The Aug. 20 news article “Demystifying the bond bubble, and understanding your risk” missed the point being made by former Federal Reserve chair Alan Greenspan. In a recent cable television appearance, Mr. Greenspan warned that the bond market could collapse and bring the stock market down with it. Yes, bonds are starting to face significant head winds as the Federal Reserve and other central bankers start to retreat from their years of bond buying and as interest rates start to rise.
The article ignored the role leverage plays in today’s high-performance investment arena. Under normal circumstances, most bonds are 100 percent safe; however, in today’s low-interest-rate environment, many hedge funds, mutual funds and exchange-traded funds goose up the returns from these safe investments by borrowing large amounts against these assets. They then use the borrowed funds to buy more of the bonds. It’s like a house of cards. The additional buying of the bond also drives up the market price of the bond, increasing the “value” of the position, permitting even more borrowing.
Trillions of dollars of bonds are held today by groups with very little financial cushion for margin coverage if prices start to decline. If these margin calls occur, and these holders want to sell, the bond bubble will burst. Will there be real buyers out there when these groups try to sell? That is what Mr. Greenspan was warning about.
Steve Schoen, North Bethesda