Why Credit Markets Are the New Insurers of Global FinanceBy
Low premiums due to govt socializing of risk: Thiruvadanthai
Credit in lose-lose position amid bid to reduce volatility
The search for financial safety in the post-crisis era is alive and well.
Investors trying to fathom the mania in credit markets that’s evaporating any cushion for losses can think about it like this: Credit markets are the new insurers of the financial system.
Low premiums are a natural step in the decades-long drive by central banks and governments to socialize risk, according to Srinivas Thiruvadanthai, the director of research at the Jerome Levy Forecasting Center in Mount Kisco, New York.
“Over the past thirty years, the nature of government involvement has changed from establishing a floor to smoothing fluctuations,” he wrote in a blog post this month. “We have gone from crisis-fighting to promoting tranquility -- that is, from selling a put to reducing” volatility, he said.
It suits both stock investors and governments for central banks to keep borrowing costs and market volatility at bay. It’s backstopping public programs and shareholders and giving the appearance of stability in the financial system, added the researcher at the forecasting and consulting agency in the post.
“The real beneficiaries are equity investors and government bond investors,” Thiruvadanthai wrote. “Credit investors are effectively selling a put option to the borrowers (equity holders).”
All-in-all, the quixotic quest by governments and central banks to insure against volatility has transformed credit into a lose-lose asset class -- a sharp jump in real economic growth would spur price drops, but so would a sizeable fall.
Investors should be prepared, Thiruvadanthai said, as despite the decline in economic volatility, the imbalance in financial markets has actually worsened in the past thirty years.
“As Minsky said, stability leads to instability,” he wrote.