Another thing that may have helped would be if they hedged their interest rate risk. That’s discussed on this podcast[0] by some folks who do that sort of thing for big banks.
It’s pretty nuts that they didn’t have a hedge in place, given the pretty clear policy of the Fed.
The stuff I read is that it was the hedge implementation that lost them all the money. It's very hard to know for sure how that happened without being inside the situation.
Long answer: Hedging rate risk in general is a very deep topic. Investment banks have massive swaps desks that are built on the back of this and there are numerous examples of people losing a ton on hedges and in certain cases the dealer banks have been fined for miss-selling etc. Not saying that's the case here but it is at least possible. For example in the UK there was this[1] and in the US from memory there were numerous munis who settled and received payouts after losing a ton on rates hedges.
On top of that, hedging rate risk on an MBS is slightly more complex than for a regular bond because it amortizes and as the underlying loans prepay or default this affects future cashflows from the bond. So you can only hedge the forward rate risk given certain assumptions about prepayment/default and if those assumptions turn out to be off you will be imperfectly hedged. Normally that isn't that big of a deal if you have a big portfolio as you can roll swaps on or off to fix the problem [2] but the cost of that adjustment is going to be a factor of how "wrong" you are about the default profile of the collateral and how much rates have moved.
[1] https://www.theguardian.com/business/2013/oct/23/interest-ra...
[2] There is also the problem of default correlation skew here meaning you have so called "wrong way risk" where if your assumptions are wrong on one bond they're highly likely to be wrong across your portfolio. This is as opposed to normal portfolio thinking where a diversified portfolio helps.
Hedge costs money, and the instruments in question were not going to default, given they were government backed, so if they could just hang on until maturity they would get the yield from the day they bought them.
Holding bonds in a rising rates environment also costs money.
Hedging could have been a way to reduce the duration without selling - i.e. without realizing losses as the bonds could still be classified as hold-to-maturity - and avoid further losses.
Maybe. Essentially anything they could've bought would've had a similar kind of interest rate exposure. Laddering maturities would definitely have helped, but they expanded their portfolio quickly, and off-the-run issues are much less deeply traded, especially if you're a newcomer that doesn't have connections with the rest of the market.
It’s pretty nuts that they didn’t have a hedge in place, given the pretty clear policy of the Fed.
[0] https://pca.st/rq7eo75p