History was made in the global capital market two weeks ago. It didn't attract much attention in the world press, maybe because it's a tough sell to the masses.
A United States government auction of 5-year, inflation-indexed bonds closed at the highest price in 100 years, reflecting returns to maturity of -0.5%.
At this point, I may be losing your interest. Returns to maturity, bonds, all that deathly jargon of finance.
Hang in there, dear reader! Let me translate that into English: Last week Washington rolled over some of its debt onto you, selling you securities that assure you lose 0.5% of your investment every year, relative to inflation.
Simpler? The price was $105.51. In five years, when it matures, you'll receive $100.
If you bought the bonds, called "TIPs," you lose 0.5% of your principal, relative to the value of your money after adjustment for inflation.
TIPs stands for Treasury Inflation Protected Securities.
The U.S. capital market is the biggest in the world, so prices and yields there affect the whole world. That includes Tel Aviv. The return to maturity on 5-year, consumer-price-index-linked Israeli government bonds recently fell below zero. Returns to maturity on 10-year bonds fell below 1%.
What does it mean for investors to buy bonds at such low yields? (Hang in there. ) It says terribly complicated things about the current state of the global economy, the future of the global economy and the liquidity trap into which the world has stumbled.
It also says something simpler. Investors will get what they paid for: zero or negative returns.
Israeli investors read this and scratch their heads. The economic news has been upbeat, hasn't it? The latest reports from their investment adviser at the bank or wherever have shown annual returns of 5%-10%, in most cases. And they've reads that Israel's economy is in pretty good shape compared to the rest of the world. Can't they rest assured of future prosperity?
Perhaps not. Profits in 2009 and the past few years are the mirror image of soaring bond prices in the U.S. and elsewhere, a leap that reduced returns on TIPs to historic lows.The good ship QE2 sets sail
The losses on TIPs didn't make headlines, maybe because it happened in proximity to something much more jolting to the world markets: the U.S. Federal Reserve's announcement of its second quantitative easing plan, called, wouldn't you know it, QE2 or QEII, and no, that doesn't stand for Queen Elizabeth the Second.
What is quantitative easing, anyway? It means the Fed is pouring cash into the market by buying bonds, or any other security, from the public.
To put it another way, it's as though the Fed were writing checks covered solely by the faith that the Fed will be able to write even more checks in the future.
Federal Reserve Chairman Ben Bernanke knows perfectly well that writing checks for trillions of dollars is no way to heal America's sick economy. But he also knows he has no choice. It's the only weapon left in his arsenal, after lowering interest rates to rock bottom didn't help. America remains mired in crisis and unemployment is sky-high.
Bernanke and his boss surely know, as do most economists, the studies by Kenneth Rogoff and Carmen Reinhart. They postulate that economic crises of the magnitude experienced in the last two years are followed by a decade of stagnation. They can explain to Americans that after 30 years of brisk economic growth fueled by credit, the bill has arrived.
Rogoff and Reinhart can explain there are no shortcuts to economic health: Americans have to save more, invest more and increase their productivity and their economy's competitiveness.
It's a hard sell. Nobody wants to hear that. Hence QE1, the first quantitative easing, which involved Bernanke pouring $1.5 trillion into the market when the crisis began. Now it's the sequel, involving another trillion dollars, this time knowing for sure it won't help. But he doesn't feel he has a choice.
How will all this easing, and minting, end? Nobody can say. Central banks are desperately buying foreign currency in order to weaken their own currencies and spur exports. But all these currency games are meaningless, in the long run.
It's a zero-sum game in which everyone thinks they can save their own economy while screwing the other guy.
The Bank of Israel, headed by Stanley Fischer, has had to play that game too, buying foreign currency to weaken the shekel and help Israeli exporters. It gave exporters temporarily relief over the past year. But Fischer knows all that buying must end, and sooner rather than later. Ultimately the only solution for the Israeli economy, and others too, is structural reforms, increasing productivity and competitiveness.
For now everyone is crossing their fingers and hoping that if QE2 blows up it will not be on their watch.Replacing Roy Vermus
With government bonds trading at roughly zero yields for so long, investors don't stand much of a chance of handsome returns in the years to come. The risks are high, the markets are fragile. The way resources are allocated and fair management of conflicts of interest are more important than ever before.
Last week the Israel Securities Authority celebrated the ouster of Psagot Investment House CEO Roy Vermus, as part of a deal in which Apax Partners bought the brokerage. (For more on that sorry story, see Page 8).
We caught a big fish, ISA officials gloated - the CEO of Israel's biggest brokerage. We sent a message. Hoo-hah!
Their celebration may have been premature. First, the evidence against Vermus has never been made public and no charges were pressed. Second, according to what the press has gleaned so far, there are no suspicions that Psagot managers misused client money.
More important, until a year ago Psagot was the only big investment body in town with an active, independent investment policy designed to protect its clients' money.
The market is divided as to the success Psagot could claim for its activism. But there's no question that under Vermus it was unique among local brokerages in raising the issue of protecting investors' money. In particular, at the height of the crisis, as companies scrambled to improve their position at the expense of investors through "haircuts" - trying to force bondholders to forgo some of their money - only Psagot issued clear directives for these debt arrangements. It explained exactly how it meant to fight to protect investors' money.
Vermus' mistake was that Psagot continued to manage a portfolio for itself, exposing the brokerage to a conflict of interest. But his ouster, and Psagot's sale by York to Apax, begs the question of what the new capital market will look like without him.
Will Apax appoint a powerful, independent CEO in his image? A person determined to protect the interests of investors? Or will Apax appoint a member of the club determined mainly to protect the interests of the other club members?
The answer lies with the regulators, mainly the Israel Securities Authority. It must redefine the structure of the capital market, requiring investment managers to be independent, to protect their clients, to fight their fight. The committee the prime minister set up to discuss economic concentration is an opportunity to start setting new rules in the capital market. In a world of zero returns, every fraction of a percent lost due to conflict of interest is critical.
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