Originally Posted by
WilliamShrugged
I have really no understanding of bonds, but i've heard that their is/could be a bubble in bonds(Faber,Schiff). I have heard that bonds are long term but people are shorting them. But this makes no since to me. I don't know much about investing and bonds. If anyone could explain this to me (like you would to a child)
i would greatly appreciate it.
This is a simplified version of economic bubbles. A thorough study is warranted if you wish to understand exactly what happened. This is generally the way I understand it.
Think of economic bubbles much like a balloon. The balloon will not expand unless someone forces air into it. In that same way, forcing money into specific investments cause bubbles.
In the early 90s, 401k's were fairly new retirement investment vehicles created by law. 401k investments are tax advantaged. People became allowed, by law, to invest savings from income earnings into the stock market, or other investments, and consequently defer taxes until retirement. The idea was to boost to savings in the U.S. and provide additional retirement money for individuals.
The Internet Tech Stock Bubble
Much of this investment money went to the promising new Internet tech stocks because the government "virtually forced" investment somewhere and tech stocks were a good place for it to go as "gamblers" (otherwise known as financial advisors) bid those stocks up based, not on profits, but on price of stock. One guy said, "I'll buy ABCD.com for $25, and the next guy said, "I'll pay $30", and the next guy said, "Ill pay $40" and so on... up to $400 or more for some stocks. Even though the ABCD.com Company, INC. never produced a viable product that was sold for a profit, their corporate owners made tons of cash. The company was not a profitable company, yet the first guy in, along with scammers, made millions, and some even made billions. The bubble was blown up from the value of say ... $25 to $400+ per share.
Then when people started figuring out that many of the Internet tech companies were not profitable, people pulled their money out of those stocks, and the bubble collapsed. Some people got rich (early investors and owners). The people that made money started looking for a new place to put money since tech stocks weren't doing so well anymore. Enter real estate.
The Real Estate Housing Bubble
Real estate came into the picture real big at the collapse of the Internet tech stock bubble. Real estate had a solid history of being a safe investment, so people started putting their money into real estate. Before long housing prices started to rise and the first ones in started seeing their personal wealth rise. Flipping houses became popular because a smart investor could buy a run-down home for $75k put $5k into it and sell it for $125k. That was a tidy little profit for a couple month's work. Then TV gurus started sharing this "no money down" technique for buying real estate and the house flipping get rich quick went nationwide. New housing was booming too because people like new shiny stuff. Mortgages became easier to get as lenders relaxed lending standards.
Lots of people began making a lot of money. Mortgage lenders, real estate brokers, investment bankers, the whole economy was "hot." Governments began promoting home ownership as the "American dream." Fannie Mae, Freddie Mac, Ginny Mae, HUD, FDIC and other government institutions guaranteed loses to private investors, so lending standards were lowered even more.
By 2005, the "no money down", "stated income", "no document proof" loans were as simple to get as walking into a local mortgage store front (wearing a nice suit) and stating, "I make $100k per year and want to buy a home." Lender says, "How nice of home do you want?" Borrower says, "How nice of home can I buy?" Lender says, "Do you really make $100k, or is your income $135k? Because if you make $135k then you can buy this brand new home in a gated community on the golf course for $700k. The developer is an old friend of ours, they build excellent communities, and it looks like you might qualify." Borrower says, "I'm pretty sure that I'm getting a raise next week, and that should put me around $135k." Let's do it!
Housing prices skyrocketed until the bubble burst in 2007. The housing bubble burst because the borrower did not get his expected raise, and as a matter of fact, did not really make $100k/year to begin with. So he could not make his payments. Enter the bond market.
The Bond Market Bubble
The bond market has a long stable solid history of being a sound investment. Bonds are typically low yielding but losses are guaranteed by the U.S. Government. Yada... yada... yada... enter what cubical, and others, are saying ... ie. the bond market is building a bubble.
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