Expensive is not an excuse

by | May 7, 2025 | Real Estate

Expensive is not an excuse-"Real Estate Risk Management"


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Expensive is not an excuse

Welcome to the Real Estate Espresso Podcast, your morning shot of what’s new in the world of real estate investing. I’m your host, Victor Menasce. On today’s show, we’re taking a look at an event in financial markets that could represent a tipping point. These events have occurred with regularity over the years.

Think of the sovereign debt crisis in Greece back in 2012 that threatened to topple the entire European banking system. Think of Lehman Brothers and the bank failures in the US in 2023. These events often expose the counterparty risk that’s inherent in our globally interconnected financial system. We saw a few US banks fail in 2023, and it had the potential to cascade through the entire US banking system.

Now the Fed stepped in and implemented the bank term funding program as a mechanism that would allow banks to borrow from the Fed using bonds that were technically underwater as collateral and using the full face value of the bond without having to trigger US treasuries are supposed to be among the safest paper out there. In one sense, they are safe. So far, the US has not defaulted on the payment of the face value of a bond of maturity. But in between the day you purchase and the maturity date on the bond, the value of those bonds can and does fluctuate. According to market value, it can fluctuate quite a bit.

The failure of Silicon Valley Bank was one of those cases. There was a loss of confidence in Silicon Valley Bank, which forced the bank to sell bonds in order to fund withdrawals. You see, when you withdraw cash from a bank, you’re drawing on the liability of the bank. In order for the bank’s balance sheet to remain in balance, the bank must eliminate an asset, a corresponding asset, on their balance sheet or transfer the liability from the depositor of the bank to another bank.

Let’s give a simple example. Let’s say you transfer $100 from your Wells Fargo bank account to your Bank of America bank account. Wells Fargo needs to sell $100 worth of assets from its balance sheet to fund the cash or Bank of America needs to lend Wells Fargo $100. I’m not going to go into complexity of bank leverage in this discussion.

In the case of Silicon Valley Bank, the banks were hearing rumors of SVB’s weakness and they refused to extend that credit to the bank. They forced Silicon Valley Bank to sell treasuries that were underwater, and Silicon Valley Bank had not purchased📝 hedges against those bonds. Hedges are essentially options that would have the same effect as offering insurance against price swings. The price of those options can be thought of as portfolio insurance. And the price of that insurance is often the reflection of the risk that is perceived in the market. The failure to buy insurance caused the complete failure of the financial institution in the case of Silicon Valley Bank, First Republic, and Signature Bank.

Well the problem is showing up again in the latest spike of treasury yields. It happened very rapidly between May 1st and 2nd of last week. Now we become accustomed to very high volatility in US Treasury yields. Most of that is routinely blamed on the unpredictable nature of the White House. But, this one was different. There was no news from the White House that fundamentally would have affected Treasury yields, at least not on May 1st or 2nd. The threat to impose tariffs on foreign movies is not enough to move the needle.

So exactly who is dumping US Treasuries? Well, what happened at the exact same time as the spike in US Treasury yields last week was a precipitous drop in the Taiwanese dollar against the US dollar. This spring, Taiwan held a record $295B in US Treasuries. That figure represents a record for Taiwan’s holdings so far. Taiwan is consistently ranked among the top foreign holders of US Treasury debt, placing it around 9th or 10th on the position globally. So who in Taiwan is dumping Treasuries?

Well, it turns out that Taiwanese life insurance companies had loaded up on US Treasuries and failed to purchase a hedge against interest rate volatility. So why exactly did they not buy that insurance? Well, they thought the liberation day announcement from Donald Trump had been pending for weeks. It was making front-page headlines around the world, and still, the risk managers at the Taiwanese insurance companies thought that they would take the risk and not buy insurance. The high price of insurance was actually a reflection of the elevated risks.

So within the span of a few days, Taiwanese life insurance companies have been dumping Treasuries and the Taiwanese dollar has fallen in value against the US dollar by nearly 10% in the span of two days. That can only be described as a near free-fall situation. Overnight, the Taiwanese dollar has recovered somewhat, but the point is that any investor who’s managing money needs to have insurance against risk. I don’t care if you’re a life-insurance company, a bank, or a real estate firm. You need insurance! I don’t care how safe you think the asset is.

There’s nothing safer than U.S Treasuries, and yet, we saw U.S banks in 2023, Japanese banks earlier this year, Taiwanese insurance companies most recently, all experienced massive losses as a result of not having effective hedges in place. So for real estate investors, how many of you signed a loan commitment and not purchased a rate cap insurance policy?

That insurance used to be pretty cheap back in 2021 and 2022, and these days that insurance is expensive. It’s expensive for a reason, because the risk is elevated. Expensive is not an excuse for not buying insurance. As you think about that, have an awesome rest of your day, go make some great things happen! We’ll talk to you again tomorrow.

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