Hold-to-Maturity = Mark-to-Myth?

The big bailout is unlikely to work

LONDON: The U.S. "hold-to-maturity" bailout plan is really just the new "mark-to-myth," and even its heroic proportions are not likely to paper over solvency problems in the banking system.

I've been thinking about this idea for a few days and how it applies to my own personal finances. I believe I have a new appreciation for what the banking system is going through.

As you may recall, I participated in the 20-Year TIPS (treasury inflation protected securities) auction in January. For the record, I put roughly 10% of my overall net worth in it. The yield ended up being 1.81% (above reported CPI inflation).

The yield today on the 20-Year TIPS is 2.42%.

If I was forced to sell my 20-Year TIPS today I'd experience a loss of roughly 12% (0.61% times 19 1/2 years). Needless to say, I'm glad nobody is forcing me to sell. It gives me some small feeling of what the investment banks must be going through though as they are forced to sell. I'm in reasonably safe government backed TIPS. Just imagine what it would be like if it was subprime mortgage debt instead.

What does it really mean to me though? How much worse off will I be over the next 19 1/2 years? I know this might seem hard to believe, but I'll actually be somewhat better off. Here is my reasoning.

First, I'll still be earning 1.81% over reported inflation (technically 1.75% since I bought at a discount as part of the auction process). That doesn't change. In 19 1/2 years I'll be getting my inflation adjusted principal back. That doesn't change either. Therefore it is very hard to say that I could be any worse off in the long-term.

Second, the market is saying that inflation isn't going to be as big of a problem as I feared. That means that it is less likely I'll be earning 10% or more per year (say 8% inflation with 2% real yield) and being fully taxed on that 10%. That actually helps me. I may have overpaid for the inflation protection, but under no circumstances was I ever rooting for extra inflation. All it could do is hurt me (it would just hurt me less than people without inflation protection). I was also never rooting for a complete stock market and financial institution collapse. How could that possibly help me long-term? No, I'd be better off in the long run if the prosperity machine continued to fire on all cylinders (or at least appears to be firing on all cylinders). I might not do as well as my risk-taking neighbors by taking the safer path, but I'd still be doing okay.

Third, in 19 1/2 years I'll need to reinvest. Should these real yields hold up I'll be one happy camper at that point. That's a very good thing. My worst fear is that real yields turn negative, inflation skyrockets higher, and I'm left with no safe way to protect my nest egg without resorting to hoarding even more hard assets. Currently, the markets are saying my worst fear will not come to pass.

Fourth, I have more TIPS maturing soon (the next several years). It is in my best "interests" to root for higher real yields as I reinvest that money back into more TIPS.

Yet, here I am with a 12% loss on paper. It is a real loss and I'm certainly not trying to argue that it isn't, but it is simply an opportunity cost loss. The odds of depleting my nest egg have not gone up. Sure, had I waited I would have done better. That being said, in 19 1/2 years, based on what the markets are currently telling me (lower inflation going forward), I will still be doing better than I originally expected though. Ideally, at least as it applies to me, I'd be rooting for zero percent inflation and be getting paid a mere 1.81%. My taxes would be next to nothing. So how could I complain? The market is telling me that I'm somewhat getting my wish (just wish I could believe the market, it can tend to get very confused from time to time).

In summary, I have a 12% real loss, but it is the kind of real loss that lets me sleep better. I continue to "hold-to-maturity" and somewhat sigh in relief. It honestly doesn't concern me much what the market is willing to pay for what I own. I never intend to sell it, nor is it likely that I'll be forced to sell it. I guess that's what separates my risk from that of an investment bank.

This is the exact same mindset I have towards my toilet paper hoard. I have no doubts that the market would not pay me full price for it either (on eBay for instance). That also doesn't bother me though. I never intend to sell it either. Go figure. Further, if the market determines that I overpaid for my toilet paper hoard at some point in the future that's just fine too. It will simply be another opporunity cost loss. In fact, I'd root for it too. First, someday in the distant future I'll no doubt NEED to buy more. I will certainly not complain if it ends up being even cheaper. Second, even cheaper toilet paper means that hyperinflation did not wipe out my entire nest egg.

So is "hold-to-maturity" a "mark-to-myth"? As it relates to my personal finances, I don't see the myth in my reasoning. Perhaps there's some glimmer of hope that the same could be said of the government's plan. Oh my, I said something optimistic again. I better not make a habit of this. I think that's the second time I've done it since starting this blog, lol.

If, and this is a big if, the pricing in the market has hit an illiquid wall and the government's intent is to merely unclog the system, I do think there is some hope. Unfortunately, that's a reasonably big if. There are SO many problems and this is but one of them. For example, should the entire global economy begin to bounce back and billions of workers world wide think driving cars is in their future while simultaneously helping us to exponentially grow our trade deficit, well, I'll no doubt be back to my old pessimistic (realistic and stagflationistic?) self in no time. Of that I assure you.