Thursday, November 15, 2012

Are Junk Bonds the Next Bubble to Burst? Fed Has Pumped Up Risks and Prices

Not since the Federal Reserve (Fed) was formed in 1913 has the central bank taken such aggressive mone-tary action to stimulate the nation’s economy. They have reduced the funds rate to practically zero percent, pushed long term U.S. Treasury bond rates, adjusted for inflation, into negative territory, and bailed out non-banks, such as Goldman Sachs, with ultra-low interest rate loans.

Rather than increasing borrowing and spending by consumers and businesses, it has pushed investors into riskier “junk” bonds. U.S. junk-rated companies issued $46.6 billion of bonds in September representing a 59 percent increase over the previous month. Furthermore, the bond proceeds are going towards riskier ventures like mergers and acquisitions and to pay huge one-time dividends to private-equity owners. For example, private-equity owned Petco recently issued junk bonds in order to pay owners outrageous and unjustified cash dividends referred to as "dividend recapitalizations.”

What will burst the junk bond bubble and produce massive investor losses? Just as the Fed inflated the junk bond bubble, it will also deflate it as it raises interest rates to combat higher inflationary pressures as early as the end of 2013. As rates rise, bond prices fall generating potentially titanic financial losses for investors. Ernie Goss

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