Are U.S. bonds really a safe haven?

Banks run the risk of losing money on their hordes of Treasurys.

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Dwight Cass,

( -- It looked like a no-brainer. With a flight to quality last year pushing up U.S. Treasury bond prices and risky loans looking like losses waiting to happen, U.S. banks ploughed money into government bonds. And until about mid-May, when prices of 10-year securities topped 100 cents on the dollar, that looked like a good bet. Now, however, this safe haven isn't looking quite so secure.

A rebound in risk appetite and worries about Uncle Sam's credit rating has drained some air from the Treasury market bubble. A 10-year bond now fetches only a little over 95 cents on the dollar. That may not seem like much of a drop, but if you think of banks leveraging up their positions, it could result in some nasty losses.

How much so? Well, American depository institutions hold some $581 billion in various types of government obligations on reserve with the central bank, according to Federal Reserve statistics.

Of course, the cost of funding these positions has also plummeted. The London interbank offered rate (Libor) for three-month dollar borrowings is now a mere two-thirds of a percent. And a steeper yield curve is a boon for banks looking to earn their way out of trouble through fat net interest margins.

But one could argue that Libor is being artificially depressed by the U.S. government's interventions to prop up bank credit. Should they withdraw those measures -- say, by pulling its borrowing guarantees, its liberal discount window collateral requirements or other programmes -- Libor could easily rise to a level appropriate for the industry's average single-A to double-A credit. That was over 5% in 2006, for example.

Should that happen, and longer rates also struggle higher, banks run the risk of losing money on their hordes of Treasurys, just when their plummeting prices make them hardest to unload. If so, this port in the storm could turn out to be quite choppy. To top of page

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