If some of this seems foreign, just plow through it, because it leads to an anecdote anyone can understand:
Dan Critchett: ‘What do you think the consequences are of the overwhelming incentive in credit markets today to avoid long-term borrowing? REITs are now borrowing zillions at spreads against LIBOR (or swapping their current long mortgages) instead of financing our shopping centers and high-rises with bonds. Corporations opt for credit lines instead of floating 15-year paper. The Federal Government doesn’t even ISSUE some of its formerly-ubiquitous long bonds. And even everyday citizens prefer to borrow at 1.9% on a 6-month credit-card special rather than refinance their 30-year mortgage. All these yield-curve surfers have to come into the shore sometime, no? Where in the world will the SUPPLY of long-term credit come from – or more accurately, at what price will it come – when, one day, everybody wants to borrow long? And what kind of mess will we have gotten ourselves into?’
☞ Let me answer indirectly with an anecdote:
I got an offer from MBNA to sign up for a credit card that would let me borrow up to $100,000 at ZERO interest for the first nine months. So I made the call, as it urged, and had them wire $95,000 to my bank account, which they did. It is now my free money for nine months, which I can put to work any way I want. All I have to pay until next January is $15, the minimum monthly payment. As tickled as I am by this bonanza (if you figure I can earn 2% on the money in 9 months, and I think I may even be able to do better, MBNA just gave me $2,000), it makes me nervous . . . just as the free running shoes that some website gave me made me nervous back during the dot-com bubble.
I hesitated to brag about this – I know I am exceptionally fortunate to be able to get this kind of credit – but I do so because, in the first place, I suppose it will not astonish you to know that I am not entirely poor just because I am entirely cheap (indeed, it may be the cheapness that has spared me from the poorness) . . . and because I think it somehow relates to Dan’s point. One of these days, the low-cost short-term money will be over, to be repaid with higher-cost money. And that could be yet one more reason that the stock market, on average, as anemic as it’s seemed to some, may not be what you’d call a bargain here. Rising interest rates, when they come, will pose a problem.
The yield curve is the line your daughter could draw in a graph that shows where interest rates are for different time periods. Usually, short-term money carries a lower rate than long-term rates. Just look in your bank window: a 30-day certificate of deposit might yield (for the sake of the curve I want you to draw in your mind) 1% interest, a 90-day CD might yield 2%, a 1-year CD might be yield 3%, a 2-year CD might yield 4%, and a 5-year CD might yield 5%. These are not real-world numbers, but do you see the ‘curve’ you could draw if you made a graph of that? Sort of like a wave.
REIT = Real estate investment trust.
Libor = London Interbank Overnight Rate (or something like that) – a floating benchmark for very short-term money.
Long bonds were the 30-year bonds the U.S. Treasury used to issue.
Coming soon: The Wisdom of Dick Davis
Quote of the Day
The whole aim of practical politics is to keep the populace alarmed (and hence clamorous to be led to safety) by menacing it with an endless series of hobgoblins, all of them imaginary.~H. L. Mencken
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