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Roula Khalaf, editor of the FT, picks her favorite stories in this weekly newsletter.
The author is a former investment banker and author of “Power Failure: The Rise and Fall of an American Icon.”
There is unwarranted debate today among economists and others about how quickly interest rates rose during the Federal Reserve’s 18-month campaign to reverse its easy-money policies after the 2008 financial crisis.
But not by Steve Schwarzman, the billionaire co-founder of the hugely successful Blackstone Group. Few would question his intelligence or his investments. In an August interview, he extolled the virtues of an investment he discovered in senior secured debt that yielded nearly 13 percent.
“For those of you who aren’t financial experts,” he told me, “there’s nothing easier than lending someone senior debt, having the security of all their assets, and making 13 percent. How wonderful.”
Yes, interest rates have risen sharply, hurting many investors by driving down the price of existing bonds. The 10-year US Treasury yield – the benchmark of all financial market benchmarks – has risen from less than 0.5 percent at the start of the Covid-19 pandemic in 2020 to 4.9 percent, a 16-year high. In 2022 alone, global bonds lost 31 percent. That was the worst annual performance since 1900, according to the long-running Credit Suisse Global Investment Returns Yearbook.
Historian Niall Ferguson also recently noted that U.S. bond investors suffered the worst bust in 150 years, with a return of minus 15.7 percent, the worst since 1871.
But hello, what did the stooges expect after central banks around the world cut interest rates to their lowest levels in history between 2009 and 2022? Did they really believe that there would be no financial consequences if interest rates remained at or near zero for more than a decade? Or that the major abolition of the Fed’s relentless zero interest rate policy would be painless?
The Fed’s balance sheet exploded tenfold, housing nearly $9 trillion in assets in 2022, up from about $900 billion before the 2008 financial crisis. That was intentional — and resulted from the then-Fed chief’s decision Ben Bernanke to make the Federal Reserve the buyer of last resort for all types of corporate and government bonds that were weighing on the balance sheets of struggling Wall Street financial institutions. The process, which Bernanke called Orwell’s “quantitative easing,” had the intended effect of causing bond prices to skyrocket and bond yields to fall dramatically.
The idea – and not a bad one, at least initially – was to keep the cost of money low enough that people and businesses would borrow again – and thus ease the global recession. And that it would further ease the stress on the surviving Wall Street banks by providing them with a solvent buyer for their distressed assets.
But it was too much of a good thing. Bernanke’s two successors, Janet Yellen and Jay Powell, continued buying bonds, partly to appease traders, borrowers and moneymakers who had all become addicted to cheap money.
Let’s be honest: Who in their right mind would have thought it was a good idea to buy high-yield bonds – or “junk bonds” – in September 2021, when they were yielding less than a ridiculous 4 percent? Junk bonds are called junk bonds for a reason: They are issued by companies with less than good credit ratings and represent a reasonable amount of risk.
If a high-yield bond is yielding less than 4 percent when it should legitimately be yielding 10 percent or more, there is something very wrong with the risk-reward ratio. It didn’t take a genius to realize that bond yields could only go up from there. And it’s no surprise that that’s exactly what happened. According to the Federal Reserve Bank of St. Louis, the average yield on a junk bond is about 9.2 percent.
Obviously, this obvious and inevitable rise in interest rates has come as a shock to many people. Take, for example, the corporate bozos behind Silicon Valley Bank, which failed spectacularly this year. One of the reasons for this, it turned out, was that the bank’s executives had loaded its balance sheet with long-term bonds that they had purchased using customer deposits at the peak of the market.
But we are finally seeing a return to a world in which risk and return can be assessed more realistically after the distortions of recent years caused by the Fed’s massive interventions. The market will determine a more appropriate reward for the risk of owning a risky bond, rather than the artificial demand created by Washington bureaucrats. This will benefit both investors and the financial sector in the long term. And as Schwarzman points out, there will be plenty of buying opportunities.
Source : www.ft.com