Four flights to quality of the 2000s in North America

Wall Street
Andrea Murad By Andrea Murad, CA Today

20 June 2017

Uncertainties in the world are what cause investors to preserve capital by moving money into safer investments, known as ‘flights to quality’. But how do we predict these flights and will the markets be guaranteed to act in similar manners?

Flights to quality happen for many reasons, like geopolitical concerns, unexpected election outcomes, military conflicts, terrorism events, trade wars or corporate scandals.

“Predicting flights to quality are difficult,” said Brian Rehling, co-head of global fixed income strategy for Wells Fargo Investment Institute. 

“You can predict them around recessions, but for other events, the whole reason you have a flight to quality is because there’s an unexpected event.”

Selling risky assets like equities to buy higher-quality fixed income and bonds (or hold cash or gold) creates market volatility. During a flight to quality, equity markets drop and bond demand rises.  

The biggest impact is generally not in short-term Treasury bills, but in prices for longer-term maturities in high-quality fixed income, said Brian. “If you were not just worried about reducing risk and wanted to make a bet off a risk event, you’d want to buy long-dated fixed income.”

What have been the triggers for a 'flight to quality' in recent times?

Enron energy crisis of 2000

Enron was an energy, commodities and services company that had been manipulating energy markets, which led to the California energy crisis and rolling black-outs starting in June 2000.

In 2001, Enron announced a third quarter loss of $618 million and the SEC opened an investigation.

Enron declared bankruptcy on December 2, 2001, becoming the largest bankruptcy in US history at the time. The company used special purpose vehicles to hide losses and investors fled to safe havens to avoid corporate credit risk and weaknesses in commodities.

September 11, 2001 terrorist attacks

US markets came to a standstill when terrorists hijacked four planes on September 11, 2001. Stock markets closed and, when they reopened four trading days later, the Dow dropped 7.13% to 8,920.70. This was the worst one-day drop ever as the US fell deeper into recession.

Greek debt crisis of 2005

Hosting the 2004 Olympics exacerbated Greece’s economic problems, as public borrowing to fund the games contributed to a rising deficit. Austerity measures didn’t work, and the European Commission placed Greece under fiscal monitoring in 2005.

In February 2007, the US financial crisis triggered a global banking crisis and Greece had difficulty servicing its debt.

In December 2009, a rating agency downgrade of Greece’s debt increased the country’s borrowing costs.

In May 2010, the IMF and EU provided Greece with a €110 billion bailout over three years as worker strikes continued. Equity markets dropped, and investors bought Treasuries and held dollars to avoid potential capital losses.

2008 mortgage crash

US housing prices began to fall in 2006 in an overheated market driven by fraud in subprime mortgage originations. 

The mortgages had been packaged into complex fixed income securities and sold to investors: these high-yielding riskier bonds were attractive investments to banks and hedge funds in a low-interest rate environment.

As banks foreclosed on borrowers, the bonds financing these loans also started to have losses.

The credit crisis erupted in August 2007 with the failure of two Bear Stearns hedge funds that led to the bank’s sale to J.P. Morgan Chase & Co. on March 16, 2008. 

Lehman Brothers, the owners of five mortgage lenders, didn’t divest from the mortgage business and declared bankruptcy on September 15, 2008.

That same day, the Dow fell 504.49 points, or 4.4%, to 10,917.51 and Treasuries began to rally.


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