Matt Levine, Columnist

Banks Prefer Losses They Don't Have to Talk About

There is loss aversion, but an equally important psychological bias is aversion to talking about losses. Sometimes those aversions cut in opposite ways.

February 26, 2014 at 7:43 PM UTC

By Matt Levine

Matt Levine is a Bloomberg Opinion columnist. A former investment banker at Goldman Sachs, he was a mergers and acquisitions lawyer at Wachtell, Lipton, Rosen & Katz; a clerk for the U.S. Court of Appeals for the 3rd Circuit; and an editor of Dealbreaker.

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If you own a bond and interest rates go up, your bond will lose value. That's just a fact.1 But the consequences of that fact, if you're a bank, are all over the place. If you own that bond in your trading portfolio, you have what is colloquially called a trading loss: You owned a thing, it went down in price, you have lost money. Not in a strict literal sense -- you have not turned the bond back into money, so your losses are "on paper" -- but in every relevant accounting and capital and so forth sense.2 So your net income goes down (or becomes a net loss), and your regulatory capital goes down, by the amount of value that your bond has lost.

If you own that bond for investment purposes, and you don't have any "intent of selling it within hours or days," you have an investment loss on paper, but you get to treat it a bit more gently. (This is called "available for sale," or AFS.) The loss doesn't flow through your net income; instead it flows through a different place called "other comprehensive income," and everyone agrees to treat that as somewhat less important than net income.3 Everyone except Basel III bank capital regulation: L ast year, regulators ungallantly decided to require you to treat those unrealized investment losses as reducing your capital.