Corporate Debt Could Make Next Recession “Difficult to Manage”

Corporate Debt Could Make Next Recession “Difficult to Manage” from Schiff Gold

Bankers, investors and executives are increasingly worried about corporate debt,  according to a Reuters report.

Specifically, the concerns center around “leveraged lending.” These are loans made to firms already deeply in debt. Think subprime loans for corporations. As the Reuters report put it, “the concern is that the loans would be difficult to either collect or resell in a downturn, putting both the borrower and lender at risk.”

With the second-longest US expansion in its advanced stages, the worry is that a key part of the credit market could be particularly vulnerable to a slowdown, as highly-indebted companies face a greater risk of default.”

According to the S&P/LSTA Leveraged Loan Index, the total leveraged loan market has doubled since 2008 and has grown by about 17% this year alone. Currently, there are some $1.12 trillion in outstanding leveraged loans.

A record 59% of these loan rate B+ or worse, according to S&P Global.  According to the credit rating agency, “Risks attributable from this debt binge are significant.”

The concern is the high level of corporate debt could make the next economic downturn difficult to manage. While few think it could cause the same kind of cascading meltdown we saw with the subprime mortgage market in ’08, it does “risk handcuffing companies and lenders trying to react to a downturn, possibly making it more painful.”

In a worst-case scenario that would faintly echo the financial crisis a decade ago, the defaults could worsen any downturn by destabilizing big non-bank lenders, such as private equity firms and hedge funds, and hitting employment across US industries. Leveraged loans are typically made to already indebted firms with low credit ratings, and the concern is that the loans would be difficult to either collect or resell in a downturn, putting both the borrower and lender at risk.”

One Fed official likened the risk to the popping of the tech bubble at the turn of the century.

Guggenheim Partners managing partner Scott Minerd told officials at the New York Federal Reserve Bank he didn’t think they would be able to avoid a “messy recession” in light of the credit buildup.

Because it is now so extreme, any attempt to rein in credit expansion is going to ultimately blow up.”

Now, some movers and shakers in the financial sector want the Fed to “do something” about all of this leveraged lending. In the first place, it’s unclear what exactly the central bank can do. In the second place, the Federal Reserve is a big part of the problem in the first place. Even the Reuters article acknowledged this.

The central bank itself may have contributed to the ballooning $1.12-trillion US leveraged loan market by holding interest rates near zero for seven years in the wake of the recession to encourage lending and investment.”

Well, duh.

The Fed’s monetary policy fueled a massive credit expansion and blew up all kinds of bubbles. With the Fed now trying to “normalize” interest rates, the bubbles are starting to pop. We’ve already seen signs of trouble in the housing market and auto industry, two sectors particularly sensitive to interest rates. Rising interest rates are not good for an economy built on piles of debt. And corporate debt is just one of many trouble-spots in the US economy. We also have massive amounts of government debt and consumer debt in the US.

The stock market is starting to reflect these problems as well. As Peter Schiff put it in a recent appearance on RT Boom Bust, this is not just a healthy correction.

This is a bubble deflating. This is exactly how it started in 2008, only this is a bigger bubble and it’s going to produce a bigger crisis.”

Despite the pleading from investors, bankers and lenders, the Fed isn’t going to “fix” this problem. As Peter summed up succinctly in the RT interview, the Fed is the source of the problem. We basically have a repeat of the years leading up to 2008.

They kept interest rates at 1%, which at that time was the lowest they’d ever been. They left them there for an entire year, and then it took two or three years to normalize back to 5%. But we took on a lot of debt when interest rates were artificially low. A lot of it was mortgage debt. And the bubble popped. But this time, the Federal Reserve injected far more monetary heroin into the economy. They kept interest rates at zero for six years. They’ve been raising them for three years, and they’re just now back at 2%. So, you have nine years so far of extremely artificially low interest rates, which have caused a much bigger credit bubble than the one that popped in 2008.”

Sharing is caring!

Peter Schiff

Mr. Schiff began his investment career as a financial consultant with Shearson Lehman Brothers, after having earned a degree in finance and accounting from U.C. Berkeley in 1987. A financial professional for more than twenty years, he joined Euro Pacific in 1996 and served as its President until December 2010, when he became CEO. An expert on money, economic theory, and international investing, he is a highly sought after speaker at conferences and symposia around the world. He served as an economic advisor to the 2008 Ron Paul presidential campaign and ran unsuccessfully for the U.S. Senate in Connecticut in 2010.