How are Bonds Affected by Bailout/Crisis

[TromboneAl]

Can someone give me a quick tutorial on how bonds (and more specifically bond funds) might be affected by the current credit crisis, bailout etc?

Thanks,

[ziggy29]

From 40,000 feet -- the more they have illiquid securities -- particularly some mortgage-backed securities -- even if they are performing, the more mark-to-market requirements are going to cause a blow up. The Schwab Yield Plus fund -- supposedly a "safe" ultrashort bond fund -- is a textbook example. Even though all of its assets were performing, it held a lot of MBS that no one wanted, that wasn't getting bids on the open market, and the mark-to-market requirements caused the NAV to fall 30%.

[freebird5825]

i did a quick search at M* (preferred subscription), using keywords "bond funds and crisis". that search didn't turn up too much, but some of the articles were interesting. anyone else have any luck?

[audreyh1]

Quote:

Originally Posted by TromboneAl Can someone give me a quick tutorial on how bonds (and more specifically bond funds) might be affected by the current credit crisis, bailout etc? Thanks,

Anything but treasuries has already been affected BADLY.

Even the better quality diversified bond funds got hit hard two weeks ago starting around 9/15 because that's when the credit spreads started to widen badly and they have come down hard since.

I think that time frame is linked to the Lehman Bankruptcy which occurred on 9/15. That seemed to start the serious credit snowball.

Going forward - if the credit freeze can be relaxed, if lending can get going again, credit spreads will narrow and non-treasury bonds will appreciate. In the meantime, I guess we get paid higher rates and hope for few defaults. Also we hope for no more "runs" on things that aren't as safe as treasuries. It's pretty dicey out there.

Audrey

[FIREd]

I think we have seen a flight to quality and safety. Anything that carries a credit risk is out of favor (corporate bonds, munis, etc...) and even for bonds with no credit risk, people seem to prefer short term maturities. So everyone's loading up on t-bills.

[FinanceDude]

Muni bonds have been unfairly treated by the credit crunch, there are opportunities there going forward........

[ziggy29]

Quote:

Originally Posted by FinanceDude Muni bonds have been unfairly treated by the credit crunch

I'm not sure that's true in all cases. Many municipalities are facing the type of ticking time bomb with pension funds that the U.S. government will eventually face with Social Security and Medicare. And unlike the federal government, cities can't print money and often can't use deficit spending to put off the pain. And they can't just go and raise taxes without a revolt or other consequences.

So places like Vallejo blow up. I'm sure there are more Vallejos out there, most likely.

[FinanceDude]

Quote:

Originally Posted by ziggy29 I'm not sure that's true in all cases. Many municipalities are facing the type of ticking time bomb with pension funds that the U.S. government will eventually face with Social Security and Medicare. And unlike the federal government, cities can't print money and often can't use deficit spending to put off the pain. And they can't just go and raise taxes without a revolt or other consequences. So places like Vallejo blow up. I'm sure there are more Vallejos out there, most likely.

True, but not all municipalities are as stupid as Vallejo........ I am buying all the local GO bonds I can find. Of course, here in Wisconsin, our property tax payment rate is 98%, so we are in better shape than many states......

[Surfs_Up]

How might GNMA funds hold up?

Thanks,
Surf

[free4now]

I was surprised to see my VFSUX Vanguard short term investment grade bond fund, where I have 4+ years of FIRE living expenses, drop 4-5% over the past few weeks. My thinking is that this is mostly "flight to quality" and as long as the credit crisis eventually blows over the price will go back to normal. After all, in any normal market, a fund that holds mostly A rated and some B rated bonds is pretty stable. It's just that such bonds are currently paying ridiculous interest rates because nobody is sure they'll be repaid.

At this point moving to treasuries would lock in my losses, and if I ride this out it seems clear that NAV will rise back up to normal when corporate bonds start paying in the ballpark of what they were a few weeks ago. I can't see that taking more than a year or two; the high rates that bonds are paying now are completely unsustainable long term. The real risk is of not getting the money back, but these are normal bonds not MBS and I think betting on them not being paid back is tantamount to just giving up on investing completely. If those normal, relatively highly rated bonds fail to be repaid it's pretty much game over for everyone.

But I'm really a newbie in this bond arena, so I'm learning as I go and am very interested in others opinions.

[freebird5825]

Quote:

Originally Posted by FinanceDude Muni bonds have been unfairly treated by the credit crunch, there are opportunities there going forward........

i'm a big fan of TE munis and already have a nice size stake in them.
today's data:
VWAHX -3.93% YTD, 4.79% yield TTM
VNYTX -3.21% YTD, 4.30% yield TTM

i'm not freaking out over the YTD loss. i'm using them for the TE dividends now and they are going to be very long term holdings. i just recently increased my monthly DCA amount to capture the near term drop in NAV. heeeheehee

[FIREd]

Quote:

Originally Posted by Surfs_Up How might GNMA funds hold up? Thanks, Surf

They seem to have done better than most, probably because they are fully backed by the US government and therefore carry no credit risk. But they still carry an interest rate / inflation risk and I think that right now people try to stay away from longer term bonds until the smoke clears and we have a better idea about where we stand.

[socca]

I've been watching my Vanguard muni bond funds very closely. So far, everything is behaving pretty much as it should. One interesting number to watch in a bond fund is unrealized losses. This is indication of how many "bad bets" the bond manager has made with respect to her current bond portfolio. The short and intermediate term VG muni bond funds are have very little in the way of unrealized losses the last time I checked. The long term and high-yield muni bond funds have much more unrealized losses, but this is to be expected since the bond prices are much more volatile. The amount of unrealized losses isn't alarming, but I'm watching it closely nevertheless.

[audreyh1]

Quote:

Originally Posted by ziggy29 I'm not sure that's true in all cases. Many municipalities are facing the type of ticking time bomb with pension funds that the U.S. government will eventually face with Social Security and Medicare. And unlike the federal government, cities can't print money and often can't use deficit spending to put off the pain. And they can't just go and raise taxes without a revolt or other consequences. So places like Vallejo blow up. I'm sure there are more Vallejos out there, most likely.

That doesn't explain the discrepancy between municipal bonds and commercial paper. No matter how many counties/municipalities blow up, I think many more companies would blow up if economic conditions were that bad. So there is a disconnect in pricing relative risk here.

Audrey

[ziggy29]

Quote:

Originally Posted by audreyh1 That doesn't explain the discrepancy between municipal bonds and commercial paper. No matter how many counties/municipalities blow up, I think many more companies would blow up if economic conditions were that bad. So there is a disconnect in pricing relative risk here.

Probably true to a point. But ithink of many of the cost pressures that municipal governments face -- many of them having to do with the cost of benefits that are going extinct in the private sector. Private companies can often freeze wages or eliminate benefits they can no longer afford a LOT more easily than governments can.

[W2R]

Quote:

Originally Posted by free4now I was surprised to see my VFSUX Vanguard short term investment grade bond fund, where I have 4+ years of FIRE living expenses, drop 4-5% over the past few weeks. My thinking is that this is mostly "flight to quality" and as long as the credit crisis eventually blows over the price will go back to normal. After all, in any normal market, a fund that holds mostly A rated and some B rated bonds is pretty stable. It's just that such bonds are currently paying ridiculous interest rates because nobody is sure they'll be repaid. At this point moving to treasuries would lock in my losses, and if I ride this out it seems clear that NAV will rise back up to normal when corporate bonds start paying in the ballpark of what they were a few weeks ago. I can't see that taking more than a year or two; the high rates that bonds are paying now are completely unsustainable long term. The real risk is of not getting the money back, but these are normal bonds not MBS and I think betting on them not being paid back is tantamount to just giving up on investing completely. If those normal, relatively highly rated bonds fail to be repaid it's pretty much game over for everyone. But I'm really a newbie in this bond arena, so I'm learning as I go and am very interested in others opinions.

I have a few shares of VFSTX (the same fund but not Admiral), that I bought on June 2 of this year. I have been pretty horrified watching it drop like this, since for some crazy reason I expected it to be much more stable than it has proven to be. These funds are heavily invested in financials (30.7%) so maybe that has something to do with it. Obviously I still have a lot to learn about bond funds. Back to the drawing board and time to re-read the bond sections of Rick Ferri's book on asset allocation.

Anyway, VFSTX share price has gone down 4.3% since June 2 which does not make me feel one bit happy (even though we do get dividends as well). Like you, I guess I am stuck holding on for the ride since I do not want to lock in those losses. Luckily VFSTX represents only about 3% of my portfolio but still, I share your concern and I find the situation aggravating.

[FinanceDude]

Quote:

Originally Posted by audreyh1 That doesn't explain the discrepancy between municipal bonds and commercial paper. No matter how many counties/municipalities blow up, I think many more companies would blow up if economic conditions were that bad. So there is a disconnect in pricing relative risk here. Audrey

Good point....tough for muni governments to go to zero, since they always have the consistent funding of the taxpayers to ease their pain.......

[cute fuzzy bunny]

Local governments will have problems with their property tax intake due to valuation drops, and we all know they arent good about cutting spending. If they take it out on public services then people wont move into those empty foreclosures.

That wont end well. It'll take a while to end, but end it will.

Otherwise it depends on the types of bonds.

I wonder whats going to happen to the hunk of Vanguard High Yield I'm holding. I cant even take a wild guess.