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.

The bond market can be a famously disagreeable place, where every player has a distinctly different idea of how to invest, what to buy and how much to pay.

In fact, about the only thing that almost everyone agrees on is that the smartest guy in the game is Pimco's Bill Gross.

Gross is a legend in bond investing. He has proven time and time again that he understands the market better than any other player (I like to point out that the first warning I heard about the mortgage crisis came from Gross -- way back when the rest of Wall Street was selling mortgage-backed securities like there was no tomorrow.)

So when Gross speaks, I listen. And you should too.

Every month he publishes his "Investment Outlook." And every month it is full of insight. Granted, his writing style is less than perfect. But the value in his statements is tremendous.

Check out this month's installment (It's also available as a podcast.) What you'll find is that while much of Wall Street insists the worst is over, Gross says "for now, investors should remain in high quality assets."

Just days after Connecticut's Attorney General filed a lawsuit claiming that Wall Street's credit-rating agencies conspired to give low ratings to municipal bonds, and just hours after Fitch announced it would change its ratings system, it may be illuminating to listen to what the defenders of the ratings agencies say.

Unfortunately, the defenders seem to be limited to folks in the credit-ratings industry.

One of those defenders is, predictably, the chairman and chief executive officer of Moody's. Raymond McDaniel noted, quite correctly I might add, that "asserting that a rating scale is wrong is the equivalent of saying that measuring distances in centimeters is wrong or measuring in inches is right."

S&P also responded -- correctly -- that filing a lawsuit to change how anyone "judges" or "values" an investment is almost certainly a violation of the First Amendment.

But what I'm not seeing are any institutional investors, regulators, politicians or other major players issuing statements in support of the industry and its right to operate as it sees fit.

And that absence of support has to be the result of the enormous anger aimed at the agencies for failing to warn us about risks in the mortgage-backed and other derivative markets.

Fitch Ratings, one of the three companies that dominate the bond-ratings industry, says it will revise the scale it uses for municipal bonds -- likely leading to upgrades for the majority of the market.

The move follows a four-month review of its muni-bond coverage. But it would be pretty naive to think that revisions are coming because Fitch decided its existing scale didn't work. Rather, the move likely reflects an attempt to offer support to an industry still reeling from the credit crisis.

And it has to be noted that Fitch is making this change just one day after Connecticut's Attorney General filed a lawsuit alleging that ratings on muni bonds are too tough.

I'd hate to think that a ratings agency would boost ratings across the board just to keep people from complaining. And I'd hate to think that a ratings agency would cave in so quickly to a threat. And although Fitch has promised for a long time that it would release the findings of its internal review today, it's likely to look to a lot of people that Fitch decided it cannot defend its processes.

Here's how Fitch explains the changes.

Here's some coverage from the AP.

It's worth taking note this is the week that historians will describe as as the beginning of an entirely new form of bond investing. And although it's too early to tell how this new market will shape up - or who will do well in it -- it's not too early to begin investigating a possible investment.

Earlier this week, four U.S. banks said they would issue so-called covered bonds, the investment vehicle that Treasury Secretary Hank Paulson has been touting as a possible savior in the continuing credit crisis. Bank of America Corp., Citigroup Inc., JPMorgan Chase & Co. and Wells Fargo & Co.announced their plans on Monday, less than two weeks after the FDIC issued guidelines on the securities.

Since then, two clearly different visions of covered bonds have emerged. First, the financial services industry welcomes the bonds as a much needed alternative to the now-failed methods of backing mortgage securities. On the other hand, critics have noted that while the bonds may offer additional safety to investors, they do so by adding risk to taxpayers.

For more information, take a look at my article on "What is a covered bond?"

Sometime later this week, we should have a better idea of what Congress intends to do about the threat posed by Fannie Mae and Freddie Mac. In the meantime, anxiety continues to grow. The threat from the crisis is, to put it mildly, gigantic. Nonetheless, most of the more common forms of bonds and other debt investments are likely safe.

For example, MarketWatch's Chuck Jaffee says money market funds, even those with Fannie Mae and Freddie Mac holdings, are safe from "financial meltdown."

Click here for an explanation of how money-market funds work.

And if you're really, really worried about a global meltdown, consider buying gold.

As the quasi-governmental agencies that dominate the mortgage market near collapse, bond holders are wondering if the bonds issued by Fannie Mae and Freddie Mac are safe.

Now it's easy for me to be calm about this. I don't own any debt from either agency. So you may want to take that into consideration when you hear my thoughts. But with that disclaimer in mind, here's what I think:

Yes. The bonds are safe. I wouldn't buy one today, but if you already own one, you're safe. It's likely you'll get your interest payments and the return of your principal if you hold the bond until maturity.

Certainly I'm not the only person to feel this way. Investment guru Porter Stansberry, writing today for the Seeking Alpha blog, says although there is "simply no doubt Fannie Mae's and Freddie Mac's shareholders will be wiped out," the government will guarantee the debt. And Stansberry is not an optimist. Rather, he thinks that the collapse of Fannie Mae and Freddie Mac is part of a series of crisis that is tied to a collapse of the monetary system!

I'm not quite as worried as he is.

Still, it's far more likely I'll be buying gold and silver in the next few days than that I'll buy any mortgage-backed debt.

For more on the crisis, read this explanation of Fannie Mae and Freddie Mac and their role in the economy, from About's Guide to the U.S. government. And check out this column from the Washington Post's David Ignatius as he reviews Treasury Secretary Hank Paulson's role.