The Corporate Subprime Bubble

Bloomberg has an editorial addressing the growing bubble in subprime corporate debt. Here’s a sample:

The U.S. is back in risk-taking mode. This time around, the problem is corporate debt, not mortgages — specifically, so-called leveraged loans. These are loans extended to firms that already have a lot of debt or a poor credit rating. It’s another kind of subprime financing, often used in corporate buyouts. Borrowers have ranged from Sears Roebuck to Mohawk Bingo Palace. As of December, an estimated $1.15 trillion of such loans were outstanding, more than twice as much as on the eve of the 2008 crisis.

The boom bears striking similarities to the mortgage frenzy that preceded it. Instead of holding the debt, lenders sell it to be repackaged into so-called collateralized loan obligations, which — by allocating income into tranches with different levels of risk and return — transform a large chunk into triple-A-rated securities. Investor demand for these securities is so strong that it has pushed lenders to lower standards. They’ve largely stopped including loan covenants that, for example, require borrowers to avoid taking on too much debt or generate ample cash for interest payments.

Some folks are claiming that “it’s different this time.” Bloomberg makes a few recommendations: stop subsidizing debt, have the Fed require banks to be better prepared and use new agencies to monitor the system.

As Warren Buffett has said, “Only when the tide goes out do you discover who’s been swimming naked.”

Posted by on February 20th, 2019 at 10:45 am


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