Lunatic Bubble Warning for U.S. Treasuries

Edward Harrison wrote a great piece about the article by Frederic Mishkin “Not all bubbles present a risk to the economy."

And oh my, my, what a really nice quick reference to the good professor’s track record on bubbles, which was an equally absurd piece of research on Iceland’s economy before it collapsed called “Financial Stability in Iceland” which he wrote with Tryggvi Herbertsson which stated:

Our analysis indicates that the sources of financial instability that triggered financial crises in emerging market countries in recent years are just not present in Iceland, so that comparisons of Iceland with emerging market countries are misguided.

Mishkin’s idea of a “pure irrational exuberance bubble” is even more absurd, as if the Dot.com bubble caused no damage! It can credibly be argued that it was the Fed’s reaction to the Dot.com crisis (lowering rates) which resulted directly in the housing bubble.

But the real issue is the paradigm shift in the attitude of what Harrison remarks:

No amount of real world evidence of the havoc that bubbles wreak will dissuade these ivory tower ideologues from supporting failed economic policy.

Greenspan famously said that “you can’t tell you are in a bubble when you are in one”, which is idiotic and he admitted that in his testimony to Congress, but now the New Guard who are resolutely sticking to his failed ideas are saying that even if they (apparently) can’t tell if there is a bubble, they know the difference between a good one and a bad one.

Err…Duhh!

But that is academic - the bubble at the moment is not in assets or the stock market which is trading under its “fundamental” according to my measure and Warren Buffett’s (GNP/Stock Market Capitalization).

Admittedly not according to Shiller and P/E ratios, or Tobin’s “Q” or Professor Roubini, but they still maintain that the S&P 500 should have gone down further in March and stayed there (by 40% according to practitioners of those models). Surely there comes a time to stop staring at the broken clock) and admit that a model is wrong?

The bubble now is US Treasuries.

And that bubble is caused by credit, specifically “bail out credit” provided to banks at 0% or thereabouts used to buy 10-Year and 30-Year paper and make a “risk-free-margin”.

Except it’s not risk-free, because as soon as interest rates start to rise, anyone who bought a 30-Year on effectively a 100% margin, will lose his shirt.

That is the stuff bubbles are made of. And that is very dangerous.

Einstein once defined a lunatic as someone who keeps on doing the same thing even after there is overwhelming evidence that course of action is misguided.

Tis the season for lunatics clearly, take care!

Disclosure: No positions

Comments

[swissfrank:]

Sound logical. Pre-2007 the bubble was ostensibly in privately-held assets (house values). Ostensibly, because of course these inflated assets merely hid the securitization mess below. The amount of the housing overvaluation that has not been drained by simple falls in real estate prices has largely been passed on intact to the public sector, through endless government borrowing and stimulus. This now shows up in the absurd mispricing of long-dated paper.

The many ways in which the government has helped the banks to conceal their losses - from free money to self-serving rule changes - have not reduced the bubble, merely displaced it from the private wallet to the public purse.

Nov 12 04:51 AM

[nobby73:]

The Treasury market may show all the signs of being a bubble, but it will be Bernanke's Last Stand. Given the assistance of the banks and all the various monetization programs, we first need to see a collapse in the Muni market, the CRE market and the Dollar. If the Treasury market starts to go, it's pretty much all over and all you will hear is the sound of the goldbugs laughing....

Nov 12 07:27 AM

[geohjr:]

Hmmmmmm, and who bought all those packaged mortages that created the bubble last time, and then suddenly stopped? And who is buying all the treasuries now at ridiculous long term rates?

Nov 12 10:58 AM

[richard_e_n...:]

I was wondering who in their right mind would buy T-bills or treasurys when real returns are negative at the bottom of the curve. But that question takes on a whole new meaing if you (being a bail-out bank) can borrow at 0% and can earn anything over the current CPI-U all-items inflation rate of 2.66%. You or I can't borrow at 0%. This is a bail-out opportunity cost to ordinary investors that no one is counting. This article tells us who those buyers/beneficiaries are and it tells us why all the money being borrowed by banks from the feds discount window isn't making it to main street as loans. When bailout banks borrow from the Fed then lend it back to the treasury who winds up paying the interest? Can anyone say taxpayer?

Nov 12 11:27 AM

[sheridan:]

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Nov 12 02:13 PM

[Tony Daltorio:]

This article is exactly right....

The treasury bubble is the biggest bubble I have seen in my near 3 decades in the industry.

Just think about what will happen when (not if) that bubble bursts and all the banks who have loaded up on Treasuries get killed (again)!

Nov 12 03:54 PM