3/28/2007 – Evidence of a bubble in the debt markets

For any investor worried about managing risk there is a must-read March 27th article in the Wall Street Journal by Dennis K. Berman. 

Here is a link for anyone with a paid subscription: Wall Street Journal Article 

This article highlights the frenzy going on in the overheated debt markets. The comment that really caught our eye was from a Princeton economist who studies bubble named Markus K. Brunnermeier. Referring to the banks that make loans and sells them to institutional investors he said, “You try to forecast when the others are getting out. You don’t focus on the fundamentals. You focus on the other players.” 

In other words, “the greater fool theory” is alive and well in the bond market. When market players stop focusing on fundamentals and become dependent on the actions of others, prices are no longer tied to value and can become inflated. 

At some point these fools will stop buying debt with modest returns and high risk. When this occurs asset markets will likely readjust to lower valuation levels.