One of the surprising consequences of the flight from asset-backed bonds is the rally in short-term US Treasury notes. US Treasury notes are, when it comes down to it, just another IOU as well. But the collateral behind US Treasury bonds is the impressive and well-armed revenue collecting capacity of the Internal Revenue Service and the federal government of the United States of America. And for institutional investors, Treasuries with short maturities are as close as you can get to being in cash without actually being in cash.
Speaking of cash, it’s in a bull market. Cash and short-term government bonds will do well while the market sorts out how deep and vast the rot is in the mortgage-backed and asset-backed securities market. Judging by the chart we saw earlier this week, the rot is vaster and deeper than what we’ve already seen.
Hundreds of billion of dollars in US subprime loans made in 2004 and 2005 will reset at a higher rate later this year and early in 2008. The market can’t accurately value those loans now. This makes it difficult for stocks to fully “price in” the non-performing loans, all of which makes for a kind of slow-motion car wreck in financial stocks, the bond market and stocks correlated to the financial health of the US consumer.
The Daily Reckoning Australia