We attended an auction of new household items in Abbotsford about 12 years ago while there visiting family. One particular auction item sticks in memory. It was a beautiful oak dining room suite with expanded seating to accommodate as many as 10.
I was already underneath it, crawling around looking at the workmanship while the auctioneer was describing the item.
I pulled apart the expansion mechanism and confirmed my suspicion - that this was in fact particleboard with a thin oak veneer. At that point he announced: "This one is a real gem. Solid oak! Guaranteed! Solid, solid oak!"
"Guaranteed" is a word, which is thrown around a lot in financial circles. An advisor can sell you guaranteed investments from any of dozens of different banks, insurers, corporations or governments.
The word has a certain pseudo finality to it; as if its use signals the end of the risk analysis. It's guaranteed? Guaranteed by whom? And what happens if the guarantor can't keep their promise? In short, not all guarantees are alike.
The risk-free investment has traditionally been the U.S. government t-bill. These instruments are guaranteed by the relatively stable finances and broad powers of taxation of the world's largest economy.
Although they are not backed by any hard collateral, any default would result in the country being punished severely by the bond market who would thereafter demand a much higher rate of interest to lend them money. (We are now witnessing this unfold in Europe).
What about the U.S. debt crisis? Worldwide, the U.S. dollar is still the home of choice for safe money, even though much of the excess and financial shenanigans originated there. Goofy politics and outright dishonesty aside, millions of people, thousands of businesses and hundreds of countries have all voted with their dollars that the U.S. is still a relatively safe bet.
The U.S., Canada, and many other governments have AAA credit ratings, enabling them to borrow at very attractive rates. But the ratings themselves are not the end of the story. The world bond market is very active, and highly sensitive to risk.
Perceptions of changes in those risks lead to variations in interest rates within the same AAA rating. Although Canada is smaller and is usually punished with a small risk premium, both Canadian and US AAA 10-year bonds/t-bills traded last week with yields of about 2.9 per cent, due to the intense scrutiny of a potential U.S. default. At the other end of the scale, Greek Bonds, rated CCC (about as low as you can go) yielded around 15 per cent and would be pretty much unsalable without implied EU support.
What about guarantees from banks and insurance companies? Canada's big banks, enjoy AA credit ratings and are now viewed as some of the safest in the world. Again, the bond market perceives different risks within the AA setting, and punishes, or rewards accordingly.
Our big insurers also enjoy solid, if lower credit ratings, and correspondingly higher interest rates when they borrow on the open market.
Other corporations are all over the map, from "junk bond" status to "investment grade" paying Greek-like yields or lower depending in their risks.
The risks of lending in fixed income markets are complex, always changing, and cannot be safely put on autopilot and turned over to a computer program or rating agency. It pays to crawl around and look for the details that lay beneath the marketing finish.
