Banks Could Be The Biggest Casualty When The Bond Bubble Bursts

If The Bond Bubble Bursts Banks Could Suffer

banks and bondsI hate to burst your bubble, but the economy isn’t out of the woods yet.  Unfortunately in this country, we have a tendency to all crowd towards the same financial endeavors creating a situation where that endeavor bloats out of proportion creating what is known as a “bubble”.  In the last several years we have seen the rise and fall of the .com bubble, the housing bubble, and now we have a all together new bubble forming…the bond bubble.  When the stock market fell apart in 2008 most investors clamored towards safe haven investments, which included being heavily invested in the bond market; as that happened, U.S. treasury interest rates dropped down near zero.  Unfortunately, like anything else, most investments tend to return to their average yield over time, and the bond market is already showing signs that it’s yields are rising.  On January 3rd, bond yields rose 0.7% from their previous lows before settling back down again.  It’s only a matter of time before those numbers creep up and bonds wreak havoc on those invested in long-term bonds.

Fed Reserve Concerned About Banks Being Heavily Invested In Bonds:  What Will Happen To Banks When The Bond Bubble Bursts?

The biggest concern surrounding the bond bubble, is the number of financial institutions who are heavily invested in the bond market.  Federal Reserve Governor, Jeremy Stein is concerned that the boned bubble could potentially devastate the financial sector and in turn, the economy.  Banks are not required to disclose their bond holdings to their investors, yet reports to the FDIC indicate that banks are more heavily invested in bonds than you may realize.  On average, banks are earning 3.86% on loans and leases, which is the lowest since 1984 when the FDIC started collecting their data.  Currently, the 10 year treasury yields only 2.0%.  Thus, banks are really reaching and working hard for yields, which gives them a propensity to invest in riskier assets and endeavors.  Compared to individual investors, banks are more likely to hold long-term bonds ie; 10 years maturity or greater.  Normally this isn’t an issue, but if yields were to go up even by 1% the overall effects could be devastating for financial institutions.

How Much Do Banks Have Invested In Bonds?

Recent numbers reported to the FDIC would indicate that banks have a large percentage of their holdings in long-term bonds.  JP Morgan currently has $200 million held in bonds that mature in over 10 years, which is 56% of their entire portfolio.  Bank of America the other big time financial institution in this country, just reported to the FDIC that 90% of their assets are tied up in bonds, which equals 266 billion dollars.  If interest rates were to rise even 1%, they could lose as much as $30 billion.   This isn’t enough to cripple the bank entirely, but it’s enough to be felt both on an institutional and an individual level.

If you’re one of the many who has turned towards bonds as a “safe haven” investment years ago when everything else was deemed “too risky”, now would be a great time to reconsider your position.  For more information on the bond bubble and on selecting an investment that is more suited to today’s investment climate, speak to a redhawk financial advisor near you today.

http://finance.fortune.cnn.com/2013/02/11/banks-bond-bubble/

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