Are "Safe Haven" Investments As Secure As We Think?

For any risk-adverse investor, bonds have always been the way to go. In comparing risk among various investments, bonds have long sat at the far end of the spectrum as safe haven investments. Bonds are easy to understand and are best defined as a promise, a promise that the issuer will pay you back with market-determined interest come the bond's maturity date. The idea that a bond is at its essence, just a promise, is what makes bonds so easily mistaken as the securest of investments, especially during weak economic times.

Unlike being a securitized investor, bonds typically have no securitization if a company goes under. Because bonds are just a promise, the investor will have no access to all of the liquidated assets held by the bond issuer during bankruptcy. This is why bonds can disappear just as easily as a company's stock when an economy goes through a crisis like that of 2008.

As of June 30th 2009, there was approximately $13.5 trillion in outstanding U.S. corporate and treasury bond debt, with the outstanding debt split evenly between the two. This combined total amounts to nearly the entire United States annual GDP. The main concern I have with so much money being owed in the bond market is that most of these promises were made during the boom phase prior to 2008. This was a time when companies were more likely to make over-extending promises to pay back bond-holders years down the line. Considering that there were virtually no forecasts predicting the recent global downturn, I believe some companies may have put themselves into a tough financial position by loading on too much bond debt, not knowing what was to come. It is also important to note that between 2004 and mid-2007, bond prices had steadily decreased causing bond yields to rise. This occurred because of the gradually increasing federal funds rate following the artificially low interest rates during Alan Greenspan's tenure as chairman of the Federal Reserve. Ultimately, this now means higher interest to be paid on each dollar of bond debt come maturity.

With the future only looking increasingly bleak for the U.S. considering the massive government debt, I fear that some companies will be under much pressure to honour bond commitments in the medium-to-long term. This is especially true when you consider the current deflationary environment that has helped contribute to the stand-still in U.S. growth. Until banks can afford to lend as much as they once did prior to 2008, money supply growth will continue to be sluggish. As an investor, I would be weary of any corporate bonds for undiversified companies that have yet to expand to emerging markets and are still exposed to a potential double-dip recession in the United States.

As companies will aim to cut costs and free up capital, I predict that pensions will be the first to come under attack. With so much money tied up in pension funds, struggling corporations may look to the attractive amounts of capital tied up in pensions as a way to greatly reduce costs. This is especially true if the U.S. continues its plan to slowly adopt and incorporate International Financial Reporting Standards (IFRS) which set out more strict accounting principles for pensions and benefits.

Finally, when the government does make the ultimate decision to get their financial house in order and attack the deficit, I believe this will further weaken the private sector and put increasing pressure on organizations to honour their bonds. If the future is even remotely close to what I predict for the United States, the tough times ahead will begin to test how much a promise is really worth.

- The Watchdog