I read an article from Peter Schiff back in February 2008 as he discussed how the U.S. Treasury market is the mother of all bubbles.  To me, it seemed pretty obvious that Peter Schiff was right.  With the fed funds rate being lowered, massive liquidity injections by the global central banks to combat the mortgage crisis, and inflation on the rise, why would anyone want to own long-term U.S. treasuries?  Sure it is considered a safe investment, but eventually foreign countries will not want to buy depreciating dollars, the feds will start increasing rates again, and by then inflation will be much higher than any rate of return from treasuries.

Today I read an article on Bloomberg titled "Treasury 10-Year Yield Rises to Highest Since December on Fed".  Looks like people are starting to figure it all out.  People are starting to realize the U.S. dollar is heading lower, inflation is on the rise, and long-term treasuries are not where you want to be.

For those interested in learning more, I highly recommend Peter Schiff's book, Crash Proof: How to Profit from the Coming Economic Collapse.

From Bloomberg:

China sold 600 billion yuan ($79 billion) of bonds, the most ever, to fund a company that will help invest the world's biggest foreign-exchange reserves.

The Ministry of Finance sold the 10-year bonds to the central bank at a coupon of 4.3 percent. Future sales may include debt maturing in 15 years or longer, the ministry said in a statement.

The nation is setting up a $200 billion investment company to seek higher returns on its $1.33 trillion of currency reserves, after cutting U.S. Treasury holdings in the second quarter. The new fund bought a $3 billion stake in New York- based Blackstone Group LP in May, suffering losses as the private equity firm's stock dropped.

The numbers are staggering:

State Street Corp. has nearly $29-billion (U.S.) in exposure to a type of investment that has recently contributed to turmoil in world financial markets, according to a regulatory filing by the Boston-based trust bank.

...

Also on Tuesday, The Boston Globe reported that one of State Street's bond funds has lost more than one-third of its value in recent weeks amid turmoil in financial markets.

The State Street Limited Duration Bond Fund, which includes investments in mortgage debt, fell about 37 per cent in a three-week period, the Globe said, citing an investor who received a client letter from State Street about the loss.

Canadian T-bills are sold out:

Ewen Mackenzie has been trading securities for nearly three decades, half of that as head of his Thornhill, Ont., investment firm. And he's always been able to buy short-term government treasury bills - until Friday.

Like scores of other fixed-income investors, Mr. Mackenzie was looking to park money in one of the safest spots in Canada - government-backed bills. But when he called one of the Big Five banks Friday to place about $250,000 in 30-day and 90-day T-bills, he was told they weren't available.

The experience illustrates just how rattled investors are. Their aversion to the perceived risk of anything connected with non-bank asset-backed commercial paper (ABCP) means many are fleeing money market funds altogether for the haven of government-backed securities.

"I've been in this business for 28 years and I've never heard of anything like that before," said Mr. Mackenzie, who runs Ewen Mackenzie Investment Advisors Ltd. "I can only surmise that individual investors are bailing out of money market funds and buying Treasury bills and maybe they've bought them all up."

Countrywide Financial was the story stock of today. I believe the trust preferred shares, which are in essence junior subordinated debentures, are an attractive investment opportunity. There are two series of trust preferreds outstanding, Series A (CFC.PR.A) 6.75% due 2033 with $500 million face value and Series B (CFC.PR.B) 7.00% due 2066 with $1.3 billion face value and. Given the bigger issue size, Series B has better liquidity. It traded for several months between $24-25 ($25 = face value), started to fall in July and this week dropped to the $18-19 range. At today's closing price, the A is priced to yield 8.96% and the B 9.2%.

What does the capital structure look like?  The trust preferreds are included in junior subordinated debentures line, and are junior to pretty much everything else in the table below.  The prospectus from October 2006 mentioned that as of June 30, 2006, Countrywide had outstanding indebtedness of $19.7 billion ranking senior to the preferreds and $161.1 billion of subsidiary liabilities effectively ranking senior to the preferreds.

	June 30,   2007			December 31, 2006
		(in thousands)
Asset-backed commercial paper		$	7,613,080		$	7,721,278
Unsecured commercial paper		5,857,146			6,717,794
Secured revolving lines of credit		3,577,960			2,174,171
Secured overnight bank loans		—			105,049
Asset-backed secured financings		2,133,510			241,211
Unsecured bank loans		—			130,000
Federal Home Loan Bank advances		28,825,000			28,150,000
Medium-term notes:
Floating-rate		12,999,692			13,155,231
Fixed-rate		9,412,381			9,783,881
		22,412,073			22,939,112
Convertible debentures		4,000,000			—
Junior subordinated debentures		2,215,278			2,232,334
Subordinated debt		990,886			1,027,797
Other		44,134			48,838
		$	77,669,067		$	71,487,584

How can I get comfortable with all that debt ahead of my preferreds? Not completely, but as of today's closing, Countrywide had a market cap of $16 billion, slightly higher than book value. For the preferreds to be wiped out, the equity has to be worth zero too.  But the market is still assigning a $16 billion value to the equity now.

Richard Lehman, who writes a column for Forbes, wrote about these Countrywide preferreds earlier this week and compared this situation with that of Ford and GM in 2005. He notes that the securities had their investment grade ratings recently reaffirmed by the agencies.

Debt downgrade can be a buying opportunity

Another data point. The senior notes (rated A/A3) due 2035 were yielding 8.4-8.5% today, which is high (up from 6.5% in mid June) but far from distressed. Looking at the capital structure, notice that the junior subordinated layer is very thin. The amount outstanding is very small compared to the rest of the debt. So in a bankruptcy, it is very unlikely that the junior subordinated will be impaired but the senior notes will be paid in full. Sophisticated investments may want to do paired trades involving the equity or the senior debt. Unsophisticated as I am, I just bought the preferred.