Traders called it the "Greenspan Put."
During the 1980s and 1990s, the Federal Reserve adopted an unofficial "bailout" policy. Whenever a crisis occurred, Fed Chairman Alan Greenspan would cut interest rates and inject billions of dollars of extra credit into the system. This "re-juiced" the markets, making them rise again.
Traders buy put options to protect themselves from catastrophe. Put options are like insurance. With the Greenspan Put in place, traders felt comfortable speculating. They knew the Fed would bail them out if needed. They had insurance.
Bernanke replaced Greenspan in 2006. The market assumed the Greenspan Put would live on. And the government validated this assumption by saving Bear Stearns last March. Following the bailout, the S&P rose from 1,250 to 1,400. The volatility index dropped from 35 to 20. Junk-bond spreads declined from 8% to 6%. We thought the credit crunch was behind us.
Then, Lehman Brothers collapsed.
Lehman Brothers was a 158-year-old firm with 26,000 employees and $59 billion in annual revenue. The government chose not to rescue Lehman. The Greenspan Put no longer existed.
Without the Greenspan Put, the market could not trust any firm's finances. Too many bogies hid in corporate balance sheets. All faith in the system vanished. Even the largest firms in the world couldn't get credit. The Dow fell 3,000 points in four weeks. Volatility climbed from 25 to 80. Junk-bond spreads flew from 8% to 25%. It was the once-in-a-century sandstorm...
When the government and the Fed realized the panic they had caused by letting Lehman fall into bankruptcy, they immediately brought back the Greenspan Put.
In his December 16 Federal Open Market Committee statement, Bernanke said the Fed would "employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability." Bernanke also said the Fed could use a $200 billion credit facility to get money to households and small businesses. And Bernanke has the ability to buy Treasury and agency debt (bonds from Fannie Mae, Freddie Mac, Sallie Mae, etc.). He has already started a program to buy $500 billion of mortgage-backed securities.
The Treasury went even further. The total cost of all the facilities, stimulus plans, equity stakes, and debt guarantees initiated by the government in 2008 is over $8 trillion. And the government will now rescue any troubled firm it thinks could generate financial and economic instability.
These actions were too little, too late. The brief disappearance of the Greenspan Put had already pushed the economy into a coma...
The U.S. government now runs the country's financial system and real estate market. This is a disaster for the economy. Government bureaucrats are the last people you want running your financial system. They invest in all the wrong places, they waste money, and their policies starve private enterprise.
Worst of all, debt is the basic problem. The government's solution is to create more of it.
But the important thing is, as long as the government is working hard behind the scenes, printing money, guaranteeing debt, bailing out failed companies, building infrastructure, supplying credit, and buying financial assets, there will be NO more bankruptcies, NO more defaults, and NO more credit crunches. Just a "vegetable" economy.
As I'll show you in tomorrow's essay, this vegetable economy will be difficult for most investors, but for corporate bond investors, it couldn't be better. Some corporate bond investments will pay their owners over 20% a year in income. With yields this high, corporate bond investors will double their money in less than four years, simply by compounding the dividends.
Right now, bond yields are up. In a vegetable economy, bond yields decline. When yields decline, bond prices rise. You make capital gains AND earn income. In short, we have the perfect environment to be a bond investor. This is why I call the period we're entering the "Golden Age" of bond investing...
Tomorrow, I'll explain why this "vegetable" economy is so good for owning bonds... and show you the best way to buy corporate bonds with huge yields.
Good investing,
Tom
Editor's note: Tom Dyson is a regular contributor to DailyWealth, a free investment newsletter focused on the world's best contrarian opportunities. We write with a simple belief in mind: You don't have to take big risks to make big money with your investments.
Sign up today to read more investment ideas from Tom Dyson.
