NYT: The Big, Dangerous Bubble in Corporate Debt

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HEDGEFUNDIE
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NYT: The Big, Dangerous Bubble in Corporate Debt

Post by HEDGEFUNDIE » Thu Aug 09, 2018 5:10 pm

https://www.nytimes.com/2018/08/09/opin ... ssion.html

Thoughts? Can any fixed income bankers here confirm / deny this trend?

Fits nicely with the other recent thread about how Treasury bonds are the only bonds you need.

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nedsaid
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Re: NYT: The Big, Dangerous Bubble in Corporate Debt

Post by nedsaid » Thu Aug 09, 2018 5:21 pm

Interest rates were so cheap that companies loaded up on low interest debt to retire stock. It actually could help cash flow as the yields on stock were often higher than yields on debt. So if companies could float debt to retire stock, keep in mind that the opposite can happen, companies float stock to retire debt.
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Re: NYT: The Big, Dangerous Bubble in Corporate Debt

Post by acegolfer » Thu Aug 09, 2018 6:31 pm

I am not Dr. Doom but I agree with the article.

As an economist, I consider corporate debt bubble as one of the 3 weakest areas in U.S. economy. Because of cheap credit, corporate debt issuance has been gradually increasing from $760 billion in 2008 to $1.676 trillion in 2017. Similar to the U.S. government, companies often issue debts to pay back debts. Sometimes with short term debt issuance. As general interest rate increases, the financing cost will become higher, the profitability will decrease. At some point, it can break.

The other 2 areas that I am concerned are trade wars and federal deficits. FOMC has to do a great job to handle the economy.

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Re: NYT: The Big, Dangerous Bubble in Corporate Debt

Post by grok87 » Thu Aug 09, 2018 6:46 pm

HEDGEFUNDIE wrote:
Thu Aug 09, 2018 5:10 pm
https://www.nytimes.com/2018/08/09/opin ... ssion.html

Thoughts? Can any fixed income bankers here confirm / deny this trend?

Fits nicely with the other recent thread about how Treasury bonds are the only bonds you need.
I think this quote is wrong?
“” wrote:Mr. Bernanke had a clever plan, what he called “quantitative easing”: The Fed would buy trillions of dollars of toxic securities that had marred the balance sheets of the Wall Street banks.

By creating artificial demand for these securities, where there had been virtually none, the Fed helped big banks cleanse their balance sheets, reassuring investors and creditors. But like anything else, bond prices are subject to the vagaries of supply and demand; the Fed’s gorging drove up not only the price of these particular bonds but also bond prices generally, lowering their yields. (When bond prices increaSe.”
As far as I know quantitative easing involved the fed purchasing treasuries and agency mortgage backed securities (which have no credit risk).

https://www.federalreserve.gov/faqs/wha ... chases.htm
“” wrote:What were the Federal Reserve's large-scale asset purchases?

In December 2008, as evidence of a dramatic slowdown in the U.S. economy mounted, the Federal Reserve reduced its target for the federal funds rate--the interest rate that depository institutions charge each other for borrowing funds overnight--to nearly zero, in order to provide stimulus to household and business spending and so support economic recovery. With short-term interest rates at nearly zero, the Federal Reserve made a series of large-scale asset purchases (LSAPs) between late 2008 and October 2014.

In conducting LSAPs, the Fed purchased longer-term securities issued by the U.S. government and longer-term securities issued or guaranteed by government-sponsored agencies such as Fannie Mae or Freddie Mac. The Fed purchased the securities in the private market through a competitive process; the Fed does not purchase government securities directly from the U.S. Treasury. The Fed's purchases reduced the available supply of securities in the market, leading to an increase in the prices of those securities and a reduction in their yields. Lower yields on mortgage-backed securities reduced mortgage rates as well.
Last edited by grok87 on Fri Aug 10, 2018 4:18 am, edited 1 time in total.
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megabad
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Re: NYT: The Big, Dangerous Bubble in Corporate Debt

Post by megabad » Thu Aug 09, 2018 7:50 pm

Agree with the above poster. NYT opinion writer does not appear to understand QE. I do not see any unusual trends in the current debt market. Debt was relatively cheaper in recent years when compared to the recent past. Some companies chose to load up on this debt. As QE recedes, I would expect that interest rates will rise and debt will become relatively less attractive.

I would actually hypothesize that the total corporate debt as a % of corporate valuations is much lower than it was in the 70,80s, and 2008. Additionally, the US total bond market cap is over $30 trillion, the entire covenant lite loan sector is estimated at less than $1 trillion. ATT's $80 billion debt is paltry in comparison. So if all of that debt became worthless, the bond market would lose a whopping 3% of its value.

Maybe there is too much corporate debt, but this article does not make a good case for it.

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Re: NYT: The Big, Dangerous Bubble in Corporate Debt

Post by TropikThunder » Thu Aug 09, 2018 8:02 pm

grok87 wrote:
Thu Aug 09, 2018 6:46 pm
As far as I know quantitative easing involved the fed purchasing treasuries and agency mortgage backed securities (which have no credit risk).
You are correct that the Fed did not purchase any corporate debt via QE (the central banks of other countries have included corporate debt in their schemes, but not the US). However, I think the author's point is that the brute force of QE on bond prices (up) and yields (down) affected corporate debt similarly (if indirectly) mainly by disconnecting risk from yield. As the author writes:
investors have been paying higher prices for the debt of riskier companies and not getting properly compensated for that risk
The bubble refers to (I believe) the likelihood of increased defaults by as continued borrowing gets more expensive (i.e., the risk shows up).

I'm not sure if that was the point you were addressing though. :|

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Re: NYT: The Big, Dangerous Bubble in Corporate Debt

Post by AlohaJoe » Thu Aug 09, 2018 8:25 pm

HEDGEFUNDIE wrote:
Thu Aug 09, 2018 5:10 pm
Thoughts? Can any fixed income bankers here confirm / deny this trend?
As an alternative viewpoint try: Time To Not Freak Out About Debt Again. (He covers household debt, corporate debt, and federal debt; scroll down to the corporate debt section.)
Corporate leverage today is not materially different than it was in 1993 or 2003, i.e., early in two expansion cycles.

More to the point, it is hard to say that corporate leverage is excessive. In the chart above, corporate net worth (i.e., assets net of liabilities, or equity) is about 4 times larger than debt. That is not onerous coverage.

Interest coverage is also not onerous. Companies in the S&P 500 can cover interest costs 7 times with earnings, a more comfortable margin than companies enjoyed at any time in the 1990s and 2000s (from JPM).

The delinquency rate on corporate loans reached an all-time low in 2014. Rates crept slightly higher in 2015 but have fallen again to just 1.1% over the past two years, lower than at any time during the prior three expansion cycles. Corporations are not finding it difficult to meet their financial obligations.

High yield spreads are falling and default rates are well below average. There is little sign of stress in this end of the debt market (from JPM).

Objectively, it is hard to see the case for current corporate debt being a worrisome risk at present.
The NYTime opinion piece feels like yet another in a long string of "But QE is going to destroy world" things that been written (and been wrong) for a decade now. Remember how the acceleration of QE unwinding earlier this year was going to destroy debt markets and cause inflation? (It is up to $30 billion a month now, I think.) Jamie Dimon has been "warning" that QE unwinding "might" cause problems for years. Here are some articles from over a year ago:

July 11, 2017: https://www.bloomberg.com/news/articles ... -you-think
October 2, 2017: https://www.ft.com/content/4c5bee74-a48 ... 1809486fe2
October 4, 2017: https://www.telegraph.co.uk/business/20 ... jp-morgan/

So it is going to be "disruptive", "unleash bank competition", and "trigger a financial crisis" according to Jamie Dimon and his team at JP Morgan. It's been a year and none of their "mights" (good hedging, they can always claim we didn't say it would definitely happen) have come to pass.

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Re: NYT: The Big, Dangerous Bubble in Corporate Debt

Post by JBTX » Thu Aug 09, 2018 8:59 pm

https://goldsilver.com/blog/corporate-d ... bt-crisis/

While I hate quoting that source there is an interesting graph about half way down. It is true that Corp debt/GDP is again approaching all time highs. On the flip side it has mostly ranged from 40-45% for 3 decades. An increase of 5% of GDP is not earth shattering. Household debt to GDP went from about 60% of GDP in 2000 to almost 100% of GDP in 2007 (it is now down in 75-80 range I think).

Plus it is somewhat rational that corporations would lock into rates when they are low.

I'll agree there is some froth and junk is overvalued but I'm not sure it is as dire as stated.

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telemark
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Re: NYT: The Big, Dangerous Bubble in Corporate Debt

Post by telemark » Fri Aug 10, 2018 1:25 am

I'm going to disagree with this part specifically
In the years leading up to the 2008 financial crisis, a sustained period of low interest rates led to a widespread deterioration of credit standards for mortgages, among other securities. The same thing is happening now for other kinds of loans and debt instruments. Only this time, the Fed has kept interest rates lower for longer.
In 2005 you could get 5 or 6 percent in a savings account, not what I would describe as a low interest rate. And if you follow the referenced link, the author doesn't mention interest rates at all. Credit standards for mortgages were indeed spectacularly low, but most people blame this on securitization and other forms of so-called financial engineering rather than interest rates.

On the other hand, my bond allocation is divided between Treasuries and a stable value fund. David Swensen argues in Unconventional Success that other types of bonds don't compensate the investor properly for the extra risk, and I found this persuasive. Are corporate bonds particularly risky just now? I don't know.

grok87
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Re: NYT: The Big, Dangerous Bubble in Corporate Debt

Post by grok87 » Fri Aug 10, 2018 4:20 am

TropikThunder wrote:
Thu Aug 09, 2018 8:02 pm
grok87 wrote:
Thu Aug 09, 2018 6:46 pm
As far as I know quantitative easing involved the fed purchasing treasuries and agency mortgage backed securities (which have no credit risk).
You are correct that the Fed did not purchase any corporate debt via QE (the central banks of other countries have included corporate debt in their schemes, but not the US). However, I think the author's point is that the brute force of QE on bond prices (up) and yields (down) affected corporate debt similarly (if indirectly) mainly by disconnecting risk from yield. As the author writes:
investors have been paying higher prices for the debt of riskier companies and not getting properly compensated for that risk
The bubble refers to (I believe) the likelihood of increased defaults by as continued borrowing gets more expensive (i.e., the risk shows up).

I'm not sure if that was the point you were addressing though. :|
thanks.

i take your point that there was likely an indirect effect from the fed's QE on corporate bond prices.
Keep calm and Boglehead on. KCBO.

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Re: NYT: The Big, Dangerous Bubble in Corporate Debt

Post by Valuethinker » Fri Aug 10, 2018 5:26 am

telemark wrote:
Fri Aug 10, 2018 1:25 am
I'm going to disagree with this part specifically
In the years leading up to the 2008 financial crisis, a sustained period of low interest rates led to a widespread deterioration of credit standards for mortgages, among other securities. The same thing is happening now for other kinds of loans and debt instruments. Only this time, the Fed has kept interest rates lower for longer.
In 2005 you could get 5 or 6 percent in a savings account, not what I would describe as a low interest rate. And if you follow the referenced link, the author doesn't mention interest rates at all. Credit standards for mortgages were indeed spectacularly low, but most people blame this on securitization and other forms of so-called financial engineering rather than interest rates.

On the other hand, my bond allocation is divided between Treasuries and a stable value fund. David Swensen argues in Unconventional Success that other types of bonds don't compensate the investor properly for the extra risk, and I found this persuasive. Are corporate bonds particularly risky just now? I don't know.
Pretty much agree with all of the above.

I am not sure if this is Swensen's argument, or only Larry Swedroe's. But corporate bonds have equity risk-- greater correlation with equities. Thus in a bond-equity portfolio, they reduce your diversification.

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Re: NYT: The Big, Dangerous Bubble in Corporate Debt

Post by garlandwhizzer » Fri Aug 10, 2018 1:43 pm

I agree that there is presently risk in higher yielding bond instruments (junk, cov-lite, P2P, student loans, sub-prime car loans, etc.,) and to a less extent in the investment grade corporate bond segment. Yield spreads between these less secure credit instruments and Treasuries contracted during QE and have remained contracted since due to investor's insatiable thirst for higher yields which I believe to be a mistake. As long as the economy keeps growing steadily and consistently I do not expect a default crisis in the corporate debt sector. The potential problem of risker debt does not show up when the economy is strong, but rather when recession hits which takes a large bite out of corporate/household cash flows. When a recession hits the happy talk about riskier debt and credit will cease and access to non-government credit will contract. As Buffett says when the tide recedes you find out who's swimming without trunks. Whether or not it precipitates a domino effect depends on the depth of the recession and the total amount of vulnerable credit when it starts.

Are there currently any factors that might possibly suggest recession risk in the near future? There are always such risks. Take your pick: unwinding of QE which has never been done before, higher interest rates, a potential trade war, increasing inflation, strong dollar, unexpected global political disasters. The list goes on and on but that doesn't means that a recession in the near term is inevitable. Nor does it mean that it won't happen. If a recession does happen, there will be corporate debt defaults, P2P debt defaults, student loan debt defaults, sub-prime auto loan defaults, credit card debt losses, and mortgage debt defaults. A lot of capital gets destroyed by defaults which can feedback into unemployment/recession in a self-reinforcing feedback loop as it did in 2007-9. Although recession is not on our horizon now it is IMO wise not to fall in love with the happy credit tune now which has IMO underpriced potential future risk. These days you're getting underpaid to take on default of duration risk in the credit markets IMO.

Garland Whizzer

Jack56
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Re: NYT: The Big, Dangerous Bubble in Corporate Debt

Post by Jack56 » Fri Aug 10, 2018 2:27 pm

Whoever is lending is probably a lot more savvy than the NYT writer (certainly he has been financially way more successful because he has the money to lend) so I am dubious that the NYT has any more insight into whether there is a "bubble" than a random person in the street.

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Re: NYT: The Big, Dangerous Bubble in Corporate Debt

Post by vineviz » Fri Aug 10, 2018 2:51 pm

Jack56 wrote:
Fri Aug 10, 2018 2:27 pm
Whoever is lending is probably a lot more savvy than the NYT writer (certainly he has been financially way more successful because he has the money to lend) so I am dubious that the NYT has any more insight into whether there is a "bubble" than a random person in the street.
The people "doing the lending" are, in large part, grandmothers looking to juice the yield on their retirement portfolios because they haven't saved enough money to live.

In other words, the marginal buyer IS a probably "a random person in the street".
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

grok87
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Re: NYT: The Big, Dangerous Bubble in Corporate Debt

Post by grok87 » Sat Aug 11, 2018 8:53 pm

vineviz wrote:
Fri Aug 10, 2018 2:51 pm
Jack56 wrote:
Fri Aug 10, 2018 2:27 pm
Whoever is lending is probably a lot more savvy than the NYT writer (certainly he has been financially way more successful because he has the money to lend) so I am dubious that the NYT has any more insight into whether there is a "bubble" than a random person in the street.
The people "doing the lending" are, in large part, grandmothers looking to juice the yield on their retirement portfolios because they haven't saved enough money to live.

In other words, the marginal buyer IS a probably "a random person in the street".
agree. aside from all all those Swensen followers...
Keep calm and Boglehead on. KCBO.

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Re: NYT: The Big, Dangerous Bubble in Corporate Debt

Post by Tycoon » Sat Aug 11, 2018 9:36 pm

Here a bubble, there a bubble, everywhere a bubble. That's it! I'm getting the shovel and burying our money in the backyard.

If one is looking for reasons to worry one can certainly find them. Asteroids, super volcanoes, sunspots, corporate debt, what next?

Investing involves risk. Measure one's risk tolerance and invest accordingly. If corporate debt scares you, buy treasuries. If treasuries scare you...

I'm not trying to be flippant; just trying to point out that using newspaper articles to time the market isn't the wisest approach.
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Re: NYT: The Big, Dangerous Bubble in Corporate Debt

Post by wootwoot » Sat Aug 11, 2018 10:05 pm

Fake news

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Re: NYT: The Big, Dangerous Bubble in Corporate Debt

Post by nisiprius » Sun Aug 12, 2018 10:59 am

For at least five years, e.g. 2013, when John C. Bogle said we have to fix the bond index, there has been a faction saying the ordinary investor should be holding more corporate bonds than in the Lehman/BarCap/Bloomberg aggregate index. And there has been another faction saying the ordinary investor doesn't need and shouldn't take the risk of anything but Treasuries. (And variations, like concern expressed by a) Vanguard, b) the SEC, and c) the IMF that illiquidity in corporate bonds posed a meaningful risk to bond mutual fund investors... although I think this was mostly a concern for lower-quality issues, e.g. so-called "high yield.")

I can't deal with a constant steady stream of advice in opposite directions from people I find credible and respectable. So I just stick with Total Bond. It has Treasuries. It has corporates. And it hasn't done anything dramatic in 32 years, including the "bond bubble" of 1993 and the "bond massacre" of 1994. At various points other things could have done better, but it's done fine.

See also: Part 2: Bond fund choices
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Re: NYT: The Big, Dangerous Bubble in Corporate Debt

Post by nedsaid » Sun Aug 12, 2018 12:06 pm

garlandwhizzer wrote:
Fri Aug 10, 2018 1:43 pm
I agree that there is presently risk in higher yielding bond instruments (junk, cov-lite, P2P, student loans, sub-prime car loans, etc.,) and to a less extent in the investment grade corporate bond segment. Yield spreads between these less secure credit instruments and Treasuries contracted during QE and have remained contracted since due to investor's insatiable thirst for higher yields which I believe to be a mistake. As long as the economy keeps growing steadily and consistently I do not expect a default crisis in the corporate debt sector. The potential problem of risker debt does not show up when the economy is strong, but rather when recession hits which takes a large bite out of corporate/household cash flows. When a recession hits the happy talk about riskier debt and credit will cease and access to non-government credit will contract. As Buffett says when the tide recedes you find out who's swimming without trunks. Whether or not it precipitates a domino effect depends on the depth of the recession and the total amount of vulnerable credit when it starts.

Are there currently any factors that might possibly suggest recession risk in the near future? There are always such risks. Take your pick: unwinding of QE which has never been done before, higher interest rates, a potential trade war, increasing inflation, strong dollar, unexpected global political disasters. The list goes on and on but that doesn't means that a recession in the near term is inevitable. Nor does it mean that it won't happen. If a recession does happen, there will be corporate debt defaults, P2P debt defaults, student loan debt defaults, sub-prime auto loan defaults, credit card debt losses, and mortgage debt defaults. A lot of capital gets destroyed by defaults which can feedback into unemployment/recession in a self-reinforcing feedback loop as it did in 2007-9. Although recession is not on our horizon now it is IMO wise not to fall in love with the happy credit tune now which has IMO underpriced potential future risk. These days you're getting underpaid to take on default of duration risk in the credit markets IMO.

Garland Whizzer
Garland, as usual, an excellent analysis. All you Bogleheads out there, write on a chalkboard 100 times: "I will not chase yields...I will not chase yields...I will not chase yields." I agree with Garland that the extra yields in higher yielding, lower credit rated bonds are not worth the risk. Spreads are just too narrow. Stick to quality and stick to shorter and intermediate term bonds and you will be just fine.
A fool and his money are good for business.

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