Wall Street’s Worst-Case Scenario: A Run on Bonds

All it takes is a few mouse clicks to buy shares in the Scout Unconstrained Bond Fund (SUBFX), an exchange-traded fund that tracks a concoction of debt tied to the government, financial firms, mortgage pools, and other entities.

And all it takes is a few mouse clicks to sell—something that has begun to worry Wall Street. Since the financial crisis, $900 billion has flowed into bond mutual funds and ETFs such as Scout Unconstrained, bringing the industry’s total holdings to $3 trillion. Fund investors who sell shares get their money back almost immediately, as if they were making a withdrawal from a money-market fund. The bonds that the funds own are far less liquid, often trading in telephone conversations or e-mails between brokers, away from exchanges. If too many people decide to get out of bond funds at the same time, the wave of selling could lead buyers to sit on their hands, bringing the system to a halt.

In the aftermath of the financial crisis, the Federal Reserve has kept short-term interest rates near zero to spur borrowing and boost economic activity. The unemployment rate has fallen to 6.3 percent, below the Fed’s target of 6.5 percent, and the central bank is curtailing its easy-money policies, reducing the amount of bonds it buys each month and getting closer to raising its benchmark interest rate. Economists surveyed by Bloomberg say rates could rise as soon as the end of this year.


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