Treasury bonds are surely among the safest investments on earth. But nothing is perfectly safe. And in the present environment, Treasury debt looks particularly vulnerable to inflation risk.

In fact, as The Capital Spectator blog pointed out this week: "Not since the early 1980s has the prospect of owning a government bond looked so grim as an income producing security once inflation is considered."

So what are bond investors -- a group traditionally worried about both safety and inflation -- to do? Well, in this environment, players in the debt market may be forced to choose between their worries. Folks who believe the evidence that inflation is rising may want to go with inflation-protected securities like TIPS. Others, who believe that the recent inflationary pressures are likely to ease because of all the other possible catastrophes threatening the market, may want to park their funds in the safety of traditional Treasuries.

What's your biggest fear in this market? And how are you protecting yourself?

While I was traveling for business the past few days the entire bond industry had a change of heart and admitted that it was staffed almost entirely by greedy and dimwitted people who have misled investors and brought the economy to its knees.

Well, that's sort of what happened.

On Friday, Wachovia said it would buy back $9 billion in auction-rate securities as part of settlement with the Securities and Exchange Commission. The SEC and some state regulators had accused Wachovia of misleading investors by claiming that the securities were safe. Wachovia's settlement comes in the wake of similar deals "mea culpas" from UBS, Citigroup, Morgan Stanley and JP Morgan Chase.

But that hardly puts an end to the scandal. New York State Attorney General Andrew M. Cuomo is now turning the screws on Merrill Lynch and Goldman Sachs to reimburse clients who lost money in the collapse of the auction-rate market.

Now I'm all for what Cuomo is doing. I wish he'd do more of it. If there's one thing we've learned in the past couple of years is that the nation absolutely cannot trust Wall Street to behave ethically, professionally or sensibly.

However, as long as Cuomo and the rest of the regulatory establishment has decided that the giant banks misled wealthy investors in the auction-rate securities market. And as long as these regulators think that misleading a customer requires the bank to make things whole, wouldn't make sense to stop those exact same banks from doing the exact same thing to non-wealthy customers? In other words, isn't it about time that someone cleaned up the credit-card business?

Better late than never.

Unless, of course, it's too late.

According to this post on the New York Times DealBook blog, the credit default swaps market is now "a rising priority for regulators who oversee banks and insurers." That's nice. But given that credit default swaps appear to be nothing more than an elaborate fantasy of valuations, and given the threat this nonsense poses to the economy, it's about bloody time they made it a priority.

But I'm being too negative. As DealBook points out, "a silver lining to the credit cloud we’ve been under for the last year does seem to be taking shape. Regulators are once again regulating. And, says (Times journalist) Ms. Morgenson, we can bury for good the fantasy that financial market participants are able and willing to police themselves."

Imagine a world in which the worse a company's credit rating was, the better things looked on the earnings statement. Sound crazy?

Well it may be crazy, but it's also the law.

A controversial clause in Financial Accounting Standards Board regulations is being used by troubled companies to boost earnings. Through a preposterous, but legal, accounting technique, companies are recording a surge in paper profits whenever Wall Street's credit-rating agencies decide things look bleak.

The latest troubled firm to employ this accounting sleight-of-hand maneuver is, remarkably, one of the key players in the entire bond and credit-rating industry! Ambac, the bond insurance company that had its own credit rating lowered earlier this year, saw its profit surge in the most recent quarter because the SEC allows them to report bad news as good news.

It's a complicated and bizarre story. And it would help to have an accounting degree or a well-developed sense of cynicism to understand it. But as CFO magazine reports, Ambac's declining credit rating led to a widening of its credit spreads. That's exactly what you would expect to happen. But under FASB rules, Ambac was able to convert those widening speads into soaring profits -- at least on paper.

So what's the lesson for bond investors? Certainly, this is yet another reason to exercise caution before buying any investment. But there may also be a deeper lesson here. As much of the regulatory world blames the credit-ratings agencies for the credit crisis, it's worth noting that in the often irrational world of finance, the credit-rating agencies are often the only rational players. So if S&P;, Moody's and the rest say Ambac is a mess, I'm going to assume Ambac is a mess -- no matter what the earnings statement says.

Want to know more about Ambac and the rest of the bond-insurance market? Here's an explanation of the role the so-called monoline insurers play in the bond industry.