PLEASE! No more asset bubbles!

It is time nations take the bull by the horns and set up a system to prevent the malignant proliferation of yet more asset bubbles, leading to more economic collapses such as occurred last year. The latest news is not one to bouy hopes, as articulated in the article, 'Concerns Grow of Overheated Debt Market' in The Financial Times today.

As noted in the piece, three asset-metastasizing nasties are now breeding. These include: cov lites, pik toggle notes, and dividend recap exercises. To varying degrees, each of these critters played a role in inflating the assets during the credit bubble years which got pricked about a year ago - leaving people with deflated 401ks, etc. All of the techniques were used on Wall Street because in their various ways, they enticed companies and consumers into taking on crippling levels of debt. No surprise they have returned to the Street - ever wonder how the DOW is getting juiced toward 11,000?

Let's look at each in turn. In the cov lites, short for covenant light, borrowers are granted credit with few if any restrictions. Meanwhile, Pik toggle transactions allow debt to be "repaid" with MORE debt using a device called "payment in-kind notes". Then, in dividend recaps, businesses take on additional debt to pay dividends to share holders. Anything wrong with these pictures?

Why is it that these debt-tilted instruments are being seen again? The reason, primary, is that yields in normal instruments, facilities are so low that people are trying to jack up returns with risk- be- damned gambits. Blame the Federal Reserve for this, and their abnormally low interest rates, next to zero. If the Fed had the gumption to even raise the rates to just 0.50 to 0.75%, it would stave off a lot of this asset bubble building bunkum which puts us all at risk. At the same time, of course, the stock market and DOW would deflate a bit, but hey - the normal investors would be able to earn a little bit more in their money market accounts, funds, or bank CDs. As opposed to risking it with a ginned up stock market.

Such a move would also strengthen the dollar immediately. As a sign that dollar erosion is still having a vast effect on confidence, one need only check the most recent Gold prices - which have topped $1200 an ounce. Showing that those who can afford it trust bullion more than paper money bucks. Why do you think the sale of those gold American Eagles has been temporarily suspended?

In the minutes of the November Meeting (FT, ibid.) of the Federal Open Market Committee it was noted: "the possibility that some negative side effects might result from the maintenance of very low interest rates included the possibility of excessive risk taking."

Well, you don't say! And I wonder why that is? Maybe because many folks are tired of chasing yield in money markets and CDs?

Still, there are millions who won't be lured by the Siren call of the Wall Street gaming tables. As noted in today's Wall Street Journal ('Back to basics', p. R7), many wealth managers are now catering to people-investors who demand 'vanilla' approaches, as opposed to the glitzy, sexy but esoteric devices that spelled the end of Lehman and others. So, these financial advisors and managers are now fulfilling a need, to earn some yield but not using "nasties" that could blow up their nest eggs.

As the WSJ author of the piece observes:

"Of course, they can't tout that such ideas will yield double digit annual returns".

True, but neither can the brokers and FAs concerning STOCKS, at least over the past eleven years. Over this period, stocks, mutual funds have returned less than treasurys or CDs!

Bring on the vanilla!

Footnote:

A major impediment to improving the regulatory provenance for the OTC (over the counter) derivatives is the current contretemps between Europe and the U.S. While the U.s. wants the formation of a clearing house to process these OTC's, to reduce the counterparty risk, the Europeans do not. At least with a clearing house to process the OTCs, some closure must occur and the counterparty must provide it. As opposed to the open-ended nightmare that descended on us via the credit default swaps last year! (With nine of ten counterparties left holding empty bags).

Stay tuned!