What if we have another crisis.

As a teenager in Orange County, I remember the days when Citron got busted for going long.  An over simplified summary is that, this man borrowed short and went long on treasuries.  How could anything go wrong?  Borrow at a low short term rate, and lend at a higher long term rate?

As more banks,treasurers, and retail investors do the same, the value of the long bond continue to increase.  With money tied up in treasuries, inflation tamed, and treasuries rose more.  Citron was a hero.

The problem is that the long bond can’t forever drop.  Once the spread hits a certain level, investors that are leveraged are called on.  They have to sell their longs.  As a result the treasuries begin to rise.

This can have a disastrous effect on the economy.  When leveraged investors/banks have to sell an asset declining in price, money literally vanishes from our money supply.  Yields can increase while money is sucked back into the banks writedowns.  Overnight, a treasury yield increase of 1% may in fact equate to a real yield increase of 3-4%.

Are there any investors trying to capitalize on this opportunity?  Of course, otherwise we wouldn’t see any participants  willing to fund 0.4% interest CD’s and money market funds.

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