Showing posts from August, 2010

Bank Debt Spiral

The zero interest rate policy (ZIRP) will kill the banks. Falling interest rates help banks by increasing the value of their bond and loan portfolios. This is the well understood inverse relationship between discount rate and present value of a future sum. But you see keeping interest rates at zero does virtually nothing for the banks as rates cannot fall further. There is a short window where ZIRP is a positive but an "extended period" (in Fedspeak) is just slow death for the banks.

During that short period, the banks are still collecting on portfolios constructed when rates were higher but as those higher-yielding assets mature, there is nothing comparable to replace them. We hear constantly how banks can just borrow at zero and invest in Treasuries - pocketing the difference. That would be fine if yields on Treasury debt were not low and falling along with everything else. The other problem is that this simplistic formula assumes that banks' operating expenses are neg…