The Reality of Unrealized Finances

Whether it’s unrealized wealth or unrealized losses, any time discussions of unrealized outcomes shows up in headlines, it’s bad news for everyone.

April 29, 2024

By: Bobby Casey, Managing Director GWP

unrealized The word “unrealized” isn’t necessarily a bad one. One could say, “That person has a lot of unrealized potential”. That would mean that person has all the indications of becoming a great or successful person, especially if you were talking about a person in sports.

But, much like everything governmental or institutional, the word “unrealized” has no positive connotations.

When Elizabeth Warren ran for President of the United States back in 2020, she proposed to pay for her agenda of spending with a “wealth tax“. This tax was meant for only the top 0.5% most wealthy people in the United States.

But it was a tax on people’s net worth, not on any transactions or income. Joe Biden tried it again, in 2022:

Their solution is a massive transformation of the tax system to levy an annual tax on unrealized gains of assets like stocks, real estate and collectibles.

His plan called for an annual 20 percent tax on taxpayers with income and assets that exceed $100 million.

Aside from the IRS assuming the great task of keeping an inventory of all our assets, they would also be responsible for appraising all of it each year.

Take a moment to wrap your head around the mere idea of the IRS doing either or both of those things and what an inevitable travesty that would be. The article goes on to cite:

Estimates of similar taxes have found they would decrease innovation and investment, driving down wages and causing unemployment. For example, an American Action Forum (AAF) study on Warren’s $3 trillion wealth tax proposal found that the tax would shrink GDP by $1.1 trillion over 10 years and would shrink labor income by $785 billion over the same time period.

You’ll notice you can’t write off unrealized dependents. Sorry folks, each of your gametes are not deductible!

And while individuals writing off “unrealized dependents” would be a boon for the economy, the one entity who needs to avoid unrealized losses is banks. But guess who’s got them in spades? You guessed it: banks.

“What does an unrealized loss look like for a bank?” you might be wondering.

These paper deficits represent the hit that a bank would take if it sold something it currently owns at the market price. An example would be bonds whose value falls as interest rates rise. If there’s no market price, banks can base the valuation on other market inputs or in-house models. If the lender has the intent and ability to hold the investment until it matures, the unrealized loss remains theoretical.

But sometimes reality intrudes, as SVB showed. The California lender had unrealized losses on government bonds and mortgage-backed securities equivalent to a large part of its capital. When depositors suddenly whipped out their cash the bank had to dump bonds, creating actual losses.

Much like any other long term investments, the point is to hold onto them either to maturity or if rates peak higher than when you bought them. If interest rates dip, and you need to liquidate, you do so at a loss. If that happens at a large enough scale, the bank goes under. Unlike “unrealized gains” in the “wealth tax” scenario, unrealized losses don’t hit the books until they are realized.

We made it all the way to April, but the first bank closing of 2024 just happened:

The FDIC just seized the troubled Philadelphia bank, Republic First Bancorp and and struck an agreement for the lender’s deposits and the majority of its assets to be bought by Fulton Bank.

Republic First had $242 million in “unrealized losses”. I say the first bank closing because there’s a good chance others will follow suit.

U.S. Banks finished the year [2023] with almost $400 billion of unrealized losses on held-to-maturity assets.

They are hoping interest rates plummet. And they need to plummet before people demand their deposits back.

But here’s the thing: We are seeing the largest deposit outflows (adjusted for tax season) since September 11, 2021; and domestic bank deposits are at equally record lows.

Compound that with this from the New York Fed: Household Debt Reaches $17.5 Trillion in Fourth Quarter; Delinquency Rates Rise.

People are withdrawing more than they are saving, and they are assuming debt to fill the gaps, which is the perfect storm for banks having to sell off assets like bonds and start taking the hits.

While higher interest rates sound like “price gouging” or “usury”, they have some harsh implications for banks as well. Higher rates are difficult on borrowers, which make them more difficult to sell. Higher rates means all the assets banks have at lower rates just depreciated. And while riding out the valleys is a normal course, it only works if you don’t need to liquidate those investments.

The economy isn’t as healthy as politicians want everyone to believe. Pointing to a rallying stock market or a growth in retail is a bit deceiving.

The stock market saw a correction in earnings in what’s known as the “Magnificent 7” (i.e. Microsoft, Apple, Nvidia, Alphabet, Amazon, Meta and Tesla). Apple and Tesla slipped, but Nvidia and Supermicro rallied hard. The Magnificent 7 might’ve shuffled around a bit, but they ultimately drove nearly 25% of earnings last year.

But multinational earnings aren’t indicative of very much, especially when it’s all tech. What does any of this have to do with the cost of groceries for a mechanic? Not a whole lot.

When people say that retail sales are booming, they aren’t adjusting for inflation. They aren’t looking at how much someone is buying. They are looking at how much they are spending. But they are spending more on the same amount. No one is buying more. Everyone is spending more, though. But it looks better to say people are spending more in retail than to finish the thought with “on the same amount of stuff”.

When pundits point to job growth, they don’t tell you that it’s mostly part-time jobs taken by those who already have full-time jobs supplementing their incomes.

There was a story out of Brazil of a woman bringing her dead uncle to the bank to cosign a loan for her. If that isn’t an apt metaphor for what’s happening in this economy, I don’t know what is!

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