Open letter to Mervyn King

Dear Mervyn

I see from your speech last night that you might start buying corporate bonds. Now that the Bank of England and the authorities have entered the prime broking industry through (a) repoing securities with banks (b) buying equity stakes in banks, and (c) writing insurance on debt, this is the next step in the Nation State’s aggressive move into financial services.

In my experience, when buying corporate bonds, the most important thing is to do your due diligence.  Obviously you have better information than anybody else on the state of the UK economy, but I would not rely only on the rating agencies for their credit views (you can see what a mess they have done rating UK banks).

With regard to your timing, I think it is very good. As you explained in your speech, corporate bond spreads are exceptionally wide on an historical basis (see previous blog here). Risk premia are at excessive levels, and all central bankers and their governments are taking appropriate action via lower base rates and traditional fiscal spending measures. The market is pricing in that you cannot save the day, but I think your and the government’s actions will successfully moderate the extent of the slowdown we are in.

Fund managers have to persuade investors to give them capital to invest on their behalf. You, however, can presumably finance your portfolio by issuing gilts or printing notes – wow ! Therefore not only can you invest in attractive corporate bonds offering excessive risk premia, but you can finance it easily, creaming off the extra yield while you wait for markets to normalise. This could prove to be a highly profitable exercise, as well as helping you to unblock the financial system by getting funds direct to the corporate sector.

By issuing gilts and buying corporate bonds, you would be both increasing the supply of gilts and increasing the demand for corporate debt (ceterus paribus). This will mean that corporate bond yields should fall relative to gilt yields, thus providing windfall gains to holders of corporate debt, who are prepared to take credit risk versus the more conservative holders of gilts. This is obviously a positive development for corporate bonds.

We look forward to seeing how you invest, and wish you luck in your day job of stabilising the economy and inflation.  And I wish you every success as a fund manager.