Fed Levitating Bond Prices Same Way 0% Down Levitated Home Prices


By Charles Biderman


Bubbles are a popular way of describing unsustainable high prices. Stocks and bonds are at bubble levels just the way housing values were before they collapsed in the last decade. Bond prices are as high as they can get, since interest rates are about as low as they can get. As interest rates started going down in 2008 bond prices went up. And as interest rates stay down, the best and safest corporate use of free cash flow is to shrink the overall amount of shares, rather then making anything resembling a risky investment. So more cash and less shares in the hands of the institutions that own 80% of all US stock has meant ever rising stock prices.


Up until the past four years, stock and bond prices traded in some sort of relationship to the underlying economy, to corporate earnings growth, stuff like that. All that matters now is that central banks keep buying back bonds from banks and that the banks use the newly printed money they get from the government to keep buying enough new government bonds to keep the game going.


How else can the US government keep funding a $100 billion monthly deficit? Banks currently have $1.3 trillion on deposit with the Fed. Where did the banks get that $1.3 trillion? The Fed printed that money and used it to buy bank loans and bonds. What did the banks do with that money? They gave $1.3 trillion back to the Fed. What is the Fed doing now with that cash? The Fed is now TWISTing $40 billion monthly into 10 year- mortgages. It is also printing another $40 billion per month to buy treasuries back from the banks – at a nice profit to the banks. The banks now have $40 billion more each month to fund the US deficit. And all this at virtually zero interest rates!


Before 2007 the government created an artificial housing and economic bubble by encouraging home buying through a combination of 0%-down payments and allowing below-market interest rate mortgages. Now to boost the markets, the Fed is giving banks newly printed money and the banks have used the money to buy newly issued government bonds. Is there a difference between the two in terms of ultimate negative effects on the economy. There is no difference as far as I can see.


The 0% down and below-market mortgage interest rates temporarily sent home prices to the moon. Home equity net of mortgages peaked in 2005 at over $13 trillion. But then home equity values literally dropped in half by 2009. Even today, five years after the bubble burst, the value of all homes net of mortgages is $7.4 trillion, still down more than 40% from the 2005 high.


On the other hand, the bubble still hasn’t burst on stock prices, although they are trading at greater-fool prices. But the stock bubble also eventually will burst. And maybe sooner rather than later. Just as few wanted to acknowledge how housing prices were being artificially inflated by the government, today the optimists, against all logic are hoping greater fools will keep pumping more and more money into stocks. That’s despite the fact that earnings and cash flow stopped growing sequentially since June of last year.


How does the circle jerk end? How does the bubble burst? There are two ways I can think of. One, stock prices get so expensive that even at zero interest rates corporate America stops shrinking the float and begins selling shares big time. The second will be when the smart money abandons the dollar, causing the dollar to plummet versus gold.


I can’t say for sure, but Q4 results, which will start to be reported next week, could be the beginning of the end. Remember, front running 2013 higher taxes boosted Q4 wages and salaries, bonuses and capital gains by at least $100 billion. That has to have boosted Q4 results higher than expectations.


However, the real problem comes with future guidance. Over the next few weeks, business activity has to slow both sequentially and year over year as higher individual after-tax incomes plunge due to the taxes and current income that were recognized last year to avoid this year’s higher taxes. Therefore, probably by February I would expect to see the start of a real surge in both insider and corporate selling.




5 Responses to Fed Levitating Bond Prices Same Way 0% Down Levitated Home Prices

  1. Ed_B on January 8, 2013 at 5:59 am

    There once was a time in US and world financial systems that the bond markets played an exceptionally valuable part. Back then, government spending was generally held in check by the fact that when governments ran too large a deficit, the interest rates on any new bonds they sold would be forced to rise in order to compensate bond buyers for the additional risk of government default that they were taking on. Governments were, of course, acutely aware of this and paid some attention to the “bond vigilantes”. These bond vigilantes did the same service for corporate bonds, raising interest rates in order to compensate bond buyers whenever corporate risk levels rose. This was a good system. It worked well as a balance of power in the financial world, keeping the excesses of poor management somewhat controlled.

    These days, however, this is not the case. When the interest rates on Greek, Spanish, and Italian bonds threatened to rise above 7% last year, the central bankers pulled out all the stops to bludgeon the rates back below 6%. But wait! Isn’t such a rise in the interest rates of sovereign debt a warning sign that spending is out of control and that bad things are about to happen? Why, yes, it is. But instead of heeding this warning sign and reducing their spending, other things were done to artificially reduce the interest rates, with the politicians then congratulating each other at their successful management of the EU economy. Actually, their actions were not the success that they claimed it was. All they did was manage to remove the “DANGER – BRIDGE OUT!” sign so that bond holders would not see it. In any event, interest rates were forced down and everything is now perceived as being on the road to recovery, while in actual fact EU sovereign debt is even less secure than it was before all these events took place.

    I am not picking on the EU or our European friends because Mr. Bernanke is taking some actions here in the US that may be different in structure but are precisely the same in result. US bond interest rates have been forced lower and bond buyers cannot use their financial clout to force them higher to compensate bond buyers for the additional risk created by the massive money printing, also known as QE, programs of the US Federal Reserve. The reason why bond prices can be held so low is that the Fed itself is buying massive amounts of US Gov bonds at very low interest rates. At last count, more than 70% of all US Treasury paper was purchased by the Fed. While this percentage of Fed buying is bad, it is also rising and we may get to the point where the Fed is the only buyer of these bonds.

    The resulting abnormally low interest rate is distorting the market in many ways and there will be some sensational repercussions to these Fed actions. Some of them are already appearing. For one, REAL inflation in the US was shown to be about 9.4% per the calculations of economist John Williams of http://www.shadowstats.com, as of November 2012. John uses the very same calculations that were used by the US Gov prior to 1995 when food and fuel were included in the CPI. It is absolutely essential that these be included in any measure of the CPI because all human beings MUST buy them.

    For another, we have a large and growing number of elderly folks who worked hard all their lives, saved some money for retirement, and are now finding that the CDs, money market accounts, and savings accounts that they depended on for extra income aren’t paying much of anything at all. Because of this and the fact that these folks can’t accept the higher risk in the stock market, a lot of these folks, through no fault of their own, are burning through their principle and not just through their dividends and interest earnings. This could well mean millions of elderly poor in a few years who are desperately in need of public assistance for food, rent, and utilities at a time when the public treasury is well and truly tapped out.

    The final and worst repercussion to artificially depressed interest rates will arrive in the form of the collapse of the US bond market as investors all run for the exits only to discover that only a few of them will escape unscathed. I believe that a collapse in the derivative market will be the cause of this bond implosion and that we will see it sometime in 2014-15.

    I have no data to support this but after having invested in the US stock and bond markets successfully for over 36 years, this is the “feel” of it. I could certainly be wrong and quite often fall asleep at night praying that I am. But… if I am right, what then? Got gold or silver?

  2. Lincoln Hawks on January 8, 2013 at 6:07 pm

    The collapse of the Bond Market will occur soon after ideas like the $1 Trillion Treasury coin gain more traction from the bozos in Washington. Unfortunately, the result of Debt Ceiling negotiations may start this.

    Right now the Fed is out of ideas, and is resorting to threats of raising rates to get people out of bonds & into equities since QE couldn’t do it these past 4 years. I believe Madoff type event(s) will erupt throughout the Stock Market if a 20% drop in the S&P and Dow occur with no Fed intervention. Many QE infused funds are now leveraged to the max in equities, and desperately need the return of retail investors to absorb some of their positions.

  3. fedwatcher on January 8, 2013 at 7:58 pm

    Many have been predicting another stock and bond market crash for some time now. On the basis of fundamentals they are all correct. However, governments, central banks, and the big banks have been able to pull another rabbit out of the hat again and again.

    The length of the present insanity will determine the depth of the fall. The all important ‘when’ could be close or still many months away.

  4. Dan on January 9, 2013 at 1:28 pm

    I’m going to be 62 this March. My wife and I have lived frugally, despite periods of high income. I currently have no debt. I live on a 25 acre farm 5 miles from
    Wal-Mart’s world headquarters. I’ve had my money managed by at least 3 different, money managers (fee based). I haven’t been happy with any of them. The one I’m currently with seems to have tremendous faith in Bill Gross at Pimco and has quite a bit of my money with his Total Return Fund. I asked him why they didn’t use the BOND etf, because of the many advantages of etf’s over bond funds and he came up with some BS answer. My wife thinks I’m too hard on these money managers and just wants to stick it out with our current outfit.

    Personally, I’m scared that everything I’ve worked for is going to go, “POOF”. My money mgr. will be very sorry and tell me that if Bill Gross didn’t see it coming, who could have. Well, I spend an inordinate amount of time reading the various well know web sites, many of which Charles has links to on this site. The question is what to do? Today, I”m going to subscribe to Charles Biderman’s investment picks, because he’s one of the few that seems to see the insanity going on, while many of the talking heads (I never watch CNBC or Fox News) I read the WSJ, Zero Hedge, Investors B. Daily and some other blogs. I need some income, so as not to deplete my life’s savings. I guess I’ll see how I can do with Charles’ service.

  5. Joey Anchovey on January 11, 2013 at 4:41 pm

    My question is – if the banks have $1.3 trillion and are paying that back to the Fed, when will that money leak out to the real economy thereby initiating hyperinflation? Is that money being fed into stocks and thus propping up a false economy? How and when will interest rates rise outside of the long arm of the Fed and put an end to this circular firing squad?

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Charles BidermanCharles Biderman is the Chairman of TrimTabs Investment Research and Portfolio Manager of the TrimTabs Float Shrink ETF (TTFS)

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