NOT SO CHEAP TRANSFER

 

 If you've ever rode on any public transit system you're most likely familiar with transfers.

Transfers usually have a slight extra charge for allowing you to connect with another part of the transit system to get to your destination. It's simple concept.

A good part of risk management is about transfers. For a fee you can buy an instrument that allows you to transfer that risk to someone else. Most people know them as insurance policies but there are many other forms.

If you buy a home and have a mortgage, the lender usually mandates what's called a homeowner's policy to protect you and the lender from something both presumably don't what to happen, unexpected damage to the property.

It's really just a put option. It has a beginning date and an ending date, cost a certain amount and the closer it gets to expiration the less it's worth if you want to redeem it. In the world of option trading it's known as a decaying asset, much like you and me.

The point is the only way that option can go up in value is if something neither you nor the lender wants to happen. Then it becomes worth a lot more than the funds you most likely begrudgingly coughed up to own it.

In the world of high finance there are all kinds of options, many with fancy names like swaps, Cocos, CLOs, etc., not just the ones that get traded daily on the option exchanges. And the denizens of Wall Street and investment banking are never short on ideas about how to create new ones.

What all these fancy items share is the principle of transfer. Hypothetically, they symbolize something physical behind each transaction like a piece of paper or so many shares of a stock. In the commodities world you could be forced to take physical possession.

Imagine the third Friday of some distant month they deliver two tons of fresh elephant manure to your door. It's a huge, smelly risk 

And that's just about where we are now with the Federal Reserve. Having taken most of the risk off their long-time friends, the big banks, the Fed with their crazy QE game and low interest rates have transferred that risk to the global markets.

In plain English, you and me and all those yield starved folks including institutions like asset managers and pension funds who have been forced out onto the same limb seeking some income oxygen. If you think about junk bonds here, you'll recall that the Fed prohibited the big boys from supplying their usual liquidity for corporate bonds.

It was a regulatory form of a slap on the big boys' wrists, a conciliatory signal to the masses that "We got this covered!" According to reports, the bond inventory that these big boys now hold is at a record low, hovering somewhere around $50 billion or a miniscule 0.5% of the entire market.

Transfers have their place and their function. Unlike those transfers one gets on the transit system, however, this is one that in the end won't be cheap.