank may have sharply limited understanding of them in real-time.

And so I ask you a rhetorical question: is this structure robust against the failure of a bank handled other-than-cleanly, such that, come the following Monday, those users receive the insurance protection which they are afforded by law? Mechanically, can that actually be done? Is our society prepared to figure that out over a weekend? [...]