U.S. banks’ unrealized losses soar to 7 times 2008 crisis levels

U.S. banks are taking massive hits, with unrealized losses on their securities skyrocketing to $750 billion by Q3 of 2024.

That’s seven times higher than the unrealized losses reported during the 2008 financial crisis, where banks faced $100 billion in losses.

These losses are tied directly to securities that banks had previously acquired, particularly their available-for-sale (AFS) and held-to-maturity (HTM) portfolios.

A combination of higher interest rates and shaky economic conditions is ripping through the market, eroding asset values across the board. U.S. banks are feeling the heat, and there’s no hiding the financial damage.

Rising losses across securities

But what’s truly driving these losses? A big chunk comes from residential mortgage-backed securities (RMBS). Higher mortgage rates have sent the prices of these securities plummeting, throwing banks deeper into the red

 The situation isn’t much better for corporate bonds and Treasuries. Rising interest rates have hammered their valuation, pushing banks’ unrealized losses even further.

The data doesn’t lie. As Bank of America recently reported, their bond losses stand at about $85.7 billion. In the past three years, their held-to-maturity portfolio alone has shrunk by $116 billion.

Losses in this portfolio are piling up at around $10 billion per quarter. Another important note is there are currently 1,027 banks in the U.S. with assets exceeding $1 billion. Among them, 47 are reporting unrealized losses greater than 50% of their capital equity as of June 30.

Scrutiny and regulatory response

Regulators aren’t sitting back and watching. The FDIC is cracking down on banks, demanding that they beef up their liquidity stress tests and get serious about managing their uninsured deposit exposure.

The stakes are high. U.S. banks are walking a fine line, and regulators are watching every step. Liquidity stress is the key phrase here. Banks are expected to manage these losses, but that’s easier said than done.

Analysts are mixed on how things will play out. Some say banks could see up to 25% of their unrealized losses recover if interest rates stabilize or drop.

But that’s a big “if.” The economy is a mess, and there’s no crystal ball that can predict what will happen next. The market’s volatility is here to stay, and banks will have to adapt or go under. There’s no easy way out.

A brief glimmer of hope showed up when the yield on the 10-year Treasury dropped from 4.34% at the end of June 2024 to 3.73% by press time.

That’s a 61-basis point fall. When bond yields drop, bond prices rise, which helps banks recover some of their losses. But the damage has already been done.

Earlier in the year, the 10-year Treasury yield hit a high of 4.48%. The banks that were sitting on these long-term securities when rates were low are now in deep trouble. They thought they were locking in safe returns, but now they’re locked into losses instead.

U.S. deficit soars

To add to the financial chaos, the Biden administration’s budget deficit hit $1.833 trillion for fiscal 2024, an increase of 8% from the previous year.

This is the third-highest deficit in U.S. history, surpassed only by the COVID-19 years of 2020 and 2021. The government’s total receipts were $4.9 trillion, which sounds impressive, but it couldn’t keep up with the $6.75 trillion in outlays. Simple math tells you that’s a problem.

The national debt is now sitting at $35.7 trillion, up $2.3 trillion from fiscal 2023. The more debt the government racks up, the more interest it has to pay.

And that interest is $1.16 trillion in 2024 alone, the first time interest expenses crossed the trillion-dollar mark. The economy is buckling under the weight of this debt.

Interest expense is now the third-largest item in the budget, trailing only Social Security and health care. Looking ahead, the Congressional Budget Office (CBO) predicts even more pain.

The deficit is expected to rise to $2.8 trillion by 2034. On the debt side, the CBO expects it to balloon to 122% of GDP by 2034.