Monday, June 30, 2014

The feds may be considering Bond market changes

The American financial establishment has an incredible ability to celebrate the inconsequential while ignoring the vital. According to a small story in the Financial Times, some Fed officials would like to require retail owners of bond mutual funds to pay an "exit fee" to liquidate their positions. Come again? That such a policy would even be considered tells us much about the current fragility of our bond market and the collective insanity of layers of unnecessary regulation.

Recently Federal Reserve Governor Jeremy Stein commented on what has become obvious to many investors: the bond market has become too large and too illiquid, exposing the market to crisis and seizure if a large portion of investors decide to sell at the same time. Such an event occurred back in 2008 when the money market funds briefly fell below par and "broke the buck." To prevent such a possibility in the larger bond market, the Fed wants to slow any potential panic selling by constructing a barrier to exit. Since it would be outrageous and unconstitutional to pass a law banning sales (although in this day and age anything may be possible) an exit fee could provide the brakes the Fed is looking for. 

Fortunately, the rules governing securities transactions are not imposed by the Fed, but are the prerogative of the SEC. (But if you are like me, that fact offers little in the way of relief.) How did it come to this?

But now that Fed policies have herded investors out on the long end of the curve, they want to take steps to make sure they don't come scurrying back to safety. They hope to construct the bond equivalent of a roach motel, where investors check in but they don't check out. How high the exit fee would need to be is open to speculation. But clearly, it would have to be high enough to be effective, and would have to increase with the desire of the owners to sell. If everyone panicked at once, it's possible that the fee would have to be utterly prohibitive. 

Peter Schiff is a smart investor and author of several best selling books. He correctly predicted the economic meltdown of 2008 - 2009

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