by Eric Englund
reading Michael Lewis’ wonderful book The
Big Short: Inside the Doomsday Machine, I recommended
it to a friend. As my friend is a financial professional,
I knew he would enjoy a book about how a few obscure hedge
fund managers, and their clients, handsomely profited from
the collapse of America’s subprime-mortgage market. This friend
knew that, starting in June of 2005, I had written extensively
about the United States’ housing bubble (see articles, here,
So the meltdown in the subprime-mortgage market came as no
surprise to either of us; but it definitely caught Wall Street
by surprise. Upon finishing the aforementioned book, my friend
called me and asked a thought-provoking, two-part question:
"What is the next big short
and how do we profit from it?"
debt certainly has been in the financial headlines in 2010;
with Greece getting the lion’s share of attention. In the
midst of Greece’s debt crisis, Standard & Poor’s downgraded
Greece’s credit rating to "junk" status. S&P’s
rationale for this rating reduction was straight forward:
"The downgrade results from our updated assessment of
the political, economic and budgetary conditions that the
Greek government faces in its efforts to put the public debt
burden onto a sustained downward trajectory." What is
not stated by S&P is that by joining the European Union,
Greece no longer has its own central bank so it can’t paper
over its debt crisis by printing more money.
the United States’ central bank loves to use its printing
press and is actively
purchasing U.S. Treasury bonds with the objectives of
keeping interest rates low and spurring economic growth in
the U.S.; which will not work. As of October 15, 2010, a 30-year
Treasury bond was yielding 3.98%.
In addition to the Federal Reserve’s monetizing of Uncle Sam’s
debt, such a low yield has also come about as individuals
and large institutions, including banks, perceive U.S. Treasuries
to be a safe haven; hence they are lending to this "AAA"
rated borrower in droves. As George Goncalves stated:
"Treasury bonds are gaining ‘rock star’ status…"
Considering the heady levels the bond market has attained,
is it possible that a bond bubble has emerged in the United
von Greyerz, of Matterhorn Asset Management, certainly thinks
so. He believes, indeed, there is a bond bubble of global
proportions. Here is what he stated in a recent article:
bond market is the biggest bubble in financial markets worldwide,
in our opinion. Investors around the world are worried about
the state of financial markets and therefore believe that
government bonds represent a safe haven. These investors
will receive the most enormous shock on two accounts. Firstly,
no government will be able to repay the debts outstanding.
So there will either be government defaults, moratoria,
or money printing that totally destroys the value of the
bonds. Secondly, interest rates are likely to go up significantly
to at least 10–15%, totally destroying the value of the
luminaries, such as Marc
Faber, Jim Rogers, and Peter
Schiff do believe U.S. Treasury bonds are in a bubble.
In fact, in this
interview, Jim Rogers states he is considering shorting
U.S. Treasury bonds. If Rogers is thinking about shorting
bonds, you should too.
I do hold a short position pertaining to U.S. Treasury bonds.
I have taken this position via an inverse
bond fund. Here is a description
of this mutual fund:
investment seeks total return, before expenses and costs,
that inversely correlates to the price movements of Long
Treasury bonds. The fund employs, as its investment strategy,
a program of engaging in short sales and investing to a
significant extent in derivative instruments, which primarily
consist of futures contracts, interest rate swaps, and options
on securities and futures contracts. It invests at least
80% of net assets in financial instruments with economic
characteristics that should perform opposite to fixed-income
securities issued by the U.S. government.
not take this short position without undertaking appropriate
research. In January of 2005, LRC published my essay titled
the US Government’s Sovereign Credit Rating be Downgraded
to Junk? Here we are, over five years later,
and Uncle Sam’s financial condition is much "junkier."
I wrote the above-mentioned essay, the U.S. Government’s balance
sheet revealed a deficit net worth of over $7.7 trillion.
As of fiscal year-end September 30, 2009, the U.S. Treasury
is reporting that Uncle Sam’s net worth is a mind-numbing
deficit $11.5 trillion – I have included the 2009 balance
sheet, below, for your viewing displeasure.
billions of dollars) 2009
and other monetary assets (Note 2)
and taxes receivable, net (Note 3)
receivable and mortgage backed securities, net (Note 4)
direct loans and equity investments, net (Note 5)
interest in trust (Note 6)
and related property, net (Note 7)
plant, and equipment, net (Note 8)
and investments (Note 9)
in Government sponsored enterprises (Note 11)
assets (Note 12)
land and heritage assets (Note 27)
payable (Note 13)
debt securities held by the public and accrued interest
employee and veteran benefits payable (Note 15)
and disposal liabilities (Note 16)
due and payable (Note 17)
and guarantee program liabilities (Note 18)
guarantee liabilities (Note 4)
guarantee (Note 11)
liabilities (Note 19)
(Note 22) and Commitments (Note 23)
funds (Note 24)
liabilities and net position
news gets much worse. It is important to understand Uncle
Sam does not have "his" financial statement prepared
according to generally accepted accounting principles (GAAP).
Most notably, if you go to page 158 of the U.S. Government’s
audited financial statement (Table 6), you will see that
the net present value of future Social Security and Medicare
costs is $107 trillion. Under GAAP accounting, it could be
argued that such liabilities would be included in the U.S.
Government’s balance sheet as accrued liabilities. One could
confidently assert, therefore, that Uncle Sam’s liabilities
exceed assets by over $118 trillion. How the rating agencies
continue to rate the United States as a AAA risk completely
escapes me. Uncle Sam’s financial condition is a train wreck.
Without the Federal Reserve’s printing press, this confidence
game couldn’t keep moving forward.
information, with respect to the debt and liabilities the
U.S. is racking up at warp speed, I suggest visiting U.S.
Debt Clock.org. As of October 15, 2010, the national debt
was approaching $13.6 trillion and unfunded liabilities were
approaching $111 trillion. One would suppose even Alexander
Hamilton would be alarmed at such surreal figures. Ah,
but the bond market is forecasting tranquility and absolute
safety for the next 30 years.
is exactly why I like the idea of being short U.S. Treasury
bonds. Wall Street analysts, for the most part, will not sound
the alarm indicating a bond bubble has emerged. After witnessing
the subprime-mortgage collapse and then the ensuing bailout
of Wall Street, I have concluded Wall Street is a criminal
enterprise designed to separate you from your money. So don’t
expect any help from these crooks. As for the rating agencies,
such as Fitch, Moody’s, and Standard & Poor’s, they won’t
sound the alarm simply due to the fact that they are incompetent.
After Enron, MBIA, and the entire subprime mortgage-backed
securities disaster, who takes the rating agencies seriously
anymore? So while institutions and individuals flee to the
alleged safety of long-term U.S. Treasuries, AAA rating and
all, the "shorts" properly view Uncle Sam as a subprime
borrower; and have detected an opportunity to profit when
the Treasury-bond bubble bursts.
quick tangent, I highly recommend Christine
Richard’s book covering the downfall of MBIA. It is titled
Game: How a Hedge Fund Manager Called Wall Street’s Bluff.
This book masterfully details how a hedge fund manager skillfully
dissected MBIA’s business model and financial condition; and
then openly questioned its AAA rating via a critical research
report. The backlash, against this hedge fund manager,
was vicious. In the end, he was vindicated when MBIA was stripped
of its AAA rating and imploded. The reward for his lonely
battle, against Wall Street and the rating agencies, was over
a billion dollars in profits for his investors via astutely
purchasing credit-default swaps and shorting MBIA’s common
from the above-mentioned inverse bond fund, there are other
vehicles available to short U.S. Treasury bonds. There are
exchange-traded funds (ETFs) that appreciate as bond prices
fall (examples linked here
There is also a mutual
fund "that corresponds to one and one-quarter times
(125%) the inverse (opposite) of the daily price movement
of the most recently issued 30-year U.S. Treasury bond."
To be sure, there are other vehicles for shorting Treasury
bonds; but the purpose of this essay is to provide an idea
allowing one to profit when the Treasury-bond bubble bursts
– further research and risk assessment are up to you.
a doubt, I do see U.S. Treasury bonds as the next big short.
Uncle Sam, after all, has a subprime financial condition yet
is rated AAA. Keep in mind the hedge fund managers, who profited
from the subprime-mortgage meltdown (as chronicled in The
Big Short), waited several years for their positions to
pay off; thus patience is a virtue when holding a short position
in U.S. Treasury bonds. Even if interest rates rise and bond
prices drop like a stone, the U.S. could ban
the short-selling of Treasury bonds. Political risk, therefore,
must be considered when taking a short position in T-bonds.
Consequently, shorting T-bonds is not a risk-free proposition.
This aside, I savor the idea of making money by shorting the
long-term debt of the retarded, clumsy "debtaholic"
known as Uncle Sam.