The Face of Inflation: Does the U.S. Have a "Peso Problem" revisited

[raja]

Re: The Face of Inflation: Does the U.S. Have a "Peso Problem" revisited

As to your idea, I would look at a few issues. First, depending on the rate you get on the loan and the short term investments, you'll have some carrying costs and some losses up until the point you lock in long-term. Can you absorb these costs? Do you have sufficient cash flow? What if long term rates don't go up to where you expect, or they don't go up for a while? Is it possible you could lose money overall because of that? Your's isn't a risk free bet. You're essentially speculating that interest rates will go up enough long term to make up for your short term losses.

Next, you'll have to make payments on the HELOC or whatever other loan you take out once you lock in long term, so you have to look at cash flow after you lock in, too. Will interest payouts on your long term investment be enough to make the HELOC payments? If the payouts are every 6 months, can you cover the payments easily while waiting for your first interest payment?

Finally, taking out $100k loan will have some impact on your ability to borrow additional money and might tie your hands. As I stated above, for example, my credit rating went down considerably due to my loans. Since it was only for a year, though, and I didn't expect to be buying any houses this year, I didn't really mind.

But you're talking about 25 years. I don't know if a HELOC would hurt or help your credit rating, but there might be other consequences. What if you need to sell the house, for example? There are lots of scenarios where it won't matter, but there are also some where it will. Could you get trapped because you have to pay off the HELOC? Any chance you might need the credit for something else? Also, obviously, you wouldn't want to get a HELOC for a shorter term than your bond.

Thanks for your warnings, Andreuccio.
You have brought up many good points -- all things to be careful about.

During the conceptualization of this plan, I had thought about all the issues you mentioned, except one . . . .

You said that having the loan may affect my credit rating and my ability to borrow more money. I'm not very familiar with this subject, and I wonder why this would be the case? Doesn't one's credit rating only go down if there is a default of some sort? Wouldn't the ability to borrow money largely depend on available collateral or income, not on the fact that one has other loans outstanding?

If you or anyone could elaborate on this, I would appreciate it . . . .
.

[raja]

Re: The Face of Inflation: Does the U.S. Have a "Peso Problem" revisited

I do wonder if this carry trade will ever work as it did in the past. If bond rates go into double-digit range, it's entirely possible that the government will further shorten the non-callable period. Such an implicit option on the bonds may make them less palatable to investors but I question if it will truly make them more difficult to sell. My understanding is that the U.S. bond market is the biggest and most liquid of the world's bond markets. Assuming the United States isn't on the fast track to zero, I don't see any other bond markets (yet) that can scale to handle all the money from the world's pension funds.

Milton,

I'm glad you didn't disappear

There are all sorts of unpalatable actions that a stressed government could take -- shorten call times, extend maturity dates to delay payment, declare an emergency then default in all or part, etc. I am aware of these risks, but give them a low probability.

Regards callability, even though the U.S. is the biggest, most liquid bond market, it still has to make the bonds attractive in the marketplace. That's the motivating factor behind the rise and fall of rates. If pension funds had no other choice but to buy T-bonds, then it seems the rates would always remain low . . . .

Making a 30-year bond callable in 5, 10 or 15 years seems strange to me. Why offer a bond for 30 years if the government feels it might need to call the bond after only a short time? It would certainly reduce the value of the bond, and therefore reduce the price someone would be willing to pay for it.

Even so, I'd probably more than break even after 5 years, so there is no risk of loss from callability that I can see . . . I just wouldn't earn as much as I'd hoped.

[Andreuccio]

Re: The Face of Inflation: Does the U.S. Have a "Peso Problem" revisited

Thanks for your warnings, Andreuccio.
You have brought up many good points -- all things to be careful about.

During the conceptualization of this plan, I had thought about all the issues you mentioned, except one . . . .

You said that having the loan may affect my credit rating and my ability to borrow more money. I'm not very familiar with this subject, and I wonder why this would be the case? Doesn't one's credit rating only go down if there is a default of some sort? Wouldn't the ability to borrow money largely depend on available collateral or income, not on the fact that one has other loans outstanding?

If you or anyone could elaborate on this, I would appreciate it . . . .
.

Credit ratings are based on a number of things. The most obvious is the one you mentioned: defaults, late payments, etc. But there are other things included as well. The one that specifically affected me is they look at the ratio of unsecured debt to available credit, and downgrade you as it goes up. I'm not sure of the specifics, but I think if you pass something like 75% of the available on any one credit card, that counts as a ding against you. I know this is true for unsecured credit, like CC's. I'm not sure it's applicable to a secured loan, like a HELOC. I've heard that the opposite might actually be true for secured debt: once you've made a few on-time payments, it actually improves your score. For more specific details, try either poking around on a site like http://money.cnn.com/ or try googling "FICO score".

The other way it might affect your ability to borrow you alluded to: available income. It's been a few years since I bought a house, and credit standards have loosened and then tightened since then, but the way it used to work was as follows: They would make two ratios, overall monthly debt payments to income, and mortgage payment to income for the house you were buying. I don't remember the specific numbers, and I think they loosened as time went on, but it was something like overall debt to income couldn't exceed .45, while mortgage debt was capped somewhere around .3. Thus, your carry would need to earn you $100 for every $45 of payment on your HELOC to have no impact. Earn more, you can borrow more. Earn less, you can't borrow as much.

Hope that helps.

Edit: One afterthought - Another way it might limit your ability to borrow, which you''ve probably already considered, depends on how liquid your bonds are. During the first part of my carry I put some of the money in a CD, but later on I decided the minimal extra interest wasn't worth the lack of liquidity. Is there any chance you could need to use the HELOC equity for something else, but be trapped because you can't liquidate the bonds?

[ocelotl]

Re: The Face of Inflation: Does the U.S. Have a "Peso Problem" revisited

know you weren't talking to me but comparing usa to mexico:

- low resources per capita - check
- basically a one party political system - check
- low educated population - check

uh, oh.

There is a fourth factor that plays also and that was present in Mexico between 1970 and 1982: Explosive federal indebtedness due to misunderstood overspending. The aftermath was that between 1982 and 1988 almost no one wanted to loan money to Mexico.

* Edition, March 31st 2008 *

It is rare around here to see this, but here it goes:

Mexico's Peso Rises to 19-Month High as Yields Lure Investors
By Valerie Rota
March 31 (Bloomberg) -- Mexico's peso rose to its strongest in 19 months, sending it toward a second straight quarterly gain, as a widening differential between Mexican and U.S. interest rates lures investors to the nation's fixed-income securities.
The Mexican currency has risen 4.5 percent since the Federal Reserve carried out in September the first of six cuts that have trimmed the benchmark U.S. rate to 2.25 percent from 5.25 percent. The peso may further strengthen if President Felipe Calderon gets legislators to end a ban on private and foreign investment in the nation's oil industry.


Continue...

As of the tables I've checked, it's not a "19 month strongest level", is a "24 month strongest", since the last time the USS/MXN rate was below 10.64 was at march 16th 2006 according to the "Fix" rate published every business day by Banxico. This means that so far into the year (Q1 2008) we have gone from 10.8972 (Jan 2nd) to today's 10.6482 (Mar 31st), based on the Fix rate, for a win of 2.34% measured in bonars.

I have a mixed feeling about this, first since it is not common to see something similar, second, since usually on US recessions the opposite has happened, third, because personally I don't think we have an economy so strong that it can stand this for long, given some groups of Mexican population prone to go into over expenses in US stores...

An opportunity as this only tells me that I have to use it to improve my options, given an uncertain prospective. I have to study more about what's really going on.

Since this is playing along with a second drop in Gold and Silver (little trade into the big trade), I'm going to take it easy this time, to see how it all develops. Things I'm going to watch apart of the US data of this week are:
- INPC of March 2008 (Mexican CPI inflation, Apr 7th)
- Bank of Mexico Announcement about monetary policy (Apr 18th)

And, talking about options, somehow I got to a 2 year old Carolin Baker article. "Killing Hope, Enlivening Options" and I think I can say something about her opinion about us.

Americans have grown to rely on their government, to trust their authority figures, and that's fine when they tend to stand to those expectations.

For centuries, Mexican people have seen series after series of authority figures that were not part of their community, most of the time they were either imposed by somebody else or were doctrinized by somebody else. The end has been the same, to use the authority to their own benefit in a larger or lesser degree, with notable exceptions (Lucas Alaman, Ignacio Comonfort, Benito Juarez, Sebastian Lerdo de Tejada, Francisco I. Madero, Eulalio Gutierrez, Adolfo Ruiz Cortínez and Adolfo López Mateos). This lack of reciprocity by authorities to the support of people, has diluted expectations for things in general to improve, not an erasing of hope per se.

Hope dies last, or so a popular saying in Spanish speaking countries say. But hope is not to be dilapidated in things that don't respond to it. One can put hope in his own working abilities, on the nuclear family well being or in the immediate community, but is growingly difficult to put hope in an authority figure that for most of the last generation, hasn't been up to the task. A practical case for this was the action of people after the September 19th 1985 earthquake. It was the people that took the initiative and organized for the rescue. The government took too long to give an answer.

Another saying resuming this attitude is "No se preocupe, ocúpese" (Don't worry, occupy) indicating that the best way to overcome a dire and difficult situation is to face it. We have to thrive with government, without government or in spit of the government.