By DAVID MOON, Moon Capital Management, LLC
March 21, 2010
Last weekend I engaged in an exercise that would serve as a great learning example for the Federal Reserve Board, the US Treasury and anyone involved in the debt markets, as either a borrower, lender or as an evil derivatives participant.
I scalped some basketball tickets.
The lessons were simple and predictable. Anyone who has been to an auction knows how it works.
About two hours before the first game each day, all of the “sidewalk capitalists” crowded into the same area near the arena, creating an Amazon rainforest of buyers and sellers. This was a tournament, so there were 11 games over four days. Some games were more popular than others. Some seats were obviously more valuable than others.
At one point I had struck a deal with a gentleman to purchase two front row courtside seats for a game featuring the top seeded team. We had agreed on price, and were trying to determine how much he would pay me in exchange for my less attractive seats.
Someone overheard our conversation and offered a higher price for the two tickets I had agreed to purchase. A bidding war ensued and I ended up paying more than our initially agreed upon price. I was not amused. Other than perhaps beating the guy until his mother wouldn’t recognize him, I had little recourse. (Sitting in jail, however, the tickets would have been worthless to me.)
This is how supply and demand works.
Now imagine that the second ticket buyer with whom I was competing had a printing press – that prints trillion-dollar bills. The prices of all of the tickets in the gray market would soon get out of hand.
That ticket buyer with the printing press is the Federal Reserve.
Instead of buying basketball tickets, for over a year the Fed has been buying every type of bond imaginable. The prices of those bonds have increased, just like the tickets would.
Another way higher bond prices are reflected is in lower bond yields.
When game time would approach at the ticket scalping area, buyers would begin to leave and the crowd would thin. As the number of buyers diminished, predictably so did the prices of the tickets. A ticket that would have cost $100 five minutes earlier might sell for half that amount once the buyers began to leave.
This past week, the Federal Reserve Board announced that it was ending its $1.25 trillion program of purchasing mortgage-backed bonds.
The largest buyer of mortgage-backed securities over the past year is finished. No longer will it be pushing up those prices – and pushing down those mortgage rates.
Not only has this artificial bond demand from the folks with the printing press driven down interest rates, there’s a good chance that it has influenced stock prices, as well. The recent stock market bottom was March 9, 2009 – only a few days before news of the Fed’s $1.25 trillion purchase program became public.
The Fed is leaving the ticket scalping area. Let’s see how the market reacts.
David Moon is president of Moon Capital Management, a
Knoxville-based investment management firm. This article
originally appeared in the News Sentinel (Knoxville, TN).