2007 All Over Again, Borrowers Start Scamming Desperate Lenders
Personal_Finance / Global Debt Crisis 2018 Dec 28, 2017 - 12:16 PM GMTBy: John_Rubino
One of the hallmarks of late-stage bubbles is a shift of power from lenders to borrowers. As asset prices soar and interest rates plunge it becomes harder to generate a decent yield on bonds and other fixed income securities, so people with money to lend (like pension funds and bond mutual funds) are forced to accept ever-less-favorable and therefore far-more-risky terms.
Recall the liar loans that were popular towards the end of the 2000s housing bubble and you get the idea. Lenders were so desperate for paper to feed the securitization machine that they literally stopped asking mortgage borrowers to prove that they could cover the interest.
Here we go again, but this time in the market for leveraged buyout loans: Yield-Starved Investors Giving In to the Demands of Bond Sellers
This is just what happens when central banks push interest rates way down while flooding the market with new currency. Lenders find themselves with too much money to lend and borrowers can, as a result, can write their own tickets. With eventually disastrous results.
When things get tough, as they always do after a long debt binge, the private equity borrowers will suck as much money out of their captive companies as possible, while layering on new debt at unfavorable terms. Then they’ll let those companies default and hand off the near-worthless carcasses to creditors.
You have to feel sorry (and, yes, a bit of disgust) for the victims of this recurring scam. Pension funds, for instance, are saddled by their political masters with unrealistically high return assumptions of 7% – 8%, which are unattainable in a world where long-term bonds yield next to nothing. So the prospect of even an extra percentage point of yield is tantalizing for pension fund managers whose jobs are on the line if they can’t do the impossible.
A personal aside: My first serious finance job was as a junk bond analyst with a high-yield mutual fund, and my days boiled down to reading bond covenants and answering the question, “how can they screw us?” The assumption was that if the borrowers could screw us they would, and we wanted to see it coming.
But with bubbles of today’s magnitude, seeing it coming isn’t much help for either the owners of this increasingly toxic paper or the economy as a whole.
By John Rubino
Copyright 2017 © John Rubino - All Rights Reserved
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