Fun at the ZLB, and below!?

David Zervos: Here's Who's Buying All That Debt at Negative Yields

by Lorcan Roche KellyJoseph Weisenthal

http://t.co/4Pzf0A5YK0


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David Zervos at Jefferies takes a look at negative yielding European sovereign debt in a note sent to clients today.

In the note he asks what seems like an obvious question: "Who in their right mind would ever buy this many negative yielding bonds? Or, put another way, how can an investor look themselves in the mirror after a day of hard work buying bonds with a 'guaranteed' loss?"

His answer to the question, and what that answer means, should be of great interest to investors in the euro zone. He blames the index-driven world in which many investors live. Managers follow benchmarks, set under " longstanding rules which never anticipated negative nominal yields."


The answer for these managers is to change the rules or mandates of their funds to allow them to ignore the rules that are currently forcing them to guarantee a loss on the funds they manage.

Zervos then argues that this change will turbocharge the portfolio effect in the euro zone. When the highest-rated sovereign debt carries a negative yield, it is no longer a risk-free asset; it is a guaranteed loser. Investors will therefore move into risk assets (e.g. equities). According to Zervos, this move will happen over the coming quarters rather than over a period of years, as happened in the US.

Zervos's comments come as investors look to the European Central Bank to start sovereign bond purchases after its meeting tomorrow. With already negative yields across much of northern Europe and Mario Draghi saying that the ECB would be happy to buy at negative yields, investors will be rushing to change their investment mandates.

Zervos says of those who are late to change: " They will be fleeced! They will be the sheep of Wall Street!"
 
Ricter said:
I had the same question, but was giving him time to edit.

Unless... what about under deflationary conditions?
More...
Thanks for the edit time. That's real nice of Y'all. Actually I just assumed it would be self evident. And I guess it was, because you figured it out immediately, "deflationary conditions". Actually you don't need true deflation, i.e., a negative inflation rate, you just need the future inflation rate (an educated guess of course, there is no such thing as investing without risk!) to drop relative to the current rate by an amount greater than the absolute value of a negative nominal yield to return a positive real yield on a nominally negative yield bond..

there are two things to consider but these two things are so closely linked, or supposed to be, that if they become unlinked for any brief period, arbitrage will bring them back together tighter than three bull frogs in a fruit jar, Ya'll. One is inflation (I'm using the text book definition). The other is the relative value of the currency.

To keep it simple lets assume a hypothetical, zero coupon bond due in one year that I buy on January 1 and it matures a year later on Jan 1. If its face value is 1K but I buy it at a discounted price of $995 when inflation is running at 1.5 % then my nominal yield is $50 or 5% and my real yield calculated on the the day I buy the bond is 3.5%. If on the day the bond matures prices are actually 6% higher than they were on the day I bought the bond real yield calculated on the day I collect my $1000 is -1%. Why? Because I don't get to spend my $1000 until prices have appreciated by 6% and I only got 5% for use of my money.

Now just turn this around. Suppose I buy a 1K bond at an appreciated price of $1005, at maturity it has a nominal yield of -$5 or -0.5%, and if inflation is running at 2% my real yield calculated on the day I buy the bond is -2.5%. If at maturity, when I collect my $1000, prices are 3% lower than they were on the day I bought the bond my real yield computed on that day is +2.5%! A bond bought at a negative yield yields a positive real yield in such a case.

People will buy bonds with negative nominal yields when they anticipate an appreciation of the bond's currency by an amount greater then the absolute nominal yield.
 
piezoe said:
Thanks for the edit time. That's real nice of Y'all. Actually I just assumed it would be self evident. And I guess it was, because you figured it out immediately, "deflationary conditions". Actually you don't need true deflation, i.e., a negative inflation rate, you just need the future inflation rate (an educated guess of course, there is no such thing as investing without risk!) to drop relative to the current rate by an amount greater than the absolute value of a negative nominal yield to return a positive real yield on a nominally negative yield bond..

there are two things to consider but these two things are so closely linked, or supposed to be, that if they become unlinked for any brief period, arbitrage will bring them back together tighter than three bull frogs in a fruit jar, Ya'll. One is inflation (I'm using the text book definition). The other is the relative value of the currency.

To keep it simple lets assume a hypothetical, zero coupon bond due in one year that I buy on January 1 and it matures a year later on Jan 1. If its face value is 1K but I buy it at a discounted price of $995 when inflation is running at 1.5 % then my nominal yield is $50 or 5% and my real yield calculated on the the day I buy the bond is 3.5%. If on the day the bond matures prices are actually 6% higher than they were on the day I bought the bond real yield calculated on the day I collect my $1000 is -1%. Why? Because I don't get to spend my $1000 until prices have appreciated by 6% and I only got 5% for use of my money.

Now just turn this around. Suppose I buy a 1K bond at an appreciated price of $1005, at maturity it has a nominal yield of -$5 or -0.5%, and if inflation is running at 2% my real yield calculated on the day I buy the bond is -2.5%. If at maturity, when I collect my $1000, prices are 3% lower than they were on the day I bought the bond my real yield computed on that day is +2.5%! A bond bought at a negative yield yields a positive real yield in such a case.

People will buy bonds with negative nominal yields when they anticipate an appreciation of the bond's currency by an amount greater then the absolute nominal yield.
More...

The original article, was all about the nominal yield of bank deposit accounts going below zero. What does your above post have to do with them, and/or how is the real yield positive on them?
 
Tsing Tao said:
The original article, was all about the nominal yield of bank deposit accounts going below zero. What does your above post have to do with them, and/or how is the real yield positive on them?
More...

My post doesn't have to do with deposit accounts. It was with regard to negative nominal yield on bonds which has to do with your post re people buying sovereign debt with negative nominal yield.

I did not read your post on deposit accounts, but perhaps I should note that negative real yield on bank deposit accounts is standard practice. So it is the normal practice, at least nowadays, for people to pay the bank for holding their money. I don't know about negative nominal yields on deposit accounts, but my guess is that it won't go to far.. because there is a limit to how much folks will pay for convenience. (My bank is on the verge of negative interest-- next stop, elimination of interest, then a small service fee.) Most of us just use deposit accounts simply as a safe place to temporarily park money.

You have to realize that in a very low inflation environment what was a small positive nominal yield on a deposit account when the inflation rate was higher will be adjusted by the bank to become a small nominal negative yield when the inflation rate sinks. This may be disguised as a "service fee".

My bank gives me a whopping interest of 0.02 % on my checking account balance. That's a positive nominal yield, but a negative real yield. I received the grand total of 39 cents from them just this last month! I can't imagine How I'll ever spend so much money! :D

You are just observing what happens in a very low inflationary, and therefore, low yield environment. It does make for some rather startling newspaper headlines however.
 
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piezoe said:
My post doesn't have to do with deposit accounts. It was with regard to negative nominal yield on bonds which has to do with your post re people buying sovereign debt with negative nominal yield.

I did not read your post on deposit accounts, but perhaps I should note that negative real yield on bank deposit accounts is standard practice. So it is the normal practice, at least nowadays, for people to pay the bank for holding their money. I don't know about negative nominal yields on deposit accounts, but my guess is that it won't go to far.. because there is a limit to how much folks will pay for convenience. (My bank is on the verge of negative interest-- next stop, elimination of interest, then a small service fee.) Most of us just use deposit accounts simply as a safe place to temporarily park money.

You have to realize that in a very low inflation environment what was a small positive nominal yield on a deposit account when the inflation rate was higher will be adjusted by the bank to become a small nominal negative yield when the inflation rate sinks. This may be disguised as a "service fee".

My bank gives me a whopping interest of 0.02 % on my checking account balance. That's a positive nominal yield, but a negative real yield. I received the grand total of 39 cents from them just this last month! I can't imagine How I'll ever spend so much money! :D

You are just observing what happens in a very low inflationary, and therefore, low yield environment. It does make for some rather startling newspaper headlines however.
More...

I got $565 in interest from my preferred account at 5/3 last year. The rate isn't all that great, but at least I am not paying money for them to hold it. I get the real interest rate argument, that is more opportunity cost than anything else when it comes to bank accounts. But negative nominal rates on accounts is an absurdity put on us by your precious Fed and other central bank monstrosities.
 
I agree, in the main, with your remarks. I wouldn't agree however that negative nominal rates on accounts is an absurdity. In effect, that has always been standard practice on demand deposits where a monthly fee is charged for balances below a threshold. The fee, in effect, represents a negative nominal yield, and the real yield, because of inflation, is even lower. The bank would lose money on these accounts if they did not charge a fee. In a very low interest environment the bank may not be able to both cover their costs and make a profit on even fairly large deposit accounts without a negative nominal yield (i.e. quoting a negative yield or charging an account fee.)
 
piezoe said:
I agree, in the main, with your remarks. I wouldn't agree however that negative nominal rates on accounts is an absurdity. In effect, that has always been standard practice on demand deposits where a monthly fee is charged for balances below a threshold. The fee, in effect, represents a negative nominal yield, and the real yield, because of inflation, is even lower. The bank would lose money on these accounts if they did not charge a fee. In a very low interest environment the bank may not be able to both cover their costs and make a profit on even fairly large deposit accounts without a negative nominal yield (i.e. quoting a negative yield or charging an account fee.)
More...

You need to go back in history to when banks didn't charge fees for smaller accounts. You don't really have to go back all that far, either. That was the day when banks used deposits to back loans, not prop desk trading. When they were banks, not investment banks. Now banks can't be bothered with depositors. Thanks, Fed, thanks Congress (Glass Steagal repeal, etc.)
 
It seems your beef is with the "Financial Services Modernization Act" (Gramm Leech Bliley Act)

We're on the same wavelength there! Modernization was needed, but not what we got.

I should mention that the 1935 banking act reduced the power of the Fed Branch banks and gave it to a Board of Governors, that we have today. It also reduced the potential for conflicts of interest (though it certainly did not eliminate the potential). It made the Board more independent of the Treasury and the Banks. The Gramm Leach Bliley Act reversed some of this and increased the power of the Branch Banks a bit, which in my opinion was not a good idea.

525px-GrammLeachBliley.jpg


The FSMA, spearheaded by Gramm, with broad industry support and nearly half a billion in lobbying and political contributions, led to precisely what Michigan's John Dingle said it would, viz., "institutions to big to fail that would have to be bailed out by the Federal Government". Although this was a Republican initiative, the measure had bi-partisan support. Clinton, Greenspan, Rubin and Summers were all onboard by the time the "thing" finally, after years of lobbying, passed.

You might find the following from an October, 1999, NYT article interesting.

"October 23, 1999
Agreement Reached on Overhaul of U.S. Financial System
Related Articles
  • Leading Up to the Decision on Banking Reform
    By STEPHEN LABATON


    w.gif
    ASHINGTON -- The Clinton Administration and top Republican lawmakers reached an agreement early Friday to overhaul the financial system, repealing Depression-era laws that have restricted the banking, securities and insurance industries from expanding into one another's businesses.

    The deal was announced about 2 A.M. after a compromise was reached over the measure's effect on lending rules for the disadvantaged, the source of months of partisan bickering between the White House and Senator Phil Gramm, the Texas Republican who heads the banking committee.

    It concludes decades of attempts to rewrite banking laws to catch up with a marketplace that has already experienced broad consolidations and the rise of financial conglomerates offering bank and brokerage accounts as well as insurance.

    While these conglomerates have found ways around the old rules, those rules had made it expensive and at times impossible to expand into new lines of financial services.

    For instance, the nation's largest financial services company, Citigroup, would have been forced to sell some of its insurance operations as part of the $72 billion merger last year between Citibank and Travelers Group without either the legislation or a waiver from regulators.

    With such situations in mind, the banking, insurance and securities industries spent more than $300 million in 1997 and 1998 alone on a combination of donations to political candidates, soft money contributions to political parties and lobbying.

    The legislation will more easily enable financial companies to offer corporate clients a full range of services, from traditional loans to investment banking services, like public stock offerings. And for consumers, it paves the way for financial supermarkets, which will be able to offer one-stop shopping for an array of services, all under one roof. The measure is also expected to clear a path for a new and bigger wave of corporate deal-making as more companies consolidate.

    White House officials withheld final approval of the agreement until aides could see the measure's language. But the officials indicated Friday night that, with broad support from Democrats in Congress, the measure was all but certain to be signed by President Clinton. As such, it will be one of the most significant pieces of legislation to be written by the White House and the 106th Congress, which began its term considering whether to remove Clinton and has had a bitter relationship ever since.

    "When this potentially historic agreement is finalized," Clinton said in a statement, "it will strengthen the economy and help consumers, communities and businesses across America."

    Treasury Secretary Lawrence H. Summers said in an interview, "At the end of the 20th century, we will at last be replacing an archaic set of restrictions with a legislative foundation for a 21st-century financial system." The measure, he added, "would provide significant benefits to the national economy."

    Senator Gramm said the measure "is the most important banking legislation in 60 years."
...
for the remainder of the article please see (too long to post here)
Please see http://partners.nytimes.com/library/financial/102399banks-congress.html
 
piezoe said:
It seems your beef is with the "Financial Services Modernization Act" (Gramm Leech Bliley Act)

We're on the same wavelength there! Modernization was needed, but not what we got.

I should mention that the 1935 banking act reduced the power of the Fed Branch banks and gave it to a Board of Governors, that we have today. It also reduced the potential for conflicts of interest (though it certainly did not eliminate the potential). It made the Board more independent of the Treasury and the Banks. The Gramm Leach Bliley Act reversed some of this and increased the power of the Branch Banks a bit, which in my opinion was not a good idea.

525px-GrammLeachBliley.jpg


The FSMA, spearheaded by Gramm, with broad industry support and nearly half a billion in lobbying and political contributions, led to precisely what Michigan's John Dingle said it would, viz., "institutions to big to fail that would have to be bailed out by the Federal Government". Although this was a Republican initiative, the measure had bi-partisan support. Clinton, Greenspan, Rubin and Summers were all onboard by the time the "thing" finally, after years of lobbying, passed.

You might find the following from an October, 1999, NYT article interesting.

"October 23, 1999
Agreement Reached on Overhaul of U.S. Financial System
Related Articles
  • Leading Up to the Decision on Banking Reform
    By STEPHEN LABATON


    w.gif
    ASHINGTON -- The Clinton Administration and top Republican lawmakers reached an agreement early Friday to overhaul the financial system, repealing Depression-era laws that have restricted the banking, securities and insurance industries from expanding into one another's businesses.

    The deal was announced about 2 A.M. after a compromise was reached over the measure's effect on lending rules for the disadvantaged, the source of months of partisan bickering between the White House and Senator Phil Gramm, the Texas Republican who heads the banking committee.

    It concludes decades of attempts to rewrite banking laws to catch up with a marketplace that has already experienced broad consolidations and the rise of financial conglomerates offering bank and brokerage accounts as well as insurance.

    While these conglomerates have found ways around the old rules, those rules had made it expensive and at times impossible to expand into new lines of financial services.

    For instance, the nation's largest financial services company, Citigroup, would have been forced to sell some of its insurance operations as part of the $72 billion merger last year between Citibank and Travelers Group without either the legislation or a waiver from regulators.

    With such situations in mind, the banking, insurance and securities industries spent more than $300 million in 1997 and 1998 alone on a combination of donations to political candidates, soft money contributions to political parties and lobbying.

    The legislation will more easily enable financial companies to offer corporate clients a full range of services, from traditional loans to investment banking services, like public stock offerings. And for consumers, it paves the way for financial supermarkets, which will be able to offer one-stop shopping for an array of services, all under one roof. The measure is also expected to clear a path for a new and bigger wave of corporate deal-making as more companies consolidate.

    White House officials withheld final approval of the agreement until aides could see the measure's language. But the officials indicated Friday night that, with broad support from Democrats in Congress, the measure was all but certain to be signed by President Clinton. As such, it will be one of the most significant pieces of legislation to be written by the White House and the 106th Congress, which began its term considering whether to remove Clinton and has had a bitter relationship ever since.

    "When this potentially historic agreement is finalized," Clinton said in a statement, "it will strengthen the economy and help consumers, communities and businesses across America."

    Treasury Secretary Lawrence H. Summers said in an interview, "At the end of the 20th century, we will at last be replacing an archaic set of restrictions with a legislative foundation for a 21st-century financial system." The measure, he added, "would provide significant benefits to the national economy."

    Senator Gramm said the measure "is the most important banking legislation in 60 years."
...
for the remainder of the article please see (too long to post here)
Please see http://partners.nytimes.com/library/financial/102399banks-congress.html
More...


bogus straw man

A long list of world famous economists, including Nobel winners, tried to get the gov't to let the banks fail in 08. Just wanted the insured deposits backed. That's the way it should have been done. Gramm had nothing to do with the multi trillion dollar bailout.
 
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