Summary: That ‘70s Show - Remember gas lines?In the late 1970s, government involvement in energy markets reached a new high. They didn’t want consumers to pay excessive prices for gasoline at the pump, so they controlled what the oil companies could charge. No problem, said the markets. Instead of charging consumers more money, it charged them more time. If you’re too young to recall this episode in market mismanagement, just google the phrase “gas line 1970s image” and you’ll get an idea of what I’m talking about.By keeping prices artificially low, the government created a shortage—too much demand and not enough supply. It’s an old saw in economics that you can control the price of something or the supply of something, but not both. Well, a similar thing is happening now in the credit markets. By buying up half of the mortgage-backed securities produced every month plus promising to keep short-term rates at zero forever, the Fed has created a bond shortage.Investors who need to buy fixed income securities are lining up to pay premium prices for corporate and structured products. Remember CLOs: Collateralized Loan Obligations—the bizarre deals for sophisticated investors only with 23 pages of risk factors in their marketing materials that helped blow up a couple of German banks (it’s always the Germans) that Fabulous Fab and John Paulson and Magnetar used to make billions? A few months ago it took months for Wall Street to sell one of these fiendish concoctions. Now they fly off the shelves in hours.This is what the Fed wants. As they put risk-free assets into their balance sheet storehouse, the market reduces the cost of capital for risk-taking enterprises. Those businesses are supposed to hire and spend on new projects to spur the economy back into recovery mode. Unless they don’t.What looked like a windfall for oil companies didn’t end well in the ‘70s, as overpriced oil created a glut in the ‘80s—with a collapse in prices—and the entire State of Texas was seemingly hollowed out by the early ‘90s. Booms and busts inevitably follow price manipulation. It’s hard to tell where the bond shortage will end this time, but as markets get increasing euphoric, it’s not a bad idea to be a little bit cautious.Douglas R. Tengdin, CFA Chief Investment OfficerFollow me on Twitter @tengdin
