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How the Bond Markets React 03.01.06
Riskier Business
Investors can be an odd lot. On one hand, we look to the past as a guide to the future. On the other, we disregard those lessons and instead rely on our intuition to guide us. Big mistake.
It could be that the bond markets are poised for just such a mishap. The telling signs, the ignoring the obvious warnings, the fact the Greenspaną's conundrum hasnąt faded and in fact deepened, and that investors have become risk averse should give every pause for concern. Not so. Lured by the yield and blinded by the potential for disaster, bond traders have jumped in, sometimes with both feet, for a new product.
Known as hybrid securities, these slick little items have everything but what bond investors tend to appreciate. Bondholders, as rule, like the idea of being able to stand first in line when trouble strikes. The nature of their investment makes them the first paid for their investment efforts while equity holders are left in the cold, often with nothing to show for their efforts.
And trouble can strike from any direction at anytime. A bankruptcy proceeding or restructuring efforts would ruin the party for these investors.
These "hybrids" offer the coupon of a bond, often at high yields to entice the risk averse and the attraction of an equity. These half and half offerings have the coupons of a bond with common stock attached for good measure. There is a benefit for the company. The bond half has tax deductible incentives for the corporation while they lack, as I mentioned earlier, the financial obligation a bond would normally carry to the securities owner.
Problem lies in the buyers. Normally, investors in these kinds of fixed securities would insist on something a little more concrete.
If they did, and it seems we are in a bond market where just about any bone thrown to the crowd is considered worthy of investment, they would find two ways to do it.
The bondholder would insist that the equity side of the hybrid be preferred stock with a guaranteed dividend. Or, they can demand a yield a good deal farther north of half a percentage point above a pure fixed income security many now offer.
The warning Greenspan issued, while well noted and often referred to, has fallen on deaf ears. When the prices fall out of these markets, as the retired Fed chief suggesteded, we will all be suddenly concerned. For hybrid owners, when that event happens, it will just be too late to do much about how history will repeat itself.
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