“risk parity”

This is an idea discussed in academic circles (something that should send shivers down any investor’s spine). The main assertion is that in a portfolio consisting of (risky) equities and (not so risky) bonds, you can get better overall returns, and better downside protection) by upping the risk in the bond portion of the portfolio by buying a bunch more bonds on margin.

The idea was popularized by Bridgewater Associates in the 1990s, when a portfolio borrowing money to buy Treasuries while interest rates were in secular decline seemed like a license to steal. It was/is widely used by traditional pension funds (mostly for government employees) eager to address their chronic underfunding without calling on state legislatures to inject new funds. This even though the collapse of the bond fund Long Term Capital Management in 1998 was a case study in what can happen to illiquid assets in a time of political uncertainty.

Here we are again today …in another time of high uncertainty and political upheaval, where the illiquidity of many Treasury issues and the opaque nature of the leverage that private equity funds have used to assemble Treasury portfolios has become a worry. This time, however, the source of political fears is not Russia but the United States. The underlying issue is the same, though–again, the public doesn’t know how big these funds in the aggregate are or how highly leveraged they may be.

In a sense, here we are again.

Kilmar Abrego Garcia

As I guess just about everyone in the US now knows, Mr. Garcia fled El Salvador for the US, which he entered illegally to avoid gang violence in El Salvador. He has had legal status since 2019, however, and is now a productive worker, a taxpayer and a member of the auto workers union. Nevertheless, he was recently seized by ICE and deported to a jail in El Salvador.

Despite court orders to return Mr. Garcia to the US, the Trump administration is refusing to do so.

To my Wall Street-hardened mind, the most likely reason is that Mr. Garcia has been killed in prison by the gangs he was fleeing all those years ago. I may just be too cynical, but what other reason could there be for not correcting what the administration admits was an error? Could conditions in the prison be so hellish that the administration doesn’t want word to get out? If so, what would this say about the possible fate of other prisoners?

This stance by Washington has some relevance for Treasuries, as well. Ronald Reagan, the father of the modern Republican party, referred to the US as the “shining city upon a hill.” In his farewell address to the nation, he said:

“I’ve spoken of the shining city all my political life, but I don’t know if I ever quite communicated what I saw when I said it. But in my mind it was a tall, proud city built on rocks stronger than oceans, wind-swept, God-blessed, and teeming with people of all kinds living in harmony and peace; a city with free ports that hummed with commerce and creativity. And if there had to be city walls, the walls had doors and the doors were open to anyone with the will and the heart to get here. That’s how I saw it, and see it still.”

It’s hard to evaluate how damaging Trumpism to the US, but it’s certainly far different from Reagan’s vision. Arguably, this dramatic change embraced by the ruling Republican party has the world worrying about the safety of lending to the United States.