Bonds

Bonds

I spent some time talking to one of my readers who is an institutional bond salesman, and the more I look at the situation, the more sense it makes to buy government agency bonds. Yes, buying a 30 year bond when the prospect of substantial inflation to pay for the enormous deficits that Obama is running up isn't spectacularly wise--but the bonds that are financing houses will be called well before maturity. That's part of why these agency bonds (such as Fannie Mae) pay pretty decent interest rates--because they are likely to be called well before maturity.

Why? Because when Fannie Mae, or one of the other housing agencies issue 30 year bonds, it is to finance a collection of mortgages. If interest rates fall, borrowers refinance their houses, and pay off their mortgages. The agency then calls the bond--which means that they pay you the face value of the bond to get it back. If interest rates rise (as will certainly happen in response to rising inflation), there's less chance that borrowers will refinance their houses--but people still sell their houses, to sell up (because inflation is making their homes worth more), to relocate, or because the primary breadwinner dies, loses his job, or it's time to downsize after the kids have left home. That will also cause the bonds to be called.

There's no question that rising inflation might well cause one to get stuck with bonds that are now worth less than you paid for them. Worst comes to worst, you hold the bonds until maturity or they get called. Neither of these is optimal, but to completely get away from risk usually means a dismal rate of return. There are some Fannie Mae bonds due in 2038 that are available right now with an annualized yield to maturity of 5.510%. If they get called, the annualized yield to worst is still 5.510%. For something with the full faith and credit of the U.S. government behind it (now), that's not too bad!

I suppose that the federal government could indeed go belly-up--but if that happens, money in banks won't even be particularly safe. At that point, MREs and NATO standard caliber ammo will be the only safe investments.