and all the bubbles go pop

if you needed any more evidence that financial markets defy the typical constraint of pure rationality, these tidings of doom should punch any lingering doubts right outta you, along with a couple teeth. it appears that at least one analyst is predicting that a new bubble will menace the financial sector, and that it will, exacerbated by general economic grimness, burst fairly soon. money has been pouring into corporate bond markets at a record rate, and it has, not coincidentally, been doing so since about last september. this is largely because the spread between short-term interest rates on government debt and corporate debt has widened considerably since most national governments began slashing religiously the price of money. if it means something to you, the gap is now 4.38 percentage points; if it doesn't, then just consider that the number is a record. this analyst, at scotland's royal bank of, he whose wolf-crying is at the center of the article; this analyst thinks corporate bond rates are vastly overinflated, largely because the corporations offering them are either technically insolvent or else about to thelma-and-louise it over the brink. interest rates wouldn't be so high if demand weren't at an all-time high, and demand wouldn't be so high if the supply of other kinds of money weren't particularly low. in other words, companies have terrible balance sheets and can't raise the capital to shore them up from the usual source, namely, each other. they've now turned, as the government has, to private capital, and are willing to pay through the nose to attract it.

now, if they're willing to pay high interest rates, why should we be concerned? the answer goes back to insolvency--that is, many of the bond-issuers are selling what should be junk grade securities, and what, almost inevitably, will be junk grade, once they're forced to make earnings reports. the end result? moody's and the s&p hit these new bonds hard, the bonds in turn loose a significant amount of value, and, bob's your uncle, the pool of private capital shrinks a bit more. how much damage could be done is currently indeterminate, but from my quick review of bloomberg bond statistics it looks like volume is highest, and growing higher, in high yield markets. high yield bonds are riskier than so-called investment grade bonds; and it's telling that in low-risk categories, volume has stayed relatively flat.

is the threat overblown? i don't know, but, regardless, this is still an instructive case study in the irrationality of financial markets. that that irrationality is idiosyncratic to finance has a lot do with the commodity at its heart: money. money is unique: it has almost no fixed, and, thanks to deregulation and the virtual space within which it is transacted, almost no movement costs. the speed at which it is moved also necessitates that information about it is less transparent; money moves so quickly that it is hard to tell what, exactly, is happening to it. far less money is, then, able to chase the highest return better than anything else on the planet. as the current corporate bond bubble demonstrates (not to mention almost every other bubble in history), the plain fact is that the highest return does not produce the most efficient outcome when subject to the constraint of imperfect information. in lieu of a more accurate picture of markets, investors rely on a few simple heuristics to understand what their profit-maximizing decision will be. what we end up with more often than not, then, is either bull-headed arrogance or chicken-hearted panic, and not, surprise, surprise, rational, utility-maximizing decision-makers.