The failures of both Silicon Valley Bank and Signature Bank have been dominating news headlines and social media over the weekend as state and federal regulators have swooped in to guarantee customer deposits.
This news has sparked concern for investors all over the globe who are worried this may be the start of an overall banking system meltdown. As a result, mortgage bonds are trading higher today (meaning mortgage rates are lower) and are likely to continue improving this week as more investors flock to the safety of the bond market.
Why did this happen? And what effects will this have on the bond market and mortgage rates going forward? Let’s discuss.
How Banks Get In Trouble
Bank failures are not uncommon during times of economic stress. From the first financial panic of 1819 to the COVID-19 pandemic, several major economic events have caused banks to fail at high rates.
When you deposit money in a bank, the bank takes your funds and reinvests them in things like bonds or other securities. They pay you a small amount of interest on the funds they are using, and they hope to get an even bigger return from wherever they choose to invest.
Back when interest rates were near zero, US banks used their customer deposits to scoop up a lot of Treasuries and bonds. But as the Federal Reserve has hiked rates to fight inflation, those bonds have declined in value.
Why is that? Because when interest rates rise, newly issued bonds start paying higher rates to investors. This makes the older bonds with lower rates less attractive and less valuable. The result is that most banks have some amount of unrealized losses on their books.
This is where Silicon Valley and Signature Banks ran into trouble. With inflation rising and a recession looming, depositors have been spending more of their deposits and pulling their money out to chase higher yields elsewhere. To cover these withdrawals, the banks have had to sell their securities and take big losses – tens of billions of dollars big.
How Will This Impact Mortgage Rates?
The news of these banks closing is dominating the headlines, and the overall tone is fear about the state of the banking system. But there is an upside to all of this – it’s going to be a BOOM for the housing market.
Mortgage rates have already fallen in response to the bank failures and will likely continue to fall. Why? Because when banks fail, the short-term result is deflation.
In January of 2023 and the fourth quarter of 2022, we saw the amount of money supply in the U.S. economy contract for the first time ever. That is a deflationary event. And as inflation turns to deflation in our economy, mortgage rates will go down.
Lower mortgage rates make housing more affordable for millions of renters. Rates may not fall in a straight line, but they will continue to fall this year – and deflationary events like this are only going to speed up the process.