Meet The New Year (same as the old year)

2009 is picking up where 2008 left off. Banks are being criticized for not lending to anyone who is not a stellar credit risk and not writing non-conforming mortgages. Critics are basically bashing the banks for not engaging in the very lending practices which created the credit crisis. Why would politicians and various financial pundits demand banks engage in risky lending practices? Because it is now politically expedient to do so. The alternative would be to permit home prices to fall to levels at which banks are comfortable lending (as to not take further losses due to further declining home prices), at which potential home buyers feel comfortable purchasing a home without being upside down (owing more than it is worth) and (possibly most important) where investors are comfortable purchasing the required private-label mortgage backed securities. This is not popular with voters so politicians have chosen to try to hold back the sea. This only encourages the negative feedback loop and the housing sector (and overall economy) continues to deteriorate.

Another result is that the government continues to print money and issue debt as ways of holding back the sea. As I have written for the past two months, this has to lead to higher long-term rates at some point. Over the past several days, both the Wall Street Journal and Barron's have published articles stating similar opinions. As usual, Barron's used PIMCO to make its case. Barron's published:

"The bear market may have begun Wednesday, when prices of
30-year Treasuries fell 3%. They lost another 3% Friday. - "Get out of
Treasuries. They are very, very expensive," Mohamed El-Erian, chief
investment officer of Pacific Investment Management Co., warned
recently. Pimco runs the country's largest bond fund, Pimco Total Return
(ticker: PTTPX). - Treasuries offer little or no margin of safety if the
economy unexpectedly strengthens in 2009, or the dollar weakens
significantly, or inflation shows signs of reaccelerating. Yields on
30-year Treasuries easily could top 4% by year end"

Was I ahead of PIMCO in my prediction? As much as I would like to claim as much, I seriously doubt at. As usual, PIMCO already has engaged in strategies to take advantage of higher long-term rates and is now comfortable in making its strategy public knowledge. Yes, PIMCO is talking its book. PIMCO is probably correct and if one invested with PIMCO, one will probably do very well. Waiting for PIMCO to tell you what to do and then reacting is almost guaranteeing that you will be a day late and a dollar short.


In my last post I critiqued a Barron's article which irresponsibly stated that floating-rate preferreds are a great way to take advantage of higher interest rates and higher inflation. I shot holes in this theory by pointing out that preferred floaters have coupons which adjust off of short-term benchmarks, but trade off of long-term benchmarks as they are perpetual securities. A flattening yield curve is needed to make these vehicles perform well. I also stated that the yield curve will probably steepen as the supply of long-term debt and the printing of dollars will put pressure on the long end of the curve, but short-term rates will remain low as the Fed keeps short-term borrowing rates low for an extended period of time. Thus far, we have seen long-term rates (10-year and 30-year treasuries) rise 40 or more basis points during the past two trading sessions. However, the two-year note yield has risen only about 10 basis points. The yield curve has steepened by 30 basis points. This will probably be the trend for the next year or two.

Lastly, my opinion that investors may find better relative values in cumulative trust preferreds rather than preferred stocks due their debt components and their seniority to the government's preferred claim in the banks has caused some readers to question whether they should sell their non-cumulative preferred holdings. I do not think that the government will wipe out preferred stock dividends, though it could if it so desired. If I already owned non-cumulative preferreds, I would hold onto them, but if I had new money to invest in preferreds I would buy the trust preferreds as one is not being sufficiently rewarded in terms of yield for taking on the risks associated with a more subordinate class of preferred.