Free is just another word for nothing left to do.

December 16, 2008 1:08 PM

ZIRP! Not an exclamation,it stands for Zero Interest Rate Policy. One country to try this was Japan in 2001, using the euphemism Quantitative Easing in an attempt to fight a multiple year long recession. The most current country? The United States of America.

The reason?

Since the Committee's last meeting, labor market conditions have deteriorated, and the available data indicate that consumer spending, business investment, and industrial production have declined. Financial markets remain quite strained and credit conditions tight. Overall, the outlook for economic activity has weakened further.

posted by eriko (50 comments total)

And they only had to maintain that zero rate until the end of 2007!
posted by absalom at 1:16 PM on December 16, 2008

Why is it that large businesses get all the breaks? Since no one's interested in bailing out excessive college loans, I'd at least like to be able to get 0% interest on my loans instead, but noooo....

Seriously though, this is scary. Japan had these issues and it took them over a decade to recover. I hope we manage to do so faster.
posted by explosion at 1:17 PM on December 16, 2008

Awesome! Now I can look forward to my bank adopting a Negative Interest Rate Policy for my savings account.
posted by burnmp3s at 1:18 PM on December 16, 2008

Now I can look forward to my bank adopting a Negative Interest Rate Policy for my savings account.

Mine has that. They call them "service" fees, but they don't actually do anything except collect them.
posted by rokusan at 1:23 PM on December 16, 2008 [3 favorites]

Wow, it's like someone thought "Hey, let's see what would have happened to Japan if they didn't even know how to make cars..."
posted by qvantamon at 1:24 PM on December 16, 2008 [29 favorites]

What a bunch of whiners! It's just a mental recession!
posted by billysumday at 1:25 PM on December 16, 2008 [4 favorites]

... and freedom's just another word for nothing left to lose, according to Kris Kristofferson and Fred Foster. (Ignore the spelling errors, or snicker softly to yourself.)

College grads paying off loans with no interest rate would just spend their new-found gift on wild parties. But AIG realized now is not the time for manicures and massages, so maybe there is hope for fiscally responsible expenditures of government gifts.
posted by filthy light thief at 1:26 PM on December 16, 2008

To pick a few nits, its a target range of 0-25bp, and only brings to target to where the market was anyway. The substantive portion of the announcement was more the explicit and definitive statement that they would buy a broad range of assets as conditions warranted and use 'all the tools' at their disposal. I guess the market liked it.
posted by sfts2 at 1:28 PM on December 16, 2008 [1 favorite]

You want to consider this on the national level or the personal level. One the personal level:

I'd at least like to be able to get 0% interest on my loans instead, but noooo....

You can certainly get 0% on a car and a ridiculously low rate on you mortgage, and yes, student loan rates are coming down as well. The less on here is to be a saver when everyone else is spending and the economy is hot (i.e. when prices are high) and be a spender when prices are collapsing. In other words, do the opposite of what everyone else was doing. No point in being a saver when prices are falling.

On a national level, well what did you expect after a dot-com boom and a real estate bom and commodities boom with no inflation because there was also a chinese no-labor-cost manufacturing boom. Do you really want the easy money back?

Now I can look forward to my bank adopting a Negative Interest Rate Policy for my savings account.

How about checking accounts that pay over 5% interest instead?
posted by Pastabagel at 1:32 PM on December 16, 2008 [2 favorites]

It'll be interesting to see what effect, if any, this has. One of the problems that led to this decision was the recent dearth of interbank lending - banks that have cash aren't doing anything with it. Until the money starts moving again, it really doesn't matter what the rate is.
posted by tommasz at 1:34 PM on December 16, 2008

Market should've rallied at least 10% today, but it really only made a one-in-a-(recent-)week move, this was big huge news for what the government is willing to do. People are scared.

What we just witnessed was not just quantitatively to 0, but a crossing of a line in the sand policy-wise. This means that the Federal Reserve will do anything to stop a recession. Many believe that the Fed would leave a few percentages on there to "leave a few bullets in the gun" so to speak. Lowering to 0 indicates that the Fed is saying, "Screw this, launch all nukes, guns a-blazing." The Fed can no longer do any more conventional interest rate easing so it must do more unorthodox policies.

As to references to Japan, as much as we complain about our deficit, Japan has a government debt of 120% of GNP or something ridiculous like that.
posted by amuseDetachment at 1:36 PM on December 16, 2008

I am so refinancing come the New Year.
posted by GuyZero at 1:39 PM on December 16, 2008 [1 favorite]

How about checking accounts that pay over 5% interest instead?

In a bank about to fail :P.

As to references to Japan, as much as we complain about our deficit, Japan has a government debt of 120% of GNP or something ridiculous like that.

Our GDP was 14.334 trillion in 2006 (according to wikipedia), and our debt is closing in on 11 trillion, so we're not that far off.

The problem is these banks have all this garbage on their books, and so they want to hoard cash. Then everyone starts to panic, lay people off, which causes reduced consumption, which causes more panic, more layoffs, etc. Each person is being 'prudent' but the end result is much worse.

If there was a revolution and I was appointed dictator, I would cancel every credit default swap and option contract, confiscate all the money from them, and then have regulators go through and figure out who was being 'responsible' and who was just gambling.

Or I would nationalize a couple banks, wipe out the shareholders -- and (and this important) retroactively rescind all the bonuses that the financial wizards paid themselves while racking up all these fake profits.

Unfortunately, no revolutions appear imminent, so I will post comments on the internet, where I'm sure policy makers will read them before they go to glitzy D.C. parties with banking lobbyists.
posted by delmoi at 1:56 PM on December 16, 2008 [5 favorites]

You can certainly get 0% on a car and a ridiculously low rate on you mortgage, and yes, student loan rates are coming down as well.

Yes, but that doesn't help those of us already in repayment. I've looked into loan consolidation before, and the banks seemed pretty content to offer me the weighted average of my interest rates. They're in it to make money, and they're not going to adjust downward.

I don't need a car, and unfortunately I'm not in a good position to buy a house, even though now seems like the optimal time.

I just think it's ridiculous that fully-grown adults get bailouts and bankruptcy filings, but 17 and 18-year-olds can take out student loans that they're on the hook for, no matter what. I suppose this all goes back to "college is too expensive," but it really sucks that "financial aid" is really a euphemism for money-lending.
posted by explosion at 1:56 PM on December 16, 2008 [3 favorites]

Oh, I forgot to mention, after nationalizing the banks, I would direct the employees to make loans as company policy, for stuff like infrastructure and capital investment.

The labor is out there, but the problem is the dysfunction of capital markets in moving that money to employers, thanks to the aforementioned CDSs as well as sub prime mortgage problems.
posted by delmoi at 1:58 PM on December 16, 2008

This unforseen credit crisis is really unfortunate. If only somebody had warned us...

وَأَخْذِهِمُ الرِّبَا وَقَدْ نُهُوا عَنْهُ وَأَكْلِهِمْ أَمْوَالَ النَّاسِ
بِالْبَاطِلِ ۚ وَأَعْتَدْنَا لِلْكَافِرِينَ مِنْهُمْ عَذَابًا أَلِيمً ا

That they took [interest], though they were forbidden; and that they devoured men's substance wrongfully;- we have prepared for those among them who reject faith a grievous punishment.

-Qu'ran, Surah An-Nisa [4:161]
posted by koeselitz at 2:01 PM on December 16, 2008 [7 favorites]

No sex no drugs no wine no women no fun no sin no you no wonder it's dark. . .

This means that the Federal Reserve will do anything to stop a recession

TOO LATE!

But yeah, if the choice is 1931-1945 World or 1990-2007 Japan the decision is obvious.

I got out the short side of the market a bit early but if my thesis is good I've made some pretty f'in amazing equity buys these past two months -- we're talking 40% dividends from here on out.
posted by troy at 2:06 PM on December 16, 2008

troy: Yeah, I meant stop the recession already in place.

I'm watching out for free money as well, but I'm staying out right now because I suspect that the P/E Ratios are still a little too high (yes, even now), as the denominator may be dropping some more with some new rounds of earnings reports. I am regretting not getting into GDX in the past 2 months.
posted by amuseDetachment at 2:15 PM on December 16, 2008

"That they took [interest], though they were forbidden; and that they devoured men's substance wrongfully;- we have prepared for those among them who reject faith a grievous punishment."


In Mere Christianity, C.S. Lewis observed that the ancient Greeks, the Old Testament, and the Christian teachers of the Middle Ages all condemned usury. While admitting that he didn't know if their precepts could be applied to modern capitalism, he added, "I should not have been honest if I had not told you that three great civilisations had agreed (or so it seems at first sight) in condemning the very thing on which we have based our whole life."
posted by Joe Beese at 2:17 PM on December 16, 2008 [7 favorites]

All those guys also supported slavery so we should take their teachings on economics with a grain of salt.
posted by GuyZero at 2:21 PM on December 16, 2008 [9 favorites]

The fundamental problem is too much debt, brought on by exactly the same thing that the Fed is doing now, only written in lowercase.

You can't fight a debt problem with more debt; you fight a debt problem with savings and production. Dollars are just a different form of debt, payable by everyone in the economy; every dollar issued is a claim on your future production.

Even if this works, and I'm starting to think it may not, this time -- we're just going to end up back here. At best, we'll set off another set of bubbles and end up right back here again, but in much poorer shape than we are now. At worst, it will turn a depression into a powerful stagflation. In a depression, you could at least live on your savings; in a stagflation, your savings and wages are destroyed by dollar devaluation while the economy still goes nowhere.

The US economy simply can't service the debt that's been piled on top. We're trying to extract more wealth out of the economy than it can actually provide. Adding yet more obligations on top of the ones that are already there is very much like prescribing heroin to a codeine addict.

The actual solution is the crash; it's the detox program. We're desperately trying to stay high instead.
posted by Malor at 2:31 PM on December 16, 2008 [13 favorites]

Why is it that large businesses get all the breaks? Since no one's interested in bailing out excessive college loans, I'd at least like to be able to get 0% interest on my loans instead, but noooo....

Huh? Do you think that the Fed rate only applies to businesses? Every type of loan decreases with the Fed rate. This is a break (in theory, because the market beat the Fed to it) for all borrowers, not just "large corporations" (boo!)

"I should not have been honest if I had not told you that three great civilisations had agreed (or so it seems at first sight) in condemning the very thing on which we have based our whole life."

This whole usury argument really gets my goat. Sure, a lot of people ran wild with usury in the past decades, but to negatively compare modern society to Ancient Greece, Rome, Mecca, whatever, is absurd. You may think that it would be great to live in that time, where money was free!, but only if you were one of about 100 people who really lived it up. 99.9% of people were absolutely f*cked, compared to maybe 10% in modern Western society. And things like lending have a lot to do with that.
posted by jckll at 2:36 PM on December 16, 2008 [3 favorites]

1931-1945 World or 1990-2007 Japan

The only reason Japan temporarily came out of their slump was because they started printing yen like crazy to keep up with the boatloads of dollars coming from overseas; they were importing our inflation to keep their exports cheap. They'll go right back into their stagflation, precisely because they refuse to allow things to fail. They have never fixed their problems, and until they do, things will suck.

In other words, it's not 1990-2007, it's 1990-foreseeable future.
posted by Malor at 2:38 PM on December 16, 2008

saaaaved byyyyy zeeeeeroooooo
posted by East Manitoba Regional Junior Kabaddi Champion '94 at 3:08 PM on December 16, 2008 [2 favorites]

The actual solution is the crash; it's the detox program. We're desperately trying to stay high instead.

Crash doesn't solve, it's a status and even if it's not declared or recognized as such, it will eventually come and go. It's a matter of how long will it last and how to recover from it.

Imho, there is no single solution, rather it's a set of changes that need to be implemented. For instance, I would tentatively start from resetting financial instruments whose value is calculated on variables that can change quickly and with large effects on the value of the instrument. Suppose that an instrument was created so that its value is largerly affected by a change of federal fund rate.

Today it would have taken a large hit, entirely because of a flawed premise that FFR doesn't change very often and that historically adjustments' absolute value was small. If the very own structure of the instruments is such that its value _could_ be largely affected by one single variable change, then it should clearly show its structurally implicit risk , regardless of the forecasts of so called "experts", who can and will obviously fail.
As far as I know, I'm not asking for anything that isn't describe in manuals of financial risk immunization, yet I am not sure that the structural risk is always made evident to buyers, hidden behind layers of complex math as it is likely to be.

Then we have the problem of accountability. Clearing houses seems to be the only instruments running to my mind at this time, yet there's work to be done on how transparent they are and on running them at cost, without creating incentives for the clearing house to mismanage.
posted by elpapacito at 3:08 PM on December 16, 2008

Don't worry. In 2012 our mortgage on the American continent resets, and the Mayans will foreclose us and kick us out. Or something like that.
posted by qvantamon at 3:09 PM on December 16, 2008 [2 favorites]

"You can't fight a debt problem with more debt; you fight a debt problem with savings and production. Dollars are just a different form of debt, payable by everyone in the economy; every dollar issued is a claim on your future production."

But if the problem is a greater production capacity than consumer market, you can't fight that with more production and savings. In fact, that's the absolute worst thing to do, as it leads to deflation, where you're better off holding on to your money than buying things. And since it's not wealth, but exchange of wealth, that drives the economy and gives us money to do things like pay to post on a website, that's bad.

Anyway, please tell me more about your plan to save the economy, William Jennings Bryan. We're all interested in your yellow brick road.
posted by klangklangston at 3:15 PM on December 16, 2008 [4 favorites]

Oh hai deflation! How r u?
posted by ryoshu at 3:16 PM on December 16, 2008 [1 favorite]

GuyZero, how do you equate being pro-slavery with teachings on economics? Are you suggesting that slavery made it possible to do away with exorbitant or unlawful rate of interest? Or lending in general? I just thought the idea was to not be in debt to another, nor to have another indebted to you (at least financially). Doing good for another so they might do good in return is usually a positive thing.

I had to find a definition for "usury," and I don't know if it really fits what Joe Beese was talking about - I thought the notion was simply "neither a borrower nor lender be," not "you can lend money at a reasonable rate." Maybe I found the wrong definitions.

Isn't December 21, 2012 just the next "calender reset" date? Kind of like 99 being followed by 00, in truncated computer years?
posted by filthy light thief at 3:50 PM on December 16, 2008

Saying it's OK to have lots of unpaid human labour is at least indirectly a statement about economics. I mean, no modern economist makes models based around coercion and unpaid human labour. And it's easy to say that usury is bad if the alternative is to go conquer some backward tribe and make them build your pyramids and work your fields as opposed to having to hire people.

As for whether biblical and ancient-world usury meant any lending or simply lending with an excessive interest rate as it does today, I don't know. Islamic law prohibits any interest.
posted by GuyZero at 4:00 PM on December 16, 2008 [1 favorite]

I don't know. Islamic law prohibits any interest
There are ways to disguise an interest, as much as cheap beer is labeled "premium lager import extra".
posted by elpapacito at 4:12 PM on December 16, 2008

GuyZero: All those guys also supported slavery so we should take their teachings on economics with a grain of salt.

فَضْلِهِ ۗ وَالَّذِينَ يَبْتَغُونَ الْكِتَابَ مِمَّا مَلَكَتْ أَيْمَانُكُمْ

And such of your slaves as seek a writing (of emancipation), write it for them if ye are aware of aught of good in them, and bestow upon them of the wealth of Allah which He hath bestowed upon you.

- Qu'ran, Surah An-Noor [24:33]
posted by koeselitz at 4:46 PM on December 16, 2008

"Those guys" were: the ancient Greeks, the Old Testament, and the Christian teachers of the Middle Ages. I'm assuming that the Koranic verse you quote means that people should free slaves who ask to be freed.
posted by GuyZero at 5:08 PM on December 16, 2008

Since when did an economics thread turn into Qu'ran lessons?
Once is plenty; cut that crap out...
posted by jckll at 5:21 PM on December 16, 2008

Only on Metafilter would utopia be described as both communist and Islamic.
posted by oncogenesis at 5:34 PM on December 16, 2008 [3 favorites]

Before the implementation of bankruptcy laws anyone with debts they were incapable of ever paying off owed their creditor everything they had left, ie: themselves, so the connection between interest and slavery was very clear and direct. You can still find slaves-in-all-but-name wherever bankruptcy is unavailable and debts are inherited. The prophets and philosophers who were against usury but apparently accepting of slavery were advocating all that could be done to minimise the incidence of enslavement in their societies. They would have seen forcing the freeing of existing slaves as morally complex, financially catastrophic (for a more recent example note the difficulties of one Thomas Jefferson), politically impossible, and in any event temporary.
posted by Canard de Vasco at 6:00 PM on December 16, 2008

Since when did an economics thread turn into Qu'ran lessons?

All economic threads are going to turn into Qu'ran lessons if we're not careful.
posted by Faint of Butt at 6:06 PM on December 16, 2008 [2 favorites]

College grads paying off loans with no interest rate would just spend their new-found gift on wild parties.
The point of a money gift is to spend it. I dunno why they piss about giving them to old folks, hard-working families, people who own gold and the like. You want money spent fast as hell? Give it to students.
posted by bonaldi at 6:44 PM on December 16, 2008 [1 favorite]

This will have the net effect of pushing on a string as it does not fix the fundamental underlying problem:

I-N-S-O-L-V-E-N-C-Y

Trying to fix a problem where millions are buried in debt by asking them to assume *more debt* is just plain silly.
posted by tgrundke at 6:57 PM on December 16, 2008

Are not violinists people who push on strings, at least half the time? And do they not make beautiful music, which could not be accomplished by other means? And what of the violists, the cellists, the acoustic-string-bassists? To say nothing of the viol-de-gamba-ists.

Whence comes this poor metaphor, both inaccurate and unjust? Huzzah! Let us all heartily hail those who conscientiously push on the strings - our lives would be the poorer without them!
posted by newdaddy at 7:45 PM on December 16, 2008 [3 favorites]

GuyZero: "Those guys" were: the ancient Greeks, the Old Testament, and the Christian teachers of the Middle Ages. I'm assuming that the Koranic verse you quote means that people should free slaves who ask to be freed.

In my reading, yes. But you're painting with an incredibly broad and provincial brush if you truly think nothing in the Talmud and no one among the Medieval Christian teachers and none of the Greeks objected to slavery, or even that the majority of them didn't - that's certainly not clear.

This is all an aside. Sorry about the derail.
posted by koeselitz at 8:52 PM on December 16, 2008

No fair trying to get the last word by proclaiming it a derail to discourage further debate.
posted by pracowity at 9:23 PM on December 16, 2008 [2 favorites]

Personally, I figure it's about time to go on a spending spree. Not only do I have excess cash by benefit of having bought s.f.a. during the past five years or so, prices are dropping like a rock and interest rates are damn near give-away.
posted by five fresh fish at 10:55 PM on December 16, 2008

Wow I was giving a presentation last evening (on a finance related topic, what else?) when this news swept the room, about one hundred BlackBerrys beeping all at once, tangible action, the mood was electric, historic and yes, amazing times, to be sure.

Everyone's read the news and had time to digest (or at least start to digest, this is surely a big pill to swallow), so no sense recapping other than to say this recent cut is surely close to "shock and awe". But perhaps a different perspective.

I've been pretty consistent in calling for a period of stagflation, perhaps protracted giving some of the balance sheet repair that's clearly necessary. We've got people in the market and have been positioning assets in anticipation of this outcome, at least in the near term.

But those positions were setup months ago, and I always counsel folks to look past the now to what may transpire later. The markets are constantly changing, and the only way to be successful in this business is to purchase assets when few folks want them, and sell when everyone wants them.

So what are we up to now? Well, that would be telling, but I'll toss a few general ideas out there.

• Back in 2004/2005 I moved about one third of assets in my personal accounts into gold & silver. Mixture of physical and ETF, didn't sell anything during the last run up and in fact I just started purchasing physical again, aggressively adding to both positions as my cash flow allows.
• More interesting stuff about metals: gold has been flirting with backwardation recently, a rather unusual situation (for gold at least) where futures and spot prices are inconsistent (we usually see futures prices higher not lower than spot). Also I know some traders over at COMEX, and there's lots of chatter in the market about failed deliveries and exchange officials taking "aggressive" steps to counter this disturbing trend. Bottom line: failed deliveries seriously impact market liquidity. If we start to see consistent and larger failed deliveries liquidity will essentially evaporate from this market, and that will impact prices.
• TIPS, Treasury Inflation Protected Securities are dirt cheap now 'cause the mainstream media buzz is all about deflation. To price these instruments properly you need to look at the difference in yields between TIPS and other US Treasury securities. The difference is effectively the inflation rate that must persist to render it advantageous to hold TIPS. Currently we're seeing the hot run 10Y yielding 2.23% with TIPS yielding 2.06%, for a yield difference of some 0.17%. Effectively, if inflation exceeds 0.17% a year over the ten year term the investor will be better off holding TIPS than the non inflation protected 10Y Treasury. Ok, so by looking at BLS CPI data covering the period 1913 to 2007, we can see that inflation rarely was lower than this threshold for such an extended period, so by this metric TIPS are cheap now. TIPS can be purchased directly from the US Treasury or via any number of funds (look at their costs carefully please). Treasury lately has been changing some of their purchasing policies (of course the tin foil hat brigade is screaming "conspiracy" like crazy) so funds might be the easier option here. For non US based MeFites, other countries do in fact have inflation protected offerings; Canada sells something called A Real Return Bond and the UK offers Index Linked Gilts, to name but two G7 nations.
• Bonds - well, we see a lot of value in corporate bonds presently. All the nervous folks are cowering over there in treasuries, apparently comfortable with their own no-so-little bubble. But the economic outlook isn't as dire as the headlines would otherwise lead one to believe. Banks and financials have surely gotten the tar kicked out of them, but if you look at non financials, their balance sheets are very, very strong. In fact the ratio of cash to total debt is at a 45 year high, and the ratio of debt to net worth is at very low levels that we haven't seen since the mid 60's. I don't have a link (dead tree research), but Hartman from Wells Captial Management noted recently that

  "Spreads over Treasuries in the bond markets are pricing in a depression scenario"

  The Fed is clearly gonna pull out all the stops to insure we don't drift into a depression. That being said, so much money has been driven into US Government Securities over the pas few months, they are wildly overvalued at present. If you're one of those that are comfortable shorting, the (yes its still growing!!) bubble in the US Treasury market is a clear winner. Also of interest - CDS spreads in Europe are starting to decline, indicating protection sellers consider the probability of default to be falling as we move more decisively into the recession at the same time as interest rates world wide are cut. At the same time the risk of default is declining, the Merrill Lynch U.S. High Yield Master II Index. (similar to a stock index, but focused on high yield aka "junk bonds") is trading to yield roughly 20% (it has pushed past 20% a couple of times). As much as the doom & gloom crowd would like us to think otherwise, recession should never be viewed as the end state, but rather as a distinct point in business cycle. Moody's estimates the current annualised default rate at roughly 3.3% in October, with corporate defaults expected to soar to a little north of 11% before this is all done and dusted. This segment of the bond market is effectively pricing in a default rate approximating 18%. High yield bonds are cheap at this price. Finally of interest to fixed income investors - 3M $ LIBOR is finally below 2%, compare to just one year ago when it was 4.97%; a significant reduction in this very integral benchmark. All that liquidity being injected into the system is starting to have an effect; you'd like to be well positioned for when things finally take off.

So yeh, historic times but what the hell - we can still make money if we look in the right places.

Hey wanna see some grim guys?. Ha. Never sweat this shit folks; it's only money, no matter what side of the trade you end up on.
posted by Mutant at 6:08 AM on December 17, 2008 [7 favorites]

"that they devoured men's substance wrongfully"

I knew Twilight was to blame for this. Goddamn vampires, devouring substance (i.e., blood).

What? How else do you expect one to follow a Mutant Talks Economics comment?
posted by Eideteker at 6:53 AM on December 17, 2008

Mutant,

Very interesting post. I wanted ask some questions, though:

If you're one of those that are comfortable shorting, the (yes its still growing!!) bubble in the US Treasury market is a clear winner.

As I understand short selling, you want two additional factors beyond the expectation that the value of what you're shorting is going to go down. First, that the value is going to go down soon. A decline in value 6 months hence won't help if you need to make good on your loan in 30 days. Second, doesn't it also help if other people are shorting the same thing, making short-selling become a self-fulfilling prophecy?

If the above is true, what makes you confident in shorting Treasury stuff now? Couldn't the bubble continue to grow for another 3 months, making shorting a bad deal? Wouldn't waiting until other people start to short Treasuries make it more likely that your strategem works out?

Bonds - well, we see a lot of value in corporate bonds presently.

Your explanation makes sense enough, but later you add that "corporate defaults expected to soar to a little north of 11% before this is all done and dusted."

Doesn't that make corporate bonds more risky, especially junk bonds? If the default rate is so high, that seems to be like playing Press Your Luck with three times as many whammie spaces on the board. Is it just the higher payoff if you don't encounter default that makes corporate bonds such a good call right now?
posted by Law Talkin' Guy at 11:29 AM on December 17, 2008

As I understand short selling, you want two additional factors beyond the expectation that the value of what you're shorting is going to go down. First, that the value is going to go down soon. A decline in value 6 months hence won't help if you need to make good on your loan in 30 days. Second, doesn't it also help if other people are shorting the same thing, making short-selling become a self-fulfilling prophecy?

If the above is true, what makes you confident in shorting Treasury stuff now? Couldn't the bubble continue to grow for another 3 months, making shorting a bad deal? Wouldn't waiting until other people start to short Treasuries make it more likely that your strategem works out?

Don't want to answer for Mutant, but the way I understand it, there is no requirement that a short position be covered in 30-days. I would think one could require a 30-day maximum upon lending the shares to a short, but that's not the norm.

So you're right, most shorts do want stocks they are short to go down quickly, but it's simply bcause a profit tomorrow is better than a profit in a year. And the longer a stock you're short keeps its price (or, worse, rises), the longer you show a loss on that trade. There's no hard and fast rule here as far as 30 days. Someone correct me if I'm wrong.

And yes, the bubble could continue to grow for another 3 months, but if you're willing to absorb the hit for that long, there's no reason you couldn't wait it out if you think that treasuries are going down over a longer term.

And as to your last point, short-selling can become a self-fulfilling prophecy, but it would seem to me that that wouldn't really have a serious effect when shorting T-bills. The amount of shorts relative to the amount of longs is what matters. So while a "bear raid" can kill a company, the larger the company, the harder it is to do. And the Fed is about as large as it gets.

I'm no expert, and any or all of that information could be way off base, so hopefully someone else will come along and verify or refute my statements...calling Mutant
posted by jckll at 1:09 PM on December 17, 2008

So while a "bear raid" can kill a company, the larger the company, the harder it is to do. And the Fed is about as large as it gets.

The average American owes the average Chinese peasant about US$4 000. Most Americans can't absorb a $4 000 demand for immediate, full loan repayment: they're already fully in debt. Hell, soon most Americans will die owing debt: how the hell then is the Chinaman to be paid?

It would not take a bear raid to wipe out the US economy. Just a bunch of peasants who figure out that they'll never, ever get their wealth back if they don't demand it back.
posted by five fresh fish at 6:10 PM on December 17, 2008

Law Talkin' Guy -- If the above is true, what makes you confident in shorting Treasury stuff now? Couldn't the bubble continue to grow for another 3 months, making shorting a bad deal?"

cklennon has already explained it very well - I'll just make a few other points.

I'd never advocate trying to short the 3M T-Bill, although when I worked on a US Government Securities desk I certainly knew guys that did just that. But that's a game for the professionals, Primary Dealers with deep intel into the markets.

However both that long bond (i.e., 30Y) and 10Y are looking pretty overpriced to us right now. Price and yield move inversely, this AM we see the 10Y is trading to yield 2.13% but we know the average yield for the 10Y for the period 1983 to 2007 was 7.31%.

So we tend to think the 10Y is overpriced, as is the 30Y. The degree to which they are mispriced is another topic, but so much money has flowed into treasuries lately, we're pretty sure there's a bubble in the bond market and interest rates must revert to the long run average. Of course when they do they'll probably push above the long run average, how much and for how long nobody really knows. But this is just how bubbles deflate.

In any case, if one were to short the long bond you'd need to be prepared to hold that short position for a while; you'd be tremendously exposed if (as you picked up on) had a thirty day window to close. But holding a short indefinitely? Well, that's the dilemma of the short - that position can and more than likely will move against you, perhaps for a protracted period of time.

But folks that short are used to dancing that dance, so I guess they're comfortable with the exposure.


Doesn't that make corporate bonds more risky, especially junk bonds? If the default rate is so high, that seems to be like playing Press Your Luck with three times as many whammie spaces on the board. Is it just the higher payoff if you don't encounter default that makes corporate bonds such a good call right now?

There is a lot of fear in the markets presently, and all junk bonds are being mispriced, even the good ones. But that I men offered by cash rich, less than investment quality obligors.

Here's an interesting tidbit - if we look at the universe of all companies in the United States that are tracked and rated by the credit ratings agencies (we'll use S&P since I've got a publicly accessible link to hand, but I used to work for Moody's and our data was roughly identical) - looking at data current as of 2005, only 40% of the rated companies in the United States are investment grade.

In other words, debt offerings (i.e., bonds) from 60% of the companies rated in the US are below investment grade; junk, in other words.

Even if we constrain our analysis to the S&P 500, we see only 440 companies in that index hold investment grade ratings.

So I'm not suggesting a game of chance, but if one knows the companies they are investing in well (always good advice), then we can leverage off the fear and acquire some incredible bargains in this climate.

I tend to research heavily, concentrate assets (I'm only holding six cash flow generating positions presently) and then hold for long periods, collecting a relatively high coupon.

Some of the companies I purchased well over a decade ago, because they were yielding higher than 10% (one of my filters), very solid, stable enterprises are now priced to yield 30% or more.

Priced have cratered across the board, almost nobody (relative to trading volumes a year ago) wants these assets.

But they continue to pay out their coupon, not a problem and looking at their balance sheets they're not feeling excessive amounts of stress, and should be able to continue paying out.

I'd love to purchase more of these firms simply to collect the relatively high coupon, but as trading volumes have dried up I'm sitting positions sized to approximate 18% (in the most extreme case) of the daily trading volume. So that's a little uncomfortable.

However it doesn't detract that there are good values out there in high yield ("junk").

So we like to look at things that others aren't, trying to as I mentioned before, buy assets when few people want them and, if we sell, sell when these assets are in high demand.

Fascinating times, lots of opps out there, hope this helps!
posted by Mutant at 2:46 AM on December 18, 2008 [1 favorite]

I'd love to purchase more of these firms simply to collect the relatively high coupon, but as trading volumes have dried up I'm sitting positions sized to approximate 18% (in the most extreme case) of the daily trading volume. So that's a little uncomfortable.

Wow. I'll say.
posted by jckll at 8:20 AM on December 18, 2008