As we continue to watch the unfolding drama of company after company rushing into the arms of better capitalized suitors and the political fall out of the AIG bail out and Lehman Brothers collapse begins, the question on the minds of forward thinking professionals and claimants is where are interest rates going now.
First of all, what we are seeing at the moment, and which is being lost in the big headlines of the AIG takeover and other pending buyouts or mergers such as Washington Mutual and Wacovia, is a flight to safety that has driven the short term U.S. Treasury Bill rates this morning to an effective rate of ZERO. Thats right, 0. As in no return. Two year notes are yielding 1.7%. So great is the fear of credit risk that investors are willing to accept no return on their short term money in order to get that safety. This is unprecedented in US financial history and I don't expect short term rates and yields to move up for at least the next month or so as the Fed and other central banks flood the financial system with dollars to avert a further liquidity crisis.
The second thing we are seeing is a rush into gold, the refuge of the truly terrified, with gold jumping $89 an ounce on overnight markets, closing at $878 per ounce. This is a move by those who can't or won't park assets in short term treasury's and who understand what the next major issue the market is about to face really is, and that is a collapse of the U.S. dollar.
Much as before a tsunami you see people standing by the shore curiously watching the water recede into the ocean wondering what is about to come, we now see people standing and observing the unnatural phenomenon pulling the water back from the financial shore just before the really big wave is about to hit. What is that wave you might ask?
The wave that results from the flood of dollars and debasement of the U.S. currency that has occurred, and must occur, to save the bed rock financial institutions of the U.S. financial system. The wave is going to be a steady collapse of the dollar and a resultant explosion of interest rates necessary to attract investors into dollar assets such as U.S. Treasury bonds, notes and bill, not to mention U.S. corporate bonds and notes.
In short, while we will be in a brief deflationary period as this horrific unwinding of worthless debt continues to crush the balance sheets of U.S. banks, insurance and brokerage houses and interest rates collapse during the deleveraging period, what will follow is an explosive return of monetary inflation of interest rates similar to what we experienced under the Jimmy Carter administration and the early stages of the Reagan presidency. The dye has been cast in my opinion and there is no way around the impending interest rate explosion.
The question is when will it start and what should settlement professionals be advising clients who need to settle their cases now?
In the short term structured settlement rates are going to go lower and stay relatively low until the panic ends. I'd say at least through the end of this year we are going to watch the continue deleverage of assets and flight to safety, with the result being short term rates hovering at current levels until markets and investors can determine which debt is safe and which debt is going to default.
Once we get past this phase the realization that the U.S. Government has purchased Fannie Mae, Freddie Mac and AIG, effectively nationalizing the mortgage market and commercial insurance markets all with tax payer money is going to drive the dollar down even further. This will create a situation where investors from all country's will require a "dollar premium" in interest rate returns to compensate for the loss of value on the base currency. The net effect will be a spiral upward in interest rates which could mirror what we lived through back in the late 1970's and early 1980's.
Then the question before us is, if this is the scenario, how do we assist people in deciding what to do with their settlement proceeds as this unfolds. My thoughts are as follows:
1. Continue to structure payments but be careful of longer term programs if the yield drops below 5% on the IRR. There is going to be some buyer remorse if you put people into long term structures at low yields, so be judicious in how you design your programs for longer durations and needs.
2. Allocate lump sum payments for 18 months, 24 months, 36 months and 48 months out. The ability of the client to reinvest as interest rates increase is going to be exceptionally valuable to them.
3. Realize that we will be entering a phase of very high interest rate returns, higher income tax rates and desires for safety. Essentially a return to the golden age of structured settlements in the early 1980s, something that a lot of people missed out on. The difference will be that this golden age will be consumer driven and not something exploited by the casualty markets, so you better have the ability to reach out to trial lawyers, claimants and others to explain and sell your product. Our product will be an exceptionally desirable alternative in a high interest rate, high tax rate economy for the vast majority of clients.
4. Partner with quality financial planners and investment firms to assist your clients after the sale and settlement. Most clients desperately need "after care" from a qualified professional who can manage their up front cash and lump sum allocations. Rather then fighting other professionals welcome them into your practice to team as specialists in really taking care of your clients both now and in the future.
In summary, don't go long on bonds or structures right now, you'll deeply regret it later, as will your clients. Stay short, keep a healthy cash position for your client at settlement, team with professionals and set up reinvestment lump sums in anticipation of the inevitable interest rate rise to come.