Fixed Income
Bursting Bond Bubbles

As the economy weakens, so does the ability of companies, consumers and countries to pay back what they have borrowed. It is not just the fear of rising interest rates that can prick a bubble. What can bring an end to the bull market is simpler: the fear of losing money

Investors in the US bond market experienced their worst monthly loss since December 2010. Despite the continuing easy money policies of the Federal Reserve (Fed), bond yields have moved up from 1.6% to 2.2% in May.  Is this the beginning of the end? Is there a bond bubble? If so, has it burst?


Central bankers and famous economist would argue that it has not. Western central bankers have issued an estimated $7 trillion worth of quantitative easing, about equal to the GDP (gross domestic product) of China. This has pushed interest rates down to historic lows. Generally when bond yields get this low, or their prices get this high, they represent a losing proposition. The last time the Federal Reserve owned a large chunk of the US government bonds market was in 1945. In that year, yields on American Treasury Bonds were also just 2%. Investors who bought those bonds did not see a gain in purchasing power until 1989. The only exception has been Japan where, thanks to deflation, 2% bonds still have a positive return at least until now.


In theory we don’t have to worry about bond bubbles because the central banks have infinite fire power to force yields down. A few key strokes and there are another trillion dollars or yen to buy up bonds. Paul Krugman, the Nobel Laureate economist and columnist, rests his case against bond bubbles on this idea.


His argument is that there isn’t a bond bubble created by the Fed because the Fed won’t let there be a bond bubble. The bubble won’t burst because the Fed won’t let interest rates rise during periods of high unemployment and low inflation. We should not worry about historically low interest rates because the economy is in such terrible shape. With a bad economy “the usual rules about what constitutes a reasonable level of interest rates don’t apply.”


But isn’t that the point? If the rules don’t apply, how can we assume that the Fed can prevent a bubble? The argument is circular. We assume that the Fed can prevent any problem that crops up. But the problem is that the Fed does not operate in a closed system. History is the only place to begin a forecast, but it is imperfect because the environment keeps changing. An integrated global economic system introduces issues far beyond the US economy, the limit of the Federal Reserve’s mandate.


There is another issue. The Fed has suppressed interest rates. Let us assume that the Federal Reserve will continue to do so even though rates have already risen in both the US and Japan. The assumption is that if the Fed can prevent interest rates from rising, there won’t be an issue. But there is another aspect to bonds than just interest rates. A more important aspect: solvency. Interest rates could easily rise regardless of central banks, if investors are worried about getting their money back. As a result of the Fed’s distortion of the market and risk, the question of solvency is more important than ever. So even if the US government bond market is not a bubble does not mean they don’t exist.


The first candidate would be Asia. The global hunt for yield has made raising money in Asia easier than ever. Companies which never could have issued bonds are now issuing them at a rapid rate. Since the beginning of last year the number of Asian companies issuing local currency debt for the first time has risen to 20% of the market. In the US and Europe the proportion is usually 3%. The Asian debt market has doubled in size to $6.5 trillion since the end of 2008. It is not just companies. Consumer debt has grown even more rapidly than corporate debt. In Malaysia it has grown to 76.6% of GDP from 65.9% in 2007. In the US consumer debt has fallen from 100% in 2007 to 85% now.


It is argued that Asian debt growth is simply following the economic and demographic growth. But economics and demographics do not determine risk. Risk is a function of the probability of getting repaid. Getting your money back is determined by institutional efficiency. Economic growth diminishes the probability of reform, so institutional efficiency has not kept up.


It is not just Asian corporations and consumers. The hunt for yield has spread money to new sovereign borrowers. The sovereign debts of peripheral European countries have been shown to be questionable, but at least these countries do have revenues. Rwanda just issued its first bonds, $400 million, to finance a new conference centre. Rwanda gets a large part of its revenue from gifts of aid. Rwanda is not alone. Honduras and Mongolia have recently issued debt. These countries barely have institutions.


The bubble in bonds is also in the level of risk accepted for Western debtors. The returns on “high yield” or junk bonds have reached a historic low of 5.39%. The alphabet soup of financial products has reappeared. We have a return of structured finance. There is a great demand for the demand for collateralized loan obligations (CLOs), and an even greater demand for commercial mortgage-backed securities, (CMBS). These debt are being issued with ever fewer creditor protections. The number “cov-lite” loans has increased to more than 50% of all leveraged loan issuance so far this year, double the level during the credit boom in 2007.


Apparently the global economy has not gotten the memo. Despite the central bank cash, it has refused to be stimulated. The International Monetary Fund trimmed its global growth forecast last month and recently did the same for its forecast of the Chinese economy. As the economy weakens, so does the ability of companies, consumers and countries to pay back what they have borrowed. It is not just the fear of rising interest rates that can prick a bubble. What can bring an end to the bull market is simpler: the fear of losing money. 


(William Gamble is president of Emerging Market Strategies. An international lawyer and economist, he developed his theories beginning with his first hand experience and business dealings in the Russia starting in 1993. Mr Gamble holds two graduate law degrees. He was educated at Institute D'Etudes Politique, Trinity College, University of Miami School of Law, and University of Virginia Darden Graduate School of Business Administration. He was a member of the bar in three states, over four different federal courts and has spoken four languages.)



Dayananda Kamath k

3 years ago

does it mean just like to help enron we created dhabol power project. and fdi in retail to bail out walmart. killing the indian economy to provide returns to fii's all that this govt has done in the name of reforms is selling the country to fiis nothing else. and garnering votes by throwing money at poor in the name of inclusion.india will be the originator next financial crisis.



In Reply to Dayananda Kamath k 3 years ago

Indians have to be choosy while General Elections take place in the year 2014.

A case to make prosecutors personally accountable

Alexina Simon was picked up as a witness in a minor criminal case. Prosecutors in Queens held her over two days without a lawyer. Now, she wants to hold them to pay individually for what she says was misconduct

It wasn't much of a case: Queens prosecutors wanted to prosecute a woman for having falsely reported her car stolen in a bid to collect on theft insurance. A non-violent crime. Small-time really.

But the prosecutors went to unusual lengths in 2008 to try and make the case. They tracked down a person they thought had information about the alleged fraud, told her she was under arrest, and over the course of two days interrogated her in a room in the Queens District Attorney's office. The woman, Alexina Simon, was not a suspect. She was, in truth, nothing more than a potential witness.

Today, Simon is the named plaintiff in a federal case that has reached the U.S. Court of Appeals for the Second Circuit. The case is noteworthy for two reasons:

It shines a light on the issue of what are known as material witness orders, a poorly understood aspect of New York's criminal justice system in which people who are potential witnesses to crimes can be detained, evaluated and perhaps compelled to disclose what they know.

The case is also seeking a remedy that those concerned about misconduct by the country's district attorneys have long sought, namely that individual prosecutors be held personally liable for their misdeeds.

Lawyers for Simon have argued that the prosecutors in the case failed to do what is required when such material witness orders are granted by a judge — bring the witness before that judge and make sure that witness has a lawyer. Simon, they say, had no meaningful information about the alleged fraud. That might have been sorted out had proper procedures been followed, they say. In all likelihood, they suggest, prosecutors not only would have figured out that she had no information, but also that she, owing to a mix up in names, was not the person they were actually looking for.

Instead, Simon says she was detained twice — arrested first at work and then at home the following day — and questioned for hours without a lawyer.

Lawyers for the Queens prosecutors have insisted Simon willingly cooperated and thus the warrant they had obtained, and the requirements that came with it, didn't apply. They argue further that, even had the prosecutors erred, they were, under the law, immune from being held personally liable for their misconduct.

A district court judge ruled for the prosecutors, holding that the broad protections given to law enforcement officials as they pursue cases applied in this instance. But the case was appealed, and since then, a brief has been filed by the U.S. Department of Justice in support of the district court's ruling and another has been submitted by defense lawyers in opposition. A decision is expected soon.

The issue of the use and misuse of material witness orders came under scrutiny after 9/11. Federal authorities used the warrants to lock up any number of people they suspected might have information about terror investigations. A subsequent lawsuit that sought to hold former U.S. Attorney General John Ashcroft personally liable for the abuse of material witness orders made it to the Supreme Court, which held that Ashcroft was immune.

The use of material witness warrants in state cases has garnered far less attention and the Simon case has to date been a relatively obscure one. But a lawsuit brought by a man who says he was wrongly prosecuted for murder could give the use of material witness warrants in state prosecutions an explosive airing.

Lawyers for Jabbar Collins, who spent 16 years in prison before prevailing in a rare federal petition for his freedom, have accused Brooklyn District Attorney Charles J. Hynes of running what amounts to his own civil jail system. Collins's lawyer, Joel Rudin, has charged in court papers that he has evidence Hynes's office routinely and illegally detained witnesses to compel and sometimes coerce testimony.

Hynes's office has denied the assertion.

For Rudin and other defense lawyers, the misuse of such warrants — locking people up until they tell a story the prosecutors need told to make a case — could be a central cause of the kinds of wrongful convictions that, again and again, have been uncovered across the country in the last decade or so. And they argue that the problem is not likely to be corrected unless prosecutors can be held personally responsible.

The abuse of such warrants, Rudin wrote in a brief that is part of the Simon case before the appeals court, "threatens the rights of individuals held as material witnesses to prompt arraignment, representation by counsel, and an independent determination of their status." Granting prosecutors immunity when they abuse the warrants, he wrote, "would deny aggrieved individuals any compensation or other remedy for their constitutional injuries and would encourage law enforcement authorities to continue such practices."




Railways asked to pay Rs50,000 for two year delay in processing refund

The forum’s order came on the complaint by Delhi resident Pulastya Pramachala who had alleged that he had filed the refund request in April 2010, but it was not processed for over two years and then was rejected in May last year on the ground that he had filed the claim late

Pulling up the Indian Railways for taking over two years to process a passenger’s refund request and then ‘illegally’ rejecting it, a Delhi consumer forum has directed it to pay a compensation of Rs50,000 to the complainant.


The New Delhi District Consumer Disputes Redressal Forum held Indian Railway Catering and Tourism Corporation (IRCTC) directly responsible for the delay as the refund request for cancelled ticket was to be forwarded to the railways zone concerned by IRCTC.


“We hold all the opposite parties (chairman of the Railway Board, general manager of Northern Railways, chief commercial manager of South East Railways and IRCTC) guilty of deficiency by taking unduly long time in processing the refund claim of complainant and then rejecting it illegally.


“The opposite party (IRCTC) has contributed directly to the delay and harassment and inconvenience to complainant and his family,” a bench presided by CK Chaturvedi said and directed the parties to jointly and severally pay Rs25,000 as compensation to Delhi resident Pulastya Pramachala along with Rs25,000 as cost of litigation.


The forum asked the chairman of Railway Board to examine the rules and regulations governing time limit for claiming refund and processing it “so that consumers are not made to litigate for refund”.


The forum also observed that the Railways acted “penny wise and pound foolish” by spending public money to defend such cases in courts and said the Board should direct Indian Railways “to make the refund in court (forum) on first hearing itself rather than contesting such cases”.


The forum’s order came on the complaint by Pulastya who had alleged that he had filed the refund request in April 2010, but it was not processed for over two years and then was rejected in May last year on the ground that he had filed the claim late.


IRCTC had contended in its defence that refund claim was rejected as it was not filed within 12 hours of cancellation of ticket as per the rules and regulations governing ticket cancellation.


The forum rejected the contention, saying that as per the Railway Act, 1989, the Railways “in no case can refuse refund of a cancelled ticket”.


“It (Railways) cannot make rules or regulations or time limits for presenting refunds, in a manner which would lead to refusal of refund on grounds of late presentation. It can only prescribe the cancellation charges, etc,” the bench said.


The forum also noted that the Railways has set a time limit of a few hours for passengers to file the claim, but it has laid no such limit for itself.


“The complainant in this case sent a number of emails, requests and contacted service centres, wasting his time, money and effort, with all anxiety and distress for absolutely unreasonable delay of two years in getting a reply that the request has been rejected.


"Such an unreasonable delay is total imperfection in rendering services,” the forum noted and also directed Indian Railways to refund the ticket fare after deducting the applicable cancellation charges.


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