SocGen investment strategist Dylan Grice does not think “safe-haven” assets are very safe.
In Grice’s latest note to clients, he compares the illusion of safety created by faulty regulation before the 2008 financial crisis to the new, impending wave of financial regulation on the table like Dodd-Frank in the U.S. and Basel requirements on a global scale.
Grice warns “madness is going on in the government bond markets” today, furnishing this long term chart of US Treasury yields going back to 1800:
Photo: Société Générale
From the note:
The regulations which told banks that AAA-rated bonds were risk free were designed to make markets safer. But they created an artificial demand for such bonds, which created an incentive for issuers to dress up bonds as risk free when they were anything but. The regulations effectively incentivized ratings agencies to rate them as risk free when they clearly weren’t. And today, the same madness is going on in the government bond markets.
It’s very difficult to see how government bonds are anything other than risk assets (lets face it, all assets are). Yet insurers are buying them because they’ve been told to take less risk (whatever that means) by the regulators. So they are taking more risk, and they will one day suffer the consequences. Banks in the eurozone are bust because they own so much of their local sovereigns’ debt. But they were told it was OK to do that by the regulators. So they let their guard down.
Indeed, having told banks that they were of sound balance sheet before the crises (Lehman Brothers Tier 1 risk-weighted capital ratio was 11% five days before bankruptcy), those same regulators today scratch their heads and wonder how banks became too big to fail. It’s all embarrassing really.