The bond market is saying that it’s safer to lend to Warren Buffett than Barack Obama.
Two-year notes sold by the billionaire’s Berkshire Hathaway Inc. in February yield 3.5 basis points less than Treasuries of similar maturity, according to data compiled by Bloomberg. Procter & Gamble Co., Johnson & Johnson and Lowe’s Cos. debt also traded at lower yields in recent weeks, a situation former Lehman Brothers Holdings Inc. chief fixed-income strategist Jack Malvey calls an “exceedingly rare” event in the history of the bond market.
Credit markets are typically the first to raise a red flag of trouble: Before the stock market crash of 1987, yields on bonds suddenly and, of course, unexpectedly surged. A few months later, the stock market crashed. In 1997, Russian bond yields were in triple-digit territory before the ruble crisis hit. And a few months later, the stock market crashed. In 2007, the global marketplace began to shudder under the weight of bad mortgage debt and, well, you know what happened to the markets in the fall of 2008.
Berkshire Hathaway, the castle Buffett calls home, is rated Aa2 by Moody’s and AA+ by S&P. The USA rating: AAA. The price action in the corporate bond market is far from usual. In theory, those who were the triple-A crown can borrow more cheaply than anyone else in the credit kingdom. Bloomberg vividly explains:
“It’s a slap upside the head of the government,” said Mitchell Stapley, the chief fixed-income officer in Grand Rapids, Michigan, at Fifth Third Asset Management, which oversees $22 billion. “It could be the moment where hopefully you realize that risk is beginning to creep into your credit profile and the costs associated with that can be pretty scary.”
More red flags:
Last week, Moody’s rattled the cages of the US debt market, by suggesting that the US may lose its coveted triple-A rating, an event T/S colleague Michael Pollaro wrote about (don’t miss his graphics). As Bloomberg notes in its story on the Buffett bonds, Moody’s worries that US tax receipts may hit 7% of debt payments in 2010 and 11% by 2013; only the UK spends more. Memo to Moody’s: Last month, tax receipts accounted for nearly 16% of interest on the national debt.
Economists like Richard Koo of Nomura Securities argue that government needs to flood the market with cash because what we are experiencing is different from previous turndowns. Like Japan, we are undergoing what Koo calls a balance sheet recession. This is no time to choke a recovery, Koo and others argue. The recovery programs have helped to stabilize the economy, and as a result, Standard and Poor’s expect corporate defaults to plunge to 5% from 10.4% in February, Bloomberg reports.
This may be true. But there are important differences between Japan and the US, which carries a debt-to-GDP ratio of 88%. Investment firm Hedgeye focuses on this in its daily commentary this morning:
The Japanese currently have a debt-to-GDP ratio of almost 200%, and, as the narrative fallacy goes, they are fine. This higher debt ratio is cool because most of it is owned domestically by the government (about half) and 95% of the remainder is owned by Japanese citizens, so foreign investors have very little sway. In addition, Japan has very low interest rates, and its overall cost of servicing debt is 1.3%. All good, right? Being Japanese is cool?
Not exactly: Hedgeye fears for all the spending will be inflationary in the U.S. But even if that doesn’t pan out, Hedgeye notes that Japan is hardly worthy of imitation for another reason: Its stock market has been largely in a state of decline for the past 30 20 years.