Saturday, May 3, 2008

Government Backed Bonds Not Always Safe

The city of Vallejo, California, faces bankruptcy, if it goes through creditors may lose all investments, worth several hundred million USD. Apparently, the US credit mess has not passed but worsened, as fixed income vehicle investors ready for some wild rides.

Vallejo, not likely an isolated incident

Mentioned in the Vallejo article, rising labor costs and plummeting housing related taxes set off their circumstance. Since no counties, states, or even nations have avoided these concerns, more fiscal volatility will arise, probably by September as Californian adjustable mortgage rates schedule to reset.

What it means for the banks

Credit unions, banks invest heavily in government backed securities. This again leads to the possibility of bank failures, like every other economic downturn the US had faced in the past. Money in the bank is not as safe as many have taken for granted, especially in this unprecedented financial environment.

What it means for New Zealand credit investment funds

This includes financing companies and various investment funds who bought US debt and associated derivatives like hot cakes during the bull rush of last few years. Many assumed safety via diversification; it certainly did not turn out that entirely well.

With US (or UK) commercial and investments banks like JP Morgan (at -$90.72Billion Enterprise Value) and Barclay (at -$500Billion Enterprise Value) facing harsh times, the NZ funds are basically stuck with these “toxic-waste” debt instruments. Then of course liquidity remains low, as no rational institution would buy them without significant discounts.

What to do to protect your money

Learn to hedge on your own, or find an investment fund where active arbitrage strategies are utilized, instead of the buy, hold, and hope types. As general sentiment becomes more optimistic, institutional traders prepare for the next sell off. Become informed, and you will not end as a statistic.

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