Higher rates expose risk deniers

David MoonBlog

If we’ve learned nothing else surrounding the failure of Silicon Valley Bank (SVB) it is that there are a lot of people who know little-to-nothing about risk, including highly paid professionals who are supposed to know better. Instead, they have been lulled to sleep by 40 years of almost constantly declining interest rates. I don’t know if they assumed rates would never increase, could never increase, or if they thought they were smart enough to predict when rates would increase and mitigate their risk only then.

Whatever the explanation, there are a lot of supposed experts who have been exposed.

Anyone who buys a 10-year Treasury that pays less than the rate of inflation doesn’t understand risk – no matter how fancy of an office or title they might have.

It doesn’t take a fancy PowerPoint presentation or statistical analysis with a bunch of esoteric-sounding Greek letters to know that ain’t too smart. But in their blindness to the possibility of higher interest rates or their desire for an extra half-point of interest – regardless of the risk involved – that’s exactly what a lot of banks have done.

And the largest offender of them all is the Federal Reserve. Like the banks and others who don’t understand risk, the Fed extended the maturities on its bond portfolio when interest rates were at an all-time low. And now the Fed has an unrealized loss of $1.1 trillion on that portfolio. But unlike SVB, which risked its depositors’ money buying the long-term bonds paying less than the rate of inflation, the Fed purchased its behemoth bond portfolio with money it created with the click of a computer button.

And if anyone tells you they understand the risks associated with that, please have them contact me and explain it. I don’t know exactly how that risk might play out, but I know it can’t be positive.

But perhaps the most frustrating examples of “risk deniers” are in the professional investment helper industries. It doesn’t matter how many times you may have heard that “stocks are risky; bonds are conservative,” when you buy a long-term bond paying 2% at a time inflation is 3%, you are locking in a guaranteed 1% annual loss of purchasing power. This pretty simple math escaped legions of financial advisers who have long told their clients to put money in bonds for safety, without differentiating between types of bonds or maturities. And as a result, a lot of people lost more money in the “safe” portion of their 401(k) last year than in the risky/growth portion.

Because somebody didn’t understand risk.

David Moon is president of Moon Capital Management. A version of this piece originally appeared in the USA TODAY NETWORK.