Brad Setser Profile picture
Mar 10 10 tweets 3 min read
The collapse of Silicon Valley Bank highlighted the risks posed by "underwater" long duration bonds -- particularly when those bonds funded with short-term liabilities.

Who else in the global economy holds a lot of underwater bonds?

Asian insurers and policy banks ...

To be sure, the associated risks depend as much or more on an institution's funding structure as on the size of the mark to market loss on bonds in hold to maturity portfolios.

As long as the funding (for SVB, big deposits) are there, losses don't need to be realized.

Japan's insurers probably still have close to $700b in foreign bonds on their books; Taiwan's insurers have a comparable sum. These bonds in long-term portfolios that back promised payouts to holders of life insurance policies --

But they are heavily fx hedged ...

Those fx hedges have to roll roughly every 3ms, so the hedging creates a potential funding risk --

One that hasn't been realized -- in part because the hedges in Taiwan largely come from the CBC, and in part because the BoJ is credible USD lender of last resort as well.

Japan's Post Bank, Norinchukin and the Shinkins collectively hold about $1 trillion in foreign bonds against, well, liablities that are mostly deposits ...

The bulk of those bonds are now underwater (they are in hold to maturity portfolios, so the loss hasn't been realized)

These institutions seem to have stable access to dollar funding -- they are government backed (directly or indirectly) and their yen deposit base is secure, and they haven't had any trouble rolling hedges.

But it is important to understand where risk is being warehoused in the global economy, and a lot of underwater USD fixed income is on "private" balance sheets outside of the US --

it is a direct consequence of Asia's bond buying spree from 14 to 20.

My operating hypothesis is that these bonds -- mostly held on a hedged basis -- won't be sold (so losses won't be realized, see SVB) but that they will roll off as the bonds (or the investment trust holding the bonds) matures ...

But that is a hypothesis not a certainty: it depends (as we were reminded this week) on the ability of certain institutions to sustain the funding structures (often based on rolling 3m hedges and often now negative carry) that allow the bonds to be held to maturity

"As long as the funding (for SVB, big deposits) [are] IS there,"

ugh -- always make mistakes at the start of a thread too

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More from @Brad_Setser

Mar 12
The outline of the US government's response to the failure of Silicon Valley Bank is now clear, and the US didn't mess around. Clearly there was real concern about deposit flight and funding driven contagion.

The response has three legs --

First, the FDIC invoked the systemic risk exception (with the support of Treasury and the Fed) to protect all deposits (tho not the equity or the bonds) of SVB and Signature Bank. This allows the deposit insurance fund to cover any gap between ...

the funds obtained from the sale of SVB's assets and is remaining deposits, and thus makes all deposits whole. The deposit insurance fund can be refilled out of a bank levy -- so there is no cost to taxpayers (this is part of the post Dodd Frank architecture).

Read 13 tweets
Mar 10
The biggest holders of underwater bonds globally are, of course, central banks -- including the PBOC.

But central banks are different, China's above all.

The January data is finally out and China's central bank looks to have added significantly to its reserves.

Both the PBOC& the state banks added ~ $20b to their foreign assets in January -- so a combined $40b plus. The Chinese have suggested that the rise in PBOC reserves is the runoff of structures set up back in 2008 (to hide intervention then) but that isn't obvious ...

January data is now stale -- the dollar changed course in February and so did the CNY.

But if China really was intervening (to limit CNY appreciation) in January, it would not be a total surprise. The PBOC historically has resisted appreciation pressure.

Read 9 tweets
Mar 8
This story is basically off -- or at least misleading.

China likely wants people to think it is reducing its Treasury holdings. But the best available evidence suggests that China has shifted from US Treasuries to ... US Agencies.
It isn't hard to find evidence that China is buying US Agencies (Freddie, Fannie backed MBS).

It shows up directly in the TIC data (the official US data on foreign holdings)…
The data on Treasuries is more complex. The fall in "holdings" is heavily driven by valuation changes. The official TIC data does show some modest sales. But there has been a large rise in the holdings of Belgian custodians (historically numbers influenced by China)
Read 5 tweets
Mar 7
I disagree with Kevin Gallagher on this.

The MDBs are already providing concessional financing to low income countries, and by providing new concessional inflows, they balance existing outflows without a formal debt restructuring.
The small aggregate share of China in developing country debt doesn't map perfectly to actual cases of distress. China has more exposure to Zambia for example (and a decent amount of lending to Sri Lanka and Pakistan)
China isn't being asked to write off the face value of the loans of its policy banks, only take a concessional interest rate. In Zambia that likely would be 2.5 to 3%. The MDBs already charge a lower rate (1%) and have committed to similar rates on new exposure.
Read 6 tweets
Mar 5
Good point.

Would be interesting to the see Ireland and Switzerland nodes in a Shin/ Si Ying Zhang style chart of say the pharmaceutical industry ...

(and Ireland's role in the tech industry is only apparent if you look at profits not actual goods production)
Adam Tooze's latest chartbook is of course excellent ...…
only two small additional caveats to the "slow deglobalization" thesis --

One is that trade deglobalization from 09 to 19 is almost 100% driven by China, and by the nature's of China's response to the global shock ...
Read 4 tweets
Mar 2
Martin Sandbu of the FT picks up on a point that @clichfield1 has emphasized -- namely that there is a dearth of public information about the location of Russia's immobilized (sort of frozen but not quite) reserves ...…
As @MESandbu notes, the numbers most use for Russia's EUR and USD reserves actually come from the CBR (pre sanctions) -- there isn't verified matching data from either the US or the EU.

That's a big gap.
Sandbu: "But it is clear that they don’t do so [identify immobilzed CBR assets] publicly — we have asked a lot of central banks and came up empty-handed — and there is no systematic sharing of this information between the sanctioning governments."
Read 11 tweets

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