Neil Irwin of The New York Times recently wrote an economic trends column about why the state of the bond market may not be as bad as it looks.

Yields on government bonds and high-grade corporate bonds are very low right now.

Normally, Irwin writes, that would be a sign that investors expect the world economy to be cool enough to keep prices low for years to come.

Today, Irwin says, low yields on bonds may simply reflect the reality that regulators are pushing insurance companies, pension funds and banks to minimize investment risk by holding government bonds and other securities that regulators view as being very safe.

Meanwhile, Irwin says, governments have been trying to control spending and avoid issuing large amounts of new debt.

“The good news is that most of the drop in long-term interest rates is being driven by things that have little to do with the underlying strength of economic growth,” Irwin says.

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I think the bad news here that Irwin overlooks is that regulators have been encouraging insurers and other financial institutions around the world to march in lockstep.

Some investment bankers at a long-term care insurance session I attended a few years ago tried to tempt attendees to consider investing a little fun money in wild assets such as … government bonds from other countries, or domestic infrastructure bonds. Some of the long-term care insurance issuer executives there were interested, but many were skeptical of the idea of moving toward assets even slightly riskier than the assets they preferred during the grimmest days in 2008 and 2009.

Not necessarily safe

On the one hand, of course, the nail that sticks out gets hammered down. Insurers that invest too much in venture capital funds or wheat futures may face an unusually high risk of meeting with insurance department financial examiners in the near future.

On the other hand, one of the basic principles of investing is that diversifying assets is important. In the case of banks and insurance companies, regulators have subverted that principle by pushing all of the companies to invest as if they were part of one giant financial services organism.

Most of the individual companies in the organism might be small enough to fail without anyone crying too hard, but, if one company that follows the rules fails because of investment problems, it seems possible that they’ll all fail, because they’re all investing the same way.

Some market watchers will say, “Well, the investments can’t fail, because governments, and corporations that are as strong as governments, issued the bonds, and governments and big corporations just about always pay their bills.

That reminds me of how one of my business journalism class speaker who explained mortgage-backed securities in a class at Northwestern in 1990. He said companies could use pools of mortgages to back securities, and pools of those mortgage-backed securities to back more complicated types of investment instruments, because consumers just about always made their mortgage payments, and house prices just about always went up. Even if some consumers defaulted, lenders would simply sell the houses the consumers have purchased with the mortgage loans in the asset pools.

The speaker laughed off the idea that large numbers of home buyers might skip their mortgage payments, while the prices of homes were falling sharply and staying low.

If the mortgage-backed securities market could look so much different just 18 years later, it seems as if the government bond market and the high-grade corporate bond market could find a way to look a lot different in 2034 than they look today.

Congress is already letting Puerto Rico default on its payments. Why should we be so completely certain it will make good on the U.S. federal government’s own direct obligations?

If the policymakers trying to minimize systemic risk were thinking more about the big picture, maybe they would be pushing financial institutions to use a wide range of strategies and a wide range of investment types, not to put their faith in the conventional wisdom that government and big corporate bond issuers always make their payments.

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