Kevin Walmsley

The Banker's Dilemma

There are other dilemmas.

Banks are now being micromanaged by the Treasury department, who are pushing them to make more loans, but will act punitively when these new loans go bad now that it's the taxpayer, and not the common shareholder, who will be suffering losses. So you can't blame banks for hoarding cash, when the penalty for bad lending might be a Congressional investigation and prison term.

Also, every banker I've ever met loves to make good loans. But in a bad and worsening economy, good luck figuring out in advance which loans will be repaid.

The banking system is broken. And now that the government is now a preferred stockholder in all the big banks, it's screwed completely.

Bubbly Treasuries Will Disappoint

Beware when investors who didn't see the dot-com or the real estate bubbles now pretend they've spotted one in government bonds.

Consider the possibility that we're in a bona fide deflationary environment. In such a case, getting a 0% yield might be a risk-free 4%, given falling real prices across the economy. What's more, foreign investors whose currencies ARE experiencing inflation can still make money in treasuries, buying and selling at par.

Suppose you knew that next year, several hundred billion more dollars were moved out of equities, and into governments, as millions of American 401k and mutual fund buyers merely look at the trailing 12-month returns in their issue of Money magazine. As mutual fund managers, you still have to buy treasuries, irrespective of the price. That can send yields lower still. Japan coasted along for years with an effective negative yield on their paper; who's to say we won't do the same? Just because it seems an irrational trade to buy treasuries here doesn't mean you'll see an exodus into stocks anytime soon.

A lot of sophisticated investors are buying treasuries, with the unsophisticated investors soon to follow. Short govies only at your extreme peril.