Bank Runs: Fed Fumbled. We Paid the Price

Over the past year, the Federal Reserve has been raising interest rates to combat runaway inflation. From February 2022 to March 2023, the Fed raised interest rates from 0.08% to 5% based on 2023 CPI data. While this may have been an effective tool to control inflation, it has also had unintended consequences on regional banks, national debt payments, and your assets. In this blog post, we will discuss the impact of rising interest rates and provide tips for you to protect their assets.

1. The Fed Raises Interest Rates Devaluing T-bills Assets

The Fed's decision to raise interest rates was aimed at curbing inflation. Higher interest rates make borrowing more expensive, which reduces demand for goods and services and slows down the economy. However, as interest rates rose, the value of Treasury bills (T-bills) held by regional banks such as Silicon Valley Bank (SVB) and Signature Bank decreased due to the formula:

Price of T-bill = Face Value / (1 + (Discount Rate x Days to Maturity / 360))

2.??????Devalued T-bills Assets Cause Liquidity Challenge and Potential Bank Runs

When interest rates rise, the value of existing bonds and other fixed-income securities falls, causing a decline in their market value. This means that the T-bills held by regional banks became less valuable as interest rates increased. For example: SVB sold $42 billion of T-bill with average interest coupon payments of 1.8% (assume with an average maturity of 2 years), and the same T-bills now offer 4% coupon payments.?That equates to a loss of 4.4% = 2*(4%-1.8%), or ~ $1.85 billion.?

This caused regional banks to experience losses in their assets and face liquidity challenges. When many banking customers withdraw their deposits simultaneously, aka a bank run, cause the bank to collapse. Bank runs are often caused by panic, as customers fear that the bank will not be able to meet all its obligations.

3. The Fed Increases National Debt Payments

Higher interest rates also increase the cost of national debt payments. As interest rates rose, the U.S. government had to pay more to service its debt. For instance, if the government owed the US national debt of $31.46 trillion at a 2% interest rate, it would pay $629 billion in interest. However, if interest rates rose to 5%, the government would have to pay $1,573 billion in interest. This puts additional pressure on government spending and may lead to budget cuts in other areas to balance this $944 billion added payment.

4. Tips for You to Protect Your Assets

With rising interest rates and potential risks of inflation and bank runs, you need to take steps to protect your assets. Here are the top five tips that I advise my CEO clients:

• Diversify your investment portfolio: Spread your investments across different asset classes to reduce risk with smart asset allocation.
• Consider bonds with 3-6 month maturities with 5%+ interest payments: Shorter-term bonds are less sensitive to interest rate changes and offer more liquidity.?As rate hikes, you can ladder your bond portfolio and earn more interest payments.?Vanguard CDs are my preferred choices.
• Keep cash on hand: In the event of a bank run, having cash on hand can provide immediate access to funds. My rule of thumb on cash is enough to cover your financial runway.
• Pay down high-interest debt: High-interest debt, such as credit card debt, can become more expensive as interest rates rise. Paying it off can save money in the long run.
• Be cautious with adjustable-rate loans or investments: Adjustable-rate loans, such as mortgages (aka ARM), can become more expensive as interest rates rise. Consider refinancing to a fixed-rate loan to lock in the rate. Unfortunately, the average 30-year fixed mortgage rate a year ago was 3.11%, and it has significantly increased to the current rate of 6.79%. Also, I would avoid commercial property as this industry is estimated to be around $10 trillion in debts with an average 5-year maturity.

In conclusion, while the Fed's decision to raise interest rates may have been well-intentioned to combat inflation, it also had unintended consequences that I don’t think they envision. As a result, it's essential for you to be vigilant and take steps to protect your assets during times of economic uncertainty. While I have faith in the U.S. backed securities, I don’t trust the tunnel-vision Fed, the short-sighted CFOs at regional banks, or the deficit-driven spenders in Washington D.C.

Love to hear your thoughts and comments on this topic. Thank you for reading and subscribing to my newsletter. We will share the craziness of $500 billion student loan forgiveness proposal next week.

About the blogger: Jimmy Thai is a retired Fortune500 executive from the humble beginning of a Vietnamese "Boat People" refugee. He now coaches CEOs worldwide to achieve their Purpose-Profit-Peace, and has funded 125 schools for underprivileged children around the world.