Stuyvesant Town/Peter Cooper VillageWe have seen a massive transfer of private debt into the public arena during the past two years. Governments the world over have socialized huge blocks and market segments of previously held individual and corporate debt. Even the recent default by the borrowers on Stuyvesant Town / Peter Cooper Village will add enormous tabs to already bloated government deficits. High profile holders of the deal’s subordinated debt and equity include sovereign wealth funds and banks that are assumed to be backed by Uncle Sam and his overseas cousins. Of course, the taxpayer is always left holding the bag. The alternative (let the banks go bust) could have been worse and I guess and hope that we never will know. Markets are rightly worried that these policies will ultimately lead to hyperinflation or staggering devaluations of the major fiat currencies. What is missing from the recent discussion is that all this may be very good for government and high quality agency bonds! It is the other side of the hyperinflation / devaluation argument.

Governments the world over can and may raise taxes and cut spending. Team Obama has already proposed spending freezes to limit and ultimately reduce the deficit. Sure, it tough to put your faith and money behind any politician but we have already seen a massive tightening of policy. Proposed curbs on bank activity, bank restructuring and enforced sovereign fiscal discipline (e.g., in Greece) and higher taxes. Confiscated wealth may ultimately compress economic activity and lead to less red ink for government’s budgets. Sure it is a long shot but it is certainly one of many potential outcomes. The point is that the last two years were all about adding support and liquidity to financial sector. The next two may be about reversing that support. If that the is case, you want some bonds in the box.


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