Sunday, June 9, 2019

The credit story - Not a household or bank problem but a corporate problem

As part of the Financial Crisis recovery program, the Fed wanted corporations to borrow for new investments. Low interest rates would drive a credit expansion. Well, now we know what happened. There were excesses but not everywhere. Households have retrenched except for student loans. Bank leverage has been constrained by macroprudential policies. Corporate growth expanded greatly and firms borrowed even more when they thought rates were headed higher. This corporate lending was not just for long-term investing but leveraged loans for companies that are trading at high debt multiples. 

All firms have increased leverage and have taken the markets to leverage levels not seen before. While some can argue that interest expense ratios are lower, principal will still need to be paid.
All of this leveraging makes the economy more vulnerable to a shock, but the composition of lenders is what is truly different. More bonds are held by mutual funds and ETFs which will create liquidity problems. In the past, corporate bonds were held by longer-term buyers who could wait out a cycle. The current liquidity mismatch between buyer and seller may create feedback effects that will make any credit shock more disruptive.

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