Posted on 04/23/2009 5:59:45 AM PDT by george76
Describing events in the bond market in 2008—and their future implications—is a bit like describing the construction of a house of cards.
It helps to understand the structural differences between trading stocks and trading bonds. Stocks trade on electronic or bricks-and-mortar exchanges where buyers and sellers converge in a central meeting place and transact with anonymity.
Bonds trade on an over-the-counter market using an intermediary, such as a bank or broker with full knowledge of the trade counterparty. It’s similar to trading in your car with a car dealer, which then looks for a buyer. The dealer is taking a position and risking its capital. It must hold the bonds in its inventory until it finds a buyer.
Holding inventory can become an expensive proposition if there is no buyer.
Add to that a domino line of failed financial players (Countrywide Financial, Bear Stearns, Fannie Mae, Freddie Mac and Lehman Brothers were the first casualties), and you get a market that ceases to function as a source of liquidity.
Collateralized debt obligations (CDOs...
Credit default swaps (CDSs), which are insurance against default by a bond issuer... However, sellers of credit protection (most notably American International Group)...
As the true risk behind CDOs and CDSs came to light, they tumbled in value, turning profitable lenders and investors into financial train wrecks overnight. Even corners of the bond market not tied to mortgages were drawn into the crisis. Many insurers of municipal debt had strayed into these exotic products...
Between devalued homes and shrinking investment portfolios, Americans have collectively lost more than $10 trillion in net worth. To put this in perspective, the U.S. gross domestic product is around $14 trillion.
(Excerpt) Read more at bondsonline.com ...
When one asset bubble bursts , another begins
There are two questions raised by the excerpt, both dealing with the question of perception and reality.
First is, were there successful banks and investors which were then turned to dust, or where they always dust, and simply PERCEIVED as successful because of the false valuations?
Second, related, is, have we really “lost” 10 trillion in value, or did that value never exist in reality at all? In this second case, I think it’s clear the answer is that we NEVER HAD that $10 trillion, that anybody who ever tried to convert any sizable portion of that into a “safe investment” would have failed and caused what happened last year to simply happen earlier.
I’ve lived in my house for about 12 years. According to the county, it is currently worth about 25% more than I paid for it. But according to the market, it was at some point worth over twice what I paid for it, and I have “lost” significant “net worth” in the past two years.
But I have the same house I had 2 years ago, and 10 years ago. It simply carries a different assessment of cash equivalent value.
I've been thinking for some time that corporate bond funds make a lot of sense when the market is down this far from it's highs. While the market churns up and down with every Obama policy change corporate bonds just keep paying dividends - unless, of course, if they go belly-up. If the state of the economy really isn't as bad as we are being told then corporate bonds are a steal at today's prices. If things are really worse - well I don't even want to think about it.
I'm curious what other Freepers think about the bond market in general and where the best investments are to be found.
That is one of the best (complete, concise, readable) explanations of CDO/CDS that I have seen.
Thanks for the post.
My investment portfolio decreased and my rental property decreased in value. Those are real losses, especially when it comes to dividends and capital gains paid. And many people found that the mortgages they are paying on their homes exceed the value of the home, which caused some of them to foreclose. And others borrowed against equity in their homes. Decreased home values mean that people cannot borrow as much or not at all for equity loans. Less consumerism has a ripple effect on businesses and employment.
>> Many insurers of municipal debt had strayed into these exotic products, wrapping their bonds in insurance in an attempt to secure credit at lower prices.
It will be interesting to see how the debt crisis plays out vis a vis municipalities.
I’m fearful that bailing out municipalities will be the final nail in the coffin of American can-do capitalism, forcing even “red” states and “conservative” counties into Bambi’s socialism corral.
>> I’ve been thinking for some time that corporate bond funds make a lot of sense when the market is down this far from it’s highs.
I am in cash, and I regularly think about the more abstract question “what do you do with cash right now”.
I have considered corporate bonds — very carefully chosen ones.
What always makes me pull back is the fear of inflation looming on the horizon.
Many see Jimmy Carter or worse stagflation soon.
20 percent inflation, etc.
Buying long term bonds, treasuries ...at current rates may look to be a very expensive trade in a few years.
( not investment advice , just my personal opinion )
Me too.
And I'm very largely in cash as well. But cash is going to depreciate rapidly in the next few years so we have to figure out what to do. Short term bond funds would seem to be one answer. The interest paid on new issue bonds has to start rising in the near future (assuming inflation). Short term bond funds will be holding maturing bonds at lower interest than the new issues they will be buying so the the average dividend should increase with inflation.
That's my current thinking. But I'm still researching bonds in general. I'm certainly no expert.
>> But cash is going to depreciate rapidly in the next few years so we have to figure out what to do.
I’m with you 100% there. Cash is king... yet, cash is doomed.
>> Short term bond funds would seem to be one answer.
Relatively unsophisticated investor that I am, I hadn’t made the distinction between bonds in general and SHORT term bond funds. I think your suggestion has merit, and I’ll look into it. tks
Apparently most states ( 43 ? ) are under water financially now.
Many towns and cities too.
The unfunded future obligations to retired government employees is massive. No one really knows the full cost of retirement, lifetime medical premiums...
>> The unfunded future obligations to retired government employees is massive.
... and the Bambi answer to that problem? Create MORE government employees and guarantee them (unfunded) retirement and health care for life.
Going to be a bumpy ride.
Social security was to go upside down in 2017. ( Revenue versus spending ).
However, it apparently went upside in March, 2009.
Medicare and all is even worse.
The printing of US money will be massive.
The author speaks many half-truths, particularly in how he lumps ALL bonds together, regardless of the issuer, regardless of the financial context, regardless of the price and earnings rate.
The fact is, that currently, major American corporations, OUTSIDE the financial sector, raised nearly $900 billion in new bond issues in the first quarter of 2009.
As to the “$10 trillion” American’s “lost”, that is less than a half truth.
It is all “market value” not realized, converted-to-cash-in-hand value. It was a value that existed on paper before and as it exists now. The only portion of that supposed “$10 trillion” that was or will be actually “lost” to anyone is that portion someone has been, or will be, forced to accept by selling something at a value far less than what they paid; a value which also in most cases was less than the high of their portion of “$10 trillion” at the top of the on-paper-only-bubble.
For a good many people, they will never “lose” any of their portion of the “$10 trillion”, because when they do finally feel the need to sell, the market they are selling in will have regained or surpassed it’s “$10 trillion” market value.
Even my pension account, which has dropped 30%, will regain or surpass its value at the “$10 trillion” mark, and most likely do so before I am 65 - even with no further contributions from me or the employer.
Gold.
Not true? There have been plenty of reported cases that it is a fact. And even the banks are walking away from foreclosed properties,
If I purchase a home for $500,000 and take out a $400,000 mortgage and the value of the property declines to $200,000, I would seriously consider walking away from it. It would be difficult to sell and I would have to make up the $200,000 to pay off the mortgage if I sold it for $200,000. It is the reason why the Adminsitration has established a program to address this issue: Obama Mortgage Assistance Plan
That's not the point. It is up to you to decide whether you want to pay and if you have a balloon loan or ARM you may not be able to pay. It is a personal decision and the fact that the mortgage may be twice the current value of the home in the example I provided, will influence any decision one might make. That's the point.
However, if you decide to stop making payments (for whatever reason), then yes, you'll end up in foreclosure.
Duh. What a silly statement. How else can the home go into forecloure?
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