Back when interest rates were near zero, US banks scooped up lots of Treasuries and bonds. Now, as the Federal Reserve hikes rates to fight inflation, those bonds have declined in value. As interest rates go up, newly issued bonds start paying higher rates to investors, which makes the older bonds with lower rates less attractive and less valuable. The result? Most banks have some amount of unrealized losses on their books.
“The current interest rate environment has had dramatic
effects on the profitability and risk profile of banks’ funding and investment
strategies,” said FDIC Chairman Martin Gruenberg in prepared remarks at the
Institute of International Bankers last week.
“Unrealized losses weaken a bank’s future ability to meet
unexpected liquidity needs,” he added. In other words, banks
might find they have less cash on hand than they thought — especially when they
need it — because their securities are worth less than they expected.
The Potential Cost of Fighting Inflation
“Many institutions — from central banks, commercial banks
and pension funds — sit on assets that are worth significantly less than
reported in their financial statements,” said Jens Hagendorff, a finance
professor at King’s College London. “The resulting losses will be large and need
to be financed somehow. The scale of the problem is starting to cause concern.”
Still, there’s no need to panic yet, say analysts. “[Falling
bond prices are] only really a problem in a situation where your balance sheet
is sinking quite quickly… [and you] have to sell assets that you wouldn’t
ordinarily have to sell,” said Luc Plouvier, senior portfolio manager at
Van Lanschot Kempen, a Dutch wealth management firm.
Most large US banks are in good financial condition and
won’t find themselves in a situation where they’re forced to realize bond
losses, said Gruenberg. Shares of larger banks stabilized Friday after plunging
to their worst day in nearly three years on Thursday.
Do We Need to Increase Unemployment to Bring Inflation
Down?
Last week Senator Elizabeth Warren grilled Federal Reserve
Chair Jerome Powell about American job losses being potential casualties of the
central bank’s battle against high inflation. Warren, a frequent critic of the
Fed’s leader, noted that an additional 2 million people would have to lose
their jobs if the unemployment rate rises from its current 3.6% rate to reach
the Fed’s projections of 4.6% by the end of the year.
“If you could speak directly to the two million
hardworking people who have decent jobs today, who you’re planning to get fired
over the next year, what would you say to them?” Warren asked.
Powell argued that all Americans, not just two million, are
suffering under high inflation. “Will working people be better off if we just
walk away from our jobs and inflation remains 5% or 6%?” Powell replied. Warren
cautioned Powell that he was “gambling with people’s lives.”
The discussion was part of a larger cost-benefit analysis
conversation that keeps popping up around the jobs market: Which is worse —
widespread job loss or elevated inflation? CNN spoke with two top economic
analysts with different perspectives to gain a deeper understanding of the debate.
The Real Cost of Fighting Inflation
Roosevelt Institute director Michael Konczal weighed in on
the debate: “Demand for labor is so high that we probably have the ability to
take heat off of the economy by slowing some measures of hiring — the quit rate
or the job openings rate, for instance — which would allow wages to decelerate
and cool the economy but not necessarily put a lot of people out of work.”
Konczal continued, “The thing that raised my eyebrow was
Powell saying that if he walked away from his job inflation would remain at 5
or 6%. Inflation over the last three months has not been 6%, depending on what
you’re looking at it hasn’t really been 5% either.”
Konczal concluded, “Inflation comes at a high cost when it’s
at 5% or 6%, but when it does comes down to 2.5% or 3%, I’d want to know how
urgent he thinks it is to get that last mile to 2% inflation if it
meant two million-plus people were out of work. I think the dirty
secret is that economists can’t really tell you what the negative is on inflation
being at 2.5% instead of 2% — there are some winners and there are some losers,
but the net economic costs are less clear. It’s gonna be really brutal on the
labor market to bring inflation down to like that last mile, it might involve
trade-offs that are incredibly harsh. I think it would be really devastating
for so many people to lose their jobs for what is essentially a made-up
number [the 2% inflation target].
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