What to Expect After the Silicon Valley Bank Collapse

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Over the past decade, the Federal Reserve has manipulated asset prices by interfering with free markets by deciding what both short-term and long-term interest rates should be. This resulted in an increase in risk-taking behavior among investors. Risk became a four-letter word uttered only by curmudgeons; the only thing investors feared was being left out. The more risk you took, the more money you made – until you lost it all.

The First Law of Thermodynamics states that energy cannot be created or destroyed, but can be converted from one form to another. This principle applies to financial markets as well, where risk does not dissipate but, like a hot potato, gets transferred through time from one party to another.

We are observing this today in our economy. For every issuer and seller of long-term bonds that yielded next to nothing, there was a buyer who is losing money today as interest rates have risen suddenly and the prices of bonds dropped.

Over the past decade, consumers refinanced their houses with 2.5% mortgages. Some of these loans were kept by banks, while others were converted into mortgage-backed securities and sold to insurance companies, pension funds, corporations, and consumers. The majority of mortgages are fixed rate, so consumers’ ability to remain in their homes is not affected by rising interest rates. However, the risk did not leave the system; it just got transferred from consumers to banks.