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Bonds Are Not Forever: The Crisis Facing Fixed Income Investors



"Simon Lack, a former J.P. Morgan trader and money manager, advises investors to steer clear of U.S. Treasury bonds on the grounds that the government's indulgence in the age-old practice of inflating away debt makes a negative return likely. His book also offers an insider's account of the dramatic changes in international finance at a time when a global explosion in public and private debt was expanding the size, scope, and complexity of banking. Personal anecdotes, especially about the fast-paced trading of exotic 'derivatives,' make this book not only informative, but entertaining. It won't, however, relieve anxieties about the current fragile state of the global economy."
--George Melloan, former editor and columnist, Wall Street Journal, and author of The Great Money Binge

"This fascinating and prescient narrative of the bond market's past, present, and future will captivate both professional and personal investors. Peppered with anecdotes from Mr. Lack's four decades of experience in the financial markets, this book prepares financial stakeholders for an investing landscape that may look very different from what they have come to take for granted."
--Gabriel Hammond, founder and Portfolio Manager, Oppenheimer SteelPath Funds, and founder, Alerian

"In The Hedge Fund Mirage, Simon Lack exposed the appalling mediocrity of a hedge fund industry grown fat on investors' fees. In his latest book, he takes on the great thirty-year bond bull market, turning an insider's eye on how we got here and the risks that lurk in portfolios of supposedly safe debt."
--Dan McCrum, U.S. Investment Correspondent, Financial Times

Simon A. Lack has worked as a trader and hedge fund investor for more than thirty years. Following twenty-three years with J.P. Morgan, he founded SL Advisors, LLC, a Registered Investment Advisor, in 2009. Much of Simon's career at J.P. Morgan was spent in North American Fixed Income Derivatives and Forward FX trading, a business that he ran successfully through several bank mergers and culminated in his overseeing fifty professionals and $300 million in annual revenues. In addition, Simon Lack sat on J.P. Morgan's investment committee, allocating over $1 billion to hedge fund managers and founded the J.P. Morgan Incubator Funds, two private equity vehicles that took an economic stake in emerging hedge fund managers. Currently, Simon chairs the Investment Committee of Wardlaw-Hartridge School in Edison, New Jersey, and also chairs the Memorial Endowment Trust Investment Committee of St. Paul's Episcopal Church in Westfield, New Jersey. He is the author of The Hedge Fund Mirage: The Illusion of Big Money and Why It's Too Good to Be True, which received high praise from the mainstream financial press, including the Economist, the Financial Times, and the Wall Street Journal. Simon makes regular appearances on cable business shows as an expert on hedge funds and investing. He is a CFA charter holder.

Preface xi

Acknowledgments xiii

CHAPTER 1 From High School to Wall Street--The Bull Market Begins 1

Inflation Memories

As Bad as It Gets 4

Trading in Gilts 5

The Old Class Structure 8

A Nineteenth-Century Market 11

Finance Starts to Grow 12

Is Finance Good? 16

Investing after the Bubble 20

CHAPTER 2 A Brief History of Debt 23

Interest Rates in Ancient Times 23

Medieval Credit 26

The Beginnings of Modern-Day Finance 28

Borrowing Reaches the Mass Market 31

Student Debt 39

Big Borrowers in History 43

What We Owe Now 45

CHAPTER 3 Derivatives Growth 51

Welcome to New York 52

Early Derivatives Growth 56

Swaps Take Off 61

Size Isn’t Everything 65

Derivatives Reach Omaha 67

Norwegian Wood 69

CHAPTER 4 Bond Market Inefficiencies for Retail 73

A Simple Market Model

Stocks Are Fairer than Bonds 76

Why Change Is Slow 79

Structured Notes 81

The Internet Threatens the Swaps Oligopoly 84

Municipal Bonds 87

CHAPTER 5 Trading Derivatives 93

Before Banks Were Exciting Computers and Swaps 96

Should Banks Innovate? 97

Growth in Innovation 99

Volcker’s Problem 102

Bring Me Clients with a Problem 103

Derivatives Missteps 105

Trading by the Book 107

An Options Book Blows Up 110

CHAPTER 6 Politics 115

Government-Controlled Investing Why Should We Worry? 116

Who Says There Is a Problem? 120

Look to the Future 128

Looking Ahead 129

Monetization--A Thought Experiment 133

Imperial Overstretch 136

More Debt Means More Banking 141

CHAPTER 7 Managing Risk 1990-1998 143

Risk-Oriented Market Making

Traders and Risk 145

Why Traders Are Bad at Budgeting 147

The Growth of Global Trading 149

Managing Obscure Basic Risks 152

What’s the Social Purpose? 155

Wall Street Fuels the Debt Growth 156

CHAPTER 8 Inflation 165

Germany’s Defining Economic Experience 167

Inflation Today 170

The Fed’s Huge Mistake 174

You Can’t Spend Quality Improvements 177

What Critics Say 181

Measuring What They Can, Not What Counts 183

CHAPTER 9 Bonds Are Not Forever 189

Putting It All Together

Wall Street Built It 192

Make Your Own Bond 195

High Dividend, Low Beta 198

Hedged Dividend Capture 201

Master Limited Partnerships (MLPs) 202

Deep Value Equities 205

Debt Is Bad 205

Bonds Are Not Forever 207

References 209

Glossary 215

About the Author 219

Index 221