Bonds, Lame Bonds: You can lose money as a bondholder

I can say with some certainty that most households are in better financial shape now than they were during the recent financial crisis that crippled the entire economy. In the years ahead, when historians look back at that financial meltdown, I believe we’ll discover that we were a lot closer to a financial collapse than we realized.

Things do seem to be improving, although perhaps not at the level we’d like to see. But it does appear that we are heading further and further away from a meltdown.

Locally, we nearly lost our region’s heart and soul, the auto industry. We also saw our state’s major city go through a long and contentious bankruptcy proceeding. From an investor’s perspective, I’d like to address bondholders about a couple of lessons we learned from these events.

To review, bonds are essentially nothing more than IOU’s. They are debt instruments with a promise to pay back the loaned amount plus interest. Bonds are generally considered safer than stocks, but as history shows, it’s possible to lose money when investing in bonds, just as with stocks.

That’s somewhat contrary to what you learn in financial planning classes. Bondholders are supposed to be the first in line to get paid in the event that something goes wrong with the company.

Looking back, when the auto industry was near collapse and trying to settle with creditors, I was somewhat stunned that the bondholders who thought they were first to be paid were, in essence,

demoted and pushed back in line behind the auto unions.

Don’t get me wrong. I’m not bashing the unions; it was a good thing for them. But the whole procedure was contrary to what was taught in financial planning classes. Seeing that bondholders weren’t the first in line was quite a surprise.

For years, the city of Detroit borrowed money to meet many of its legal obligations. The investors who loaned the money to the city, the bondholders, loaned it because there were legal provisions that they thought guaranteed they would be paid. As it turned out, the bondholders did not get back what they thought they were guaranteed.

From the near collapse of the auto industry and the city of Detroit’s bankruptcy, I believe there are some serious lessons bondholders need to learn.

One obvious takeaway is that, in spite of the legal requirement, you may not get paid as promised, especially if the borrower is having financial issues. Apparently, the financial condition of the company or organization can outweigh your legal claims.

Another lesson you should learn as an investor is that, rightly or wrongly, you are considered Wall Street. If there is ever an issue that pits Wall Street against Main Street, you can be sure that the sentiment lies with Main Street.

In this day and age, not only do rules change faster than the weather, there are also exceptions to every rule. As an investor, in this case a bondholder, you are simply on the wrong side of public opinion.

Again, it’s great that the auto industry has rebounded and Detroit can put its bankruptcy behind it. Unfortunately, many investors were surprised that they lost money in what they thought were conservative, low-risk bond investments. Looking ahead, that’s something