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Why are bond yields going down? Should I be concerned? In a word, NO.

You live in Germany. You want to buy bonds. This is what you can “earn.” Or, precisely lose. You’ll notice every bond, no matter what its duration, will lose you money. These numbers are courtesy Bloomberg.

Let’s say you live in the U.S. This is what you can earn:

You won’t get rich on these rates. But at least you get to earn something!

If you need to buy bonds — for whatever reason — you buy them here in the good old U.S. of A.

When lots of people buy something (like bonds) the price usually goes up.

When bond prices go up, their yield goes down.

Our Treasury yields are not going down because of some sinister event — like the economy about to crater. They’re going down because lots overseas people are buying them. Germany, by the way, isn’t the only overseas country where yields are negative. There are lots of them and they’re all piling into U.S. treasuries. Wouldn’t you?

My friend Ed Sonderling explained: Bond yields don’t anticipate the future. Stock prices anticipate the future. When stocks are going up — as they are today — they’re telling us we’re doing just fine — despite the unresolved China trade “war.”

The only impact of our trade war is that it adds volatility to the stockmarket, causing nervous nellies to panic and sell, as happened on Monday this week.

I can’t tell you not to panic. I can tell to gaze upon one of the views from our Slovenian bike ride last week. Peaceful. Tranquil. And no panic. Taken with my trusty iPhone 8 plus.

Meantime let’s go back to 2008

Yields were much higher. Wall Street is doing what it always does — creating product to sell to unsuspecting investors — private and institutional. They are bundling mortgages — some good, some bad — into packages for sale. To make them attractive you enlist the aid of rating agencies.

Just like your house appraiser, the more you pay him, the higher the valuation or the safer your valuation. If you didn’t like one guy’s opinion, there were plenty of others who’d give you what you want. And help your move your stuff off your balance sheet onto someone else’s. You make sure to take a commission.

You’d think this practice would have been outlawed after 2008. You’d be wrong. Today’s Wall Street Journal tells all. This is amazing stuff. Truly amazing”

The Mall at Stonecrest’s former Sears entrance in May. S&P has said a security tied to the mall’s mortgage wouldn’t lose money. DUSTIN CHAMBERS FOR THE WALL STREET JOURNAL

Times are tough for the Mall at Stonecrest in suburban Atlanta. The Kohl’s closed in 2016. The Sears shut in 2018, and the Payless ShoeSource finished its going-out-of-business sale in May. When a $90.5 million mortgage came due last summer, the mall’s owners defaulted.

Through it all, S&P Global Inc. SPGI 3.53% has said a security tied to the mall’s mortgage wouldn’t lose money. S&P says the “situation is fluid” and “we won’t hesitate to revisit the rating.”

Inflated bond ratings were one cause of the financial crisis. A decade later, there is evidence they persist. In the hottest parts of the booming bond market, S&P and its competitors are giving increasingly optimistic ratings as they fight for market share.

All six main ratings firms have since 2012 changed some criteria for judging the riskiness of bonds in ways that were followed by jumps in market share, at least temporarily, a Wall Street Journal examination found. These firms compete with one another to rate the debt of borrowers, who pay for the ratings and have an incentive to pick rosier ones.

There are signs some investors are skeptical. Some bonds in markets where ratings criteria have been eased don’t trade at the high bond prices their ratings suggest they should. Investors have also shown skepticism about ratings on some corporate and government bonds.

“We don’t trust the ratings,” says Greg Michaud, director of real estate at Voya Investment Management, which holds $21 billion in commercial-real-estate debt.

The problem is particularly acute in the fast-growing market for “structured” debt-securities using pools of loans such as commercial and residential mortgages, student loans and other borrowings. The deals are carved into different slices, or “tranches,” each with varying risks and returns, which means rating firms are crucial to their creation.

The Journal analyzed about 30,000 ratings within a $3 trillion database of structured securities issued between 2008 and 2019. The data, compiled by deal-tracker, allowed a direct comparison of grades issued by six firms: majors S&P, Moody’s Corp. MCO 2.90% and Fitch Ratings, and three smaller firms that have challenged them since the financial crisis, DBRS Inc., Kroll Bond Rating Agency Inc. and Morningstar Inc. MORN 2.07%

The Journal’s analysis suggests a key regulatory remedy to improve rating quality-promoting competition-has backfired. The challengers tended to rate bonds higher than the major firms. Across most structured-finance segments, DBRS, Kroll and Morningstar were more likely to give higher grades than Moody’s, S&P and Fitch on the same bonds. Sometimes one firm called a security junk and another gave a triple-A rating deeming it supersafe.

“The victims are the investors,” says Marshall Glick, a portfolio manager at investment firm AllianceBernstein LP. He was among a group of professional investors who in 2015 complained about inflated ratings to the Securities and Exchange Commission and asked the agency to make it harder for issuers to cherry-pick the best ones, internal SEC memos show.

The SEC didn’t implement their recommendations, multiple meeting participants say. Jessica Kane, director of the agency’s credit-rating division, declined to comment on the investors’ concerns, saying through a spokeswoman: “We encourage anyone with comments, recommendations or concerns to reach out to us.”

Rating firms say they don’t let business influence ratings. “Just having a higher or lower rating on a deal doesn’t make you more or less aggressive. It just either makes you wrong or right in the long run,” says Kunal Kapoor, chief executive officer of Morningstar, which acquired DBRS last month. “I stand behind our methodology.”

Moody’s says “the regular adjustments we make to our models, methodologies and assumptions reflect evolving market conditions.” Fitch says “we are focused solely on getting the credit right.” S&P says “we compete on analytical excellence” and “no ratings business model is immune from potential conflicts of interest.” Kroll says that since its 2011 market entrance, “we have forced incumbent agencies to do better research and reexamine underserved sectors that they previously overlooked.”

After the financial crisis, ratings firms were criticized for taking lucrative fees and giving high grades to risky securities that caused big losses for investors. S&P paid $1.5 billion to resolve crisis-era litigation, admitting it set out to change rating models to benefit market share but not admitting wrongdoing. Moody’s settled for $864 million without admitting wrongdoing.

Investor reliance on credit ratings has gone from “high to higher,” says Swedish economist Bo Becker, who co-wrote a study finding that in the $4.4 trillion U.S. bond-mutual-fund industry, 94% of rules governing investments made direct or indirect references to ratings in 2017, versus 90% in 2010.

Strong bond issuance and a rebound in the lucrative structured-securities market have brought good times back to the rating industry. SEC disclosures show fees for rating structured deals can top $1 million. Industry revenue rose 20% to $7.1 billion in 2017 from 2016, the most recent SEC data show. S&P’s and Moody’s shares are up more than eightfold in the past decade, and their stocks hit all-time highs last week.

Two fast-growing structured-bond sectors are commercial mortgage-backed securities, or CMBS, and collateralized loan obligations, or CLOs. CMBS fund deals for hotels, shopping malls and the like. CLOs are backed by corporate loans to risky borrowers, typically to fund buyouts.

In a May speech, Federal Reserve Chairman Jerome Powell compared CLOs to precrisis mortgage-backed debt: “Once again, we see a category of debt that is growing faster than the income of the borrowers even as lenders loosen underwriting standards.”

Systemic flaw

Behind the ratings inflation is a long-acknowledged flaw Washington didn’t fix: Entities that issue bonds-state and local governments, hotel and mall financiers, companies-also pay for their ratings. Issuers have incentive to hire the most lenient rating firm, because interest payments are lower on higher-rated bonds. Increased competition lets issuers more easily shop around for the best outcome.

The Four Seasons Resort Maui at Wailea, owned by billionaire Michael Dell and featuring oceanfront suites that can go for $14,500 a night, borrowed more and won higher ratings. In 2014, the hotel’s investment bankers hired Morningstar to rate a $350 million bond sale backed by the property’s mortgage. Morningstar gave ratings to six slices of the debt that ranged from triple-A, expected to withstand the Great Depression, down 14 rungs to single-B, susceptible to losses in a mild recession.

When the resort refinanced its debt in 2017 in a $469 million deal, bankers picked DBRS as one of two firms to rate the debt. DBRS had just loosened its standards for such “single-asset” commercial-mortgage deals. DBRS issued grades as much as three rungs higher on comparable slices rated by Morningstar in 2014.

DBRS’s market share doubled to 26% within months of the change, according to industry publication Commercial Mortgage Alert.

Morningstar in June 2018 revamped its methodology for these deals, and its market share swiftly rebounded. It was one of two firms the Maui hotel’s bankers picked to rate its next offering, a 2019 deal for $650 million. While the hotel’s income had grown since 2014, the debt increase meant various slices of the offering had less cash available to repay investors than in 2014. Morningstar issued grades as much as two rungs higher on comparable slices rated by DBRS in 2017.

That should have lowered borrowing costs. Instead, investors demanded yields above where Goldman Sachs Group Inc. and Barclays PLC investment bankers had initially hoped to sell the debt, say people familiar with the pricing.

DBRS referred inquiries to Morningstar, which says its Maui ratings partly reflected improvements at the resort and that the two firms’ methodology changes were meant to provide “greater transparency” to investors. A spokesman from Mr. Dell’s investment office referred queries to Goldman and Barclays.

Goldman referred reporters to a bond-offering document, pointing out disclosures saying bankers solicited “preliminary feedback” from six rating firms and hired two based on the size of their triple-A slices.


You need to read the full, long, engrossing article. It has drawings, diagrams and useful links. Click here.

 I’ll be back tomorrow.

I played tennis this morning and wiped myself out. I took a little nap and now I feel great.

That’s me in Trieste Italy. I bring new meaning to tourist elegance (??). Michael, my son, disowned me.

That really is an awful look.


  1. jpfreemon says:

    Dow rises 500 points after US delays certain tariffs on tech. I wonder who knows in advance when Trump paints the tape.

  2. TomFromVa says:

    Harry you could use those legs as parentheses.

    Recommend long pants for future photos

  3. gerryb says:

    One never has certainty in the marketsl
    Jim Cramer seems to agree with Harry today. Cramer: “I could easily spread fear of a recession. I was willing to scream it back in 2007 and 2008 when I thought you had a chance to get out.
    But we just don’t have those circumstances now. Instead, I want you to be calm and collected and I will not scare you with false fears. That way you can calmly do some buying next time we have a false fear dip and I hope you will trust me the next time when I say the fears are overdone and it is time to do some buying.”

    Jim Collins, on the other hand, is sounding the alarm:

    Listen Up: This Time Is … Not … Different
    While the bond market has been offering a dose of reality, the U.S. stock market couldn’t be more clueless to the heightened risk of a global financial meltdown.
    By JIM COLLINS Aug 08, 2019 | 02:51 PM EDT
    This time is different. Those are the four most expensive words on Wall Street. I learned that axiom when I first got off the bus — yes, I took a bus — from Central Pennsylvania to Wall Street in 1992 and I have not forgotten those words.

    I was remembering that truism yesterday, while listening to ace economist Andrew Hunt on a conference call sponsored by my firm, Excelsior Capital Partners. Andrew delineated the current funding gap facing China and a 5 trillion renminbi hole in the nation’s balance sheet that can’t be filled by printing more yuan. As offshore exchange rates fall below 7 renminbi to the dollar, printing more yuan will only further devalue the currency.

    So, China’s banks are in trouble, and Andrew even mooted the possibility of the Chinese government proactively sending one or two systemically important financial institutions into bankruptcy to score points against Western economies in the trade war. Wow.

    If that sounds far-fetched to you, as Andrew pointed out, it has happened before. That is the exact scenario that the Russian government engineered in the late-1990s. Thailand also had similar woes during that period, and Argentina has done it more than once.

    The bond market has figured this out. The inverted yield curve in every major sovereign debt market is certainly protection against another global financial crisis. Not full protection of course, but certainly reflective of the realization that a recession in China would hamstring its financial system to a degree that would wound, in some cases mortally, Western banks.

    While the bond market has been offering this dose of reality, the U.S. stock market couldn’t be more clueless to the heightened risk of a global financial meltdown.

    “La la la. Everything is good.” We had a little bump in the road Monday, but everything is fine now. Morons.

    The bond market is telling you to sell your stocks. If you are too busy starting fantasy football advice websites to notice this, well, you are not the only one.

    Economics is known as the dismal science for a reason. It’s not fun. When guys like Andrew Hunt talk, though, you should listen.

    Managers of multibillion-dollar bond funds are just as important to the global economies as stock fund managers. Jeff Gundlach of Double Line has been sounding a bearish note on global growth — which, as he knows, is bullish for bonds given the corresponding drop in inflation expectations — for the past 12 months.

    Have you listened? Your portfolio was rocked in December, May and the first few days of August. Did you do anything about it?

    You should. This time is not different. It never is.