The Yield Hunt

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The Credit Strategist

This essay is excerpted from a recent version of The Credit Strategist (formerly the HCM Market Letter). To obtain the complete issue, you must subscribe directly to this publication; Please go here. The Credit Strategist is on Twitter - @credstrategist

“America has, for sure, the most powerful credit machine in the world, as Mr. Greenspan likes to boast. However, under the twofold influence of radically new thinking about successful corporate governance and Alan Greenspan’s novel monetary policies, this credit machine has become exclusively geared to unproductive credit for asset shuffling, financial speculation and consumption.”
Kurt Richebacher (2005)1

The world lost a valuable voice when Kurt Richebacher passed away in August 2007, just as the epic financial crisis he had long predicted was unfolding. Among Dr. Richebacher’s contributions was his argument that production, not consumption, makes a country wealthier. Capital – most of it in the form of credit – was grossly misallocated toward consumption in the thirty years leading to the 2008 financial crisis. Unfortunately, not only has nothing changed in that respect in the last four years, but the creation of debt has only accelerated and increased. The explosion of debt in the public sector is well-known. Federal debt is about to hit $16 trillion, will hit $20 trillion by 2016 regardless of who occupies the Oval Office during the next four years, and will end up somewhere between $23 and $25 trillion by 2020 without radical entitlement reform. Those numbers, by the way, assume that interest rates do not rise during that period.

The private sector has hardly done better in reducing its debt burden. Corporate balance sheets are in good condition due to high cash balances and extended maturity schedules, but the levels of corporate debt are still relatively high. The good news is that the interest rates on this debt are very low for all but the weakest companies. The explosion of debt issuance since the debt crisis illustrates that corporations are every bit as reliant on credit as they were before they has their near death experiences in 2008. During the first nine months of 2012, U.S. corporate bond issuance was 20% higher than the same period in 2011 at $984 billion and should easily break 2007’s record of $1.13 trillion. Europe and Asia are also seeing high levels of issuance. For the most part, companies are not borrowing to finance new projects or thankfully – new leveraged buyouts. Instead, they are intelligently taking advantage of low interest rates to reduce their borrowing costs and extend their debt maturities. But nobody should pretend that there is less debt in the system than before the financial crisis.2

All of this is great for borrowers and trouble for lenders. In fact, it has been absolutely devastating for investors and savers who rely on the yield from their investments for income. As a proud resident of the swing state of Florida (no hanging chads in Palm Beach County this year!), the impact of low interest rates are painful to witness. As an investor in credit, the distortion of securities prices caused by the Federal Reserve’s zero interest rate policy is a fact of everyday life. Anyone who does not understand that the price of every stock and every bond is being artificially altered by the fact that interest rates are being manipulated by the Federal Reserve should not be risking any money in the markets.

Monetary policy has driven investors to search for yield in the riskiest assets. Both subprime mortgages and Greek bonds have rallied to some of their highest levels in years on the back of central bank policy. In the U.S., the Federal Reserve is taking a lot of mortgage paper out of the market, which is forcing investors into riskier subprime paper. At least there are signs that the housing market has stabilized and is beginning to recover. In Europe, the European Central Bank (ECB) has somehow convinced some investors that Greek bonds are worth buying. But the Greek economy is continuing to fall into the abyss, and another bailout would just be throwing (more) good money after bad. If Greek bondholders are not forced to take losses – even if they are German and French banks – there will be little chance of Europe solving its debt crisis. But just as investors who speculated on an upset in Venezuela’s election are licking their wounds if they didn’t sell fast enough, those who are betting on a payoff on Greek bonds are likely to be injured here (more on Venezuela below).

1. Quoted by Dr. Marc Faber in The Gloom, Boom & Doom Report, July 31, 2012, p. 11.

2. For a more complete discussion of the fallacy of deleveraging, see Doug Noland, “The Myth of Deleveraging,” October 12, 2012 at