It may be said that during a crisis situation that things generally come full circle. In a completely absurd twist to the credit crisis, we’re watching this phenomenon play out before our very eyes.
Over the past 6-8 months, the Federal Reserve has embarked on a series of ever-increasing credit facilities and other lending programs, the purpose of which has been to keep the financial system from collapsing on itself. The mechanisms of these programs are pretty simple. The Fed either ‘buys’ toxic assets like mortgage backed securities or OTC derivatives from financial institutions or makes outright ‘loans’ to such institutions. The stated goal of these programs was to keep banks in a position to lend. We’ve documented dozens of times in our weekly MTC columns the reliance of the US Economy on ever-increasing debt loads. The problem is that for whatever reason the banks haven’t been lending so much, preferring rather to sit on the money or take it to the Treasury window and trade it in for US Treasuries with the intent on collecting interest from the US taxpayer. They were in essence given the money anyway, so why not?
The intended consequence of this action has been to drive Treasury yields to almost nothing. In fact, the yields on 3, and even 6 month Tbills are now so low that the fees to obtain these instruments exceed the interest one can hope to gain. The yield on the 3-month T Bill is 4 basis points! The yields on the longer term notes and bonds are not much better. As of this writing, the yield on the 30 year bond is now at 3.29%.
So low in fact have yields gone that bond fund managers who are required by their charters to invest only in government securities are now looking for ways to get back into the corporate bond market. The same market that was considered toxic only a few short weeks ago. Obviously, the notion that the ‘full faith and credit’ of the US Government now extends to corporate bonds is in full force. This move, if allowed to take place, will prove catastrophic for investors.
I find it extremely disconcerting that during a time when safety is of the utmost concern for Main Street investors that the government, through its own purposeful actions, has made that safety impractical for many people. The biggest problem for small investors will now be identifying which US Government bond funds are actually investing in government bonds and which ones have returned to the scene of the crime and are once again testing the toxic waters.