Are you curious about the iceberg beneath the surface of the banking industry? It's a problem that's been brewing for some time now, but many people are just starting to take notice. 

Understanding this investment strategy utilized by the banks will help you understand its implications on the recent banking crisis. You see, many banks are holding onto assets that are essentially losing money. The only way they can avoid taking a loss is by holding onto these assets until maturity. 

The problem is that some of these assets can't be held to maturity because of liquidity issues. So, what’s going on here? Let’s dive in and find out!

What Exactly Does "Held-to-Maturity" Mean? 

Held-to-Maturity (or HTM) is a term used to describe an investment strategy where an investor purchases a bill, bond, or note with the intention to hold it until it matures, regardless of what happens in the market. 

For example, if you were to purchase a 10-year note, you would be committing to holding onto it for the full 10 years, regardless of whether the market goes up or down during that time. However, the reality is the banks in question could not hold onto these types of investments for their full term.

Why Hold on to a Losing Asset? 

At this point, you might be asking why banks are holding onto these losing assets. In 2020 and 2021, interest rates were pushed so low that banks had to find alternative ways to make money from the deposits they were holding onto. 

They turned to buying longer-term investments, such as 10-year notes, which they could hold onto until maturity and hopefully make a profit.

But what happens if interest rates rise again as they have? These longer-term investments lose value, and the banks holding were forced to sell them before maturity, which led to a major loss due to liquidity issues. 

That's where the problem lies. Many banks are holding onto these assets, hoping that they can hold them to maturity to make a profit. However, as interest rates continue to rise, the value of these investments continues to decrease, and banks are left with assets that are losing money on their balance sheets.

What Problem Does this Create for the Banks?

As you may already know, banks rely on deposits to make loans and earn interest. If a bank is holding onto assets that are losing money, they may not have enough money to meet the demands of their depositors if they decide to withdraw their funds. This can lead to a domino effect of banks being unable to meet their obligations, which can cause panic in the financial markets.

The Federal Reserve has attempted to address this problem by offering a temporary buyback and swap program, allowing banks to swap their losing long-term notes back to the Federal Reserve at par value. However, this is only a temporary fix, and it remains to be seen how effective it will be in the long term.

Bottom Line

The banking industry is currently facing a problem with no easy solution. In essence, banks are holding onto losing assets, hoping to hold them to maturity without a demand from depositors for their money.

However, as interest rates rise, these assets lose value, and banks are left with assets that are losing money. Ultimately, this may lead to a domino effect where banks may not be able to meet their obligations, which can cause panic in the financial markets. 

The Federal Reserve has attempted to address this problem, but how effective will their solution be? Tune into the latest episode of What’s Your 1 More for our commentary on their recent actions and what it means for other markets like real estate!