Evaluating the value of a government?s 'promise to pay' and 'full faith and credit'

George W. Karpus, BridgeTower Media Newswires

How did a promise to pay backed by the full faith and credit work out for Puerto Rico, the City of Detroit, Greece, Venezuela or Argentina? Historically, when cities or countries cannot pay their bills, investors get refinanced at 40% to 80% of their original investment. Put another way, they lose 20% to 60% of their monies.

Now, Illinois cannot pay its bills and could shortly be downgraded to “junk” by rating services. The Republican governor and the Democratic legislature are at an impasse as to how resolve a $6 billion dollar shortfall; years of fiscal irresponsibility are the root of many financial problems in the state.

These failures in democracy should be taught in every high school and college. When one group of people votes to take money (taxes) from another group of people, it works only until the time that investors will not finance the fiscal irresponsibility any longer. As Will Rogers once said, “I worry more about the return of my money than the return on my money.”

As an investment professional with over 48 years of experience, I am most worried about the ability and the will of the United States of America to pay its obligations to investors. With the debt at $20 trillion and Federal Tax Revenue of $3.8 trillion, I fear we may already be at a point of no return.

On top of this, the political divide seems to be as wide as I have ever seen in my lifetime, yet very few of our politicians seem to be worried about it. They only seem to think of it as job security.

Nonetheless, the world’s markets are pricing our 10-year U.S. Treasuries as second-highest among the 11 countries in Europe and even higher than South Korea. Even though they are low on an absolute level, interest rates in the United States are actually high relative to most of the developed world. With the political gridlock and debt where it is, I only trust the U.S. government’s promise to pay backed by “the full faith and credit” over the short-run (i.e., 1-3 years).

Outside of traditional government securities, we have found a pocket of securities that are under researched and don’t appear to be covered in formal education in graduate schools or the curriculum of the Chartered Financial Analyst program. We have been studying these investments for nearly 10 years and, from a fundamental perspective, have found them to be one of the safest investments that we have ever seen.

These investments are heavily collateralized, pay attractive returns, and we cannot find a single case of default. However, there is not much more than $5 billion available in the entire marketplace, and we are in the process of actively buying these securities for our clients.

From my perspective, I like 300% or more collateral backing an investment, rather than a “promise” to pay backed by some city’s or country’s “full faith and credit.”

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George W. Karpus is Chief Investment Strategist and Chairman of the Board of Karpus Investment Management, an independent, registered investment advisor that manages assets for individuals, corporations and trustees.  Offices are located at 183 Sully’s Trail, Pittsford, NY  14534 (585-586-4680).