When Did Formerly Safe Bonds Become Unsafe?

BY busadmin  August 13, 2009 at 10:32 AM EDT

piggy bank; via Flickr

Question: My question is: What about U.S. bond holders? I’ve seen bailouts of incompetent banks and businesses and some selective shareholder groups. Investment grade bonds were considered to be the safest investment next to FDIC-insured CDs, but the bondholders are either getting wiped out (GM and Chrysler) or being discounted (Morgan Stanley, GE, GMAC, etc). High-grade bonds were supposed to be a safe, low-risk, low-reward investment, but they no longer are. When did the rules change? What is the possibility of some type of insurance for investment-grade bonds similar to the FDIC?

Paul Solman: Hey, lookit, Paul: You lend your money, you takes your chances. You get paid for lending — but no one can guarantee you’ll get paid back in full. The borrower could always go bust. It’s true of homeowners who take out mortgages they can’t afford, companies who take on debts they can’t service, countries that borrow more than they can afford to repay. History is littered with such cases, literally from the dawn of record-keeping itself.

Here’s a clay ‘envelope’ of a commercial loan, this one for about 6 pounds of silver, at the usual interest rate 20 percent a year with an extra 10 percent late fee. The place? Ancient Iraq. The date? Around 1800…BCE.

A broken envelope suggests the debt was paid. But New York’s Metropolitan Museum of Art has many unbroken envelopes, and they survive in collections the world over.

clay envelope; via Metropolitan Museum of Art/NewsHour

As historian Joan Aruz told me some years ago: “If the tablet is still inside the envelope, one would assume that the debt was not yet paid.”

Twenty percent. Plus a late fee. Sounds like a credit card company. Perhaps because, like credit card holders, borrowers from the cradle of civilization couldn’t be relied upon completely.

Here’s a message from two creditors named Silla-Labbum and Elani, ca. 2000 BC, from the book Letters from Mesopotamia by Leo Oppenheim:

“Thirty years ago you left the city of Assur….[W]e have not recovered one shekel of silver from you….If [you don’t], we will send you a notice from the local ruler and the police, and thus put you to shame in the assembly of the merchants.”

As a rule, the higher the price (interest rate) you’re getting from a borrower, the more risk you’re taking. Period. Sometimes, you get fooled. But why should any lender ever suppose their debt is guaranteed? It’s only as good as the finances of the borrower who promises to repay it. To think anything else is to be naive.