Read of the Day: Junk Bonds – So Popular They’re Dangerous

In a way, I guess you can say the Fed is having the impact they were hoping for.  At least when it comes to crushing the yield curve and inducing some borrowing.  But the funny thing is that the lending boom isn’t occurring in the sector of the economy where the Fed would prefer to see.  As regular readers know, the sector of the economy that most needs the help is the household sector.  But that’s not where we’re seeing the latest borrowing boom.  Instead, it looks like we’ve spread the recklessness to another sector of the economy. In this case, it’s corporations who are attracting all the debt.  In particular, very low grade corporations.  Here are some statistics via the CNBC article:

  • Junk-bond sales in the U.S. snapped the single-year record in October and have kept climbing. Sales for the year totaled $324 billion as of Nov. 28, according to Dealogic, a data provider. In the three years leading up to the 2008 financial crisis, a time marked by easy lending, companies with junk credit ratings sold an average of $144 billion each year.
  • Companies are lining up to sell bonds because borrowing rates have never been lower. The typical company rated “speculative-grade,” one of the polite names for junk, pays 6.6 percent to borrow in the bond market. The average over the past decade was 9.2 percent, according to T. Rowe Price research.
  • Demand for junk has remained strong. Individual investors, people saving for retirement or building a nest egg, have put $28 billion into U.S. junk bond funds this year while pulling $85 billion from U.S. stock funds, according to Morningstar.
  • Over the past 10 years, individual investors have dropped $96 billion into the junk bond market, according to a Vanguard research paper. The bulk of it, 77 percent, was deposited in the past three years.
And a bit more commentary that will make you fall in love with the Fed’s various policies:

Gitlin and others say recent trends remind them of the easy-lending era before the financial crisis, when Wall Street and bond traders treated caution as a sign of weakness.

“When you start seeing things like you saw in ’06 and ’07, you should be concerned,” Gitlin says.

Over recent months, more than a third of the money raised in the market has gone to corporate borrowers that credit rating agencies consider likely candidates for bankruptcy, those with the lowest of the low credit scores, according to S&P.

Read the full article at CNBC.

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Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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  • Stephen

    The chasae for yield.Yet another accident to look forward to,the only question being when?
    On the one hand one might say more fool them to those involved in trying to find income ,but on the otherhand should we overlook the reason why this is occurring and whosefinger has been on the trigger to put the trend into effect.
    Sorry,but for preference I’d like to shoot central bankers IF we could just start afresh without them and the unholy mess they have led us toawards.Not of course without help from our govts and indeed ourselves.

  • Rich

    Another example of the Law of Unintended Consequences. The Fed regulation of interest rates is a form of “price control”. When one squeezes the baloon in one area, it causes a bulge in another area of the baloon sometimes to the point of popping. So there are also risks to the Fed’s actions other than just inflation.

  • Rich R

    If this junk debt truly is “junk”…that us of lesser great invesment quality, then I expect that one relatively high profile default/banckruptcy should have these investors scurrying for the exit.

  • jt26

    At least most of the junk companies have the cash flows (for now) to support it, which we can’t say for the subprime borrowers in ’04-’05. From a societal view, better the money go to junk companies than gold and other asset hoarding. Remember, those junk companies are real businesses, they just have junk credit because they’re being leveraged up for greater common equity return.

  • GreenAB

    it´s sad and it probably won´t end well. but pension funds or insurance companies have no other choice. they have to increase risk since riskless assets won´t earn anything thanks to the fed.