Where Did the Money Go?
Research for Online Investors

by John Dalt

3/11/09

Congress wants the Fed to release where the bailout money that has gone to AIG has migrated. After $162 billion, they would like to know where it went! It seems certain that much of this money was a backdoor bailout of Goldman Sachs and Merrill Lynch. The real question, that is unspoken, how much taxpayer money was paid overseas? Overseas banks and other countries (China) were large purchasers of Credit Default Swaps (CDS), these little jewels allowed European banks to buy our sub-prime mortgages and classify them as ‘A’ securities. This opened up the market for reselling the securitized toxic assets. The public will hit the ceiling when they find out tax dollars are going to guarantee securities held by overseas banks and countries. Like much else in Washington, the biggest questions are the ones that are not asked.

The rescue of AIG by our government is going to end up one of as one of our biggest mistakes. Everyone that bought crap (mortgage-backed securities) knew what it was, even with the nice (CDS) wrapping.

We have a copy of an article from 1999 in the New York Times, at our web site you can read it here. Regardless of what Barney Frank says, some people saw the problem coming.

20-year Treasury interest rates are moving lower. This is good for bondholders as they can still sell without discounting to current interest rate returns. I have warned you before to get out of any U.S. Treasury bonds before the interest rates start up, which would erode the principle of your holdings, if you wanted to sell before maturity. Bernanke told an audience on Saturday, the FED would “continue to forcefully deploy all the tools at our disposal as long as necessary…” Interest rates on 20-year treasuries hit their lowest in December, and have bounced up and down since. Corporate bonds offer greater yields and if you are selective in the companies can be very safe. You still have a window to move out of the ‘risky’ treasuries, but it may not be open much longer. A good article appeared on Bloomberg yesterday, you can read it here.

Jim Rogers makes a good case to short treasuries when the time is right. The best way to short treasuries is to buy the TBT, Ultra short 20-year treasuries. It moves twice the inverse of the value of a 20-year Treasury bond index. This is not a long-term play as it is a ULTRA fund, and will suffer tracking error. For a full explanation of the dangers of ULTRA funds read this. A safer play is to short the TLT. This is a straight fund that owns 20-year treasuries, beware you have to pay the interest that accrues while you are shorting the stock. This is currently around 4%, so it will eat into your profits if the market does not move immediately.

As interest rates go up, the value of existing bonds goes down. This may be hard to follow, so here is a little back of envelope math:

20-year Treasury paying: 

                            3%                         5% 

Face Value:          $1000                  $1000  

20 years interest      600                    1000 

Total Return:       $1600                  $2000 

What is a 3% 20-year treasury worth, when new ones pay 5%? 

Face value:          $1000 

Discount:                 400 

Market Value:         600 

20 years interest     600 

Total Return:       $1200

This is a simpler than real world, but demonstrates the problem. A 20 at 5% will double your money, a 20 at 3% will double your money if you buy it at a 40% discount. If you want to sell your bond after interest rates start up, you will have to sell them at a discount that matches the return current rates are paying. You can see the devastation even a small change in interest rates will have on the sales price of exiting bonds.

Everyone is looking for a Bull, Here he is.

The information presented in this newsletter is based on generally available news releases, corporate filings, current events, interviews and the editor’s opinions. It may contain errors and you should not make investment decisions based solely on what you believe you have read here. Do your own research, it is your money. If you lose it, it is your responsibility, not ours or your grandmothers! The editor may or may not have a position in any securities discussed. The editor may have held a position in a security earlier, or in the future.

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