The American population is finally awakening to the steep losses various institutions have suffered in the last year. We have seen bank runs that have quickly finished off three regional banks. We have seen the Swiss virtually force the demise of Credit Suisse into UBS (thereby keeping the Americans and British from unearthing and further revealing some of the dark secrets of the Swiss banking system).
People query me for my thoughts about this crisis in confidence. I have many, but then this note would go on seemingly forever and who reads that far. In short, the current crisis in confidence is bad and almost certainly going to get worse, much worse. Get ready to batten down the hatches financially as a major recession hits America, mainly due distrust of public institutions and political leaders.
There is approximately $8 trillion dollars of American 30-year mortgage debt. The average coupon on that mortgage debt is in the low 3 percent area. Hence, let me use the 3.00% Universal MBS as a proxy for the entire American mortgage market. It declined in price from 103.67 on January 1st, 2022 to approximately 86.80 on December 31st, 2022. Recall that these are AAA-rated securities, and yet they "lost" 16.25% of their value in 2022. This simple fact means that there are approximately $1.3 trillion in mortgage losses spread out across the American financial system.
We have not seen anything yet regarding those losses. Many more banks will be revealing their unrealized losses in bonds held to maturity. So too will many insurance companies and non-profit organizations.
However, the big shoe yet to drop concerns the American pension system. The losses on the asset side of the ledgers are staggering. Think 20%, 30%, and even greater. The pension asset losses will be partially offset by the higher discount rates used to value future liability payments. However, due to the negative convexity of 30-year mortgage debt, almost certainly the funding gaps increased. What this means is that greater contributions will be required to get the pension plans back to the beginning of 2022 levels.
In many cases, this will require higher taxes for local and state governments to make up for the 2022 losses. Just imagine your taxes going up as the American economy tips over into a major recession!! Yikes!!