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Fed Peaks the Irony Meter With Worry About Corporate Debt

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The Federal Reserve is worried about corporate debt, which is ironic given that Fed policies made the corporate debt problem possible.

The Fed’s latest Financial Stability Report issued in November laments the pileup of business debt.

Borrowing by businesses is historically high relative to gross domestic product (GDP), with the most rapid increases in debt concentrated among the riskiest firms amid weak credit standards.”

In absolute terms, business debt has skyrocketed to a record $16 trillion. Business debt has increased by 5.1% year-on-year, much faster than economic growth. As a result, debt levels have also reached historic highs in terms of percentage of GDP. According to the report, debt growth has outpaced economic output “through most of the current expansion.”

In other words, the economy is a debt-fueled bubble.

A large percentage of the current corporate debt load is categorized as “risky.”

Half of investment-grade debt outstanding is currently rated in the lowest category of the investment-grade range (triple-B)—near an all-time high.”

The Fed warns, “In an economic downturn, widespread downgrades of bonds to speculative-grade ratings could lead investors to sell the downgraded bonds rapidly, increasing market illiquidity and downward price pressures in a segment of the corporate bond market known already to exhibit relatively low liquidity.”

This is a technical way of saying the air could come out of this corporate debt level very quickly.

The Fed also expresses concern about the high level of leveraged loans and what it describes as “weak underwriting standards.” There are more than$1.1 trillion in leveraged loans outstanding. These are loans made to firms already deeply in debt. Think subprime loans for corporations.

A broad indicator of the leverage of businesses—the ratio of debt to assets for all publicly traded nonfinancial firms—is at its highest level in 20 years.”

This is less than ideal. As the Fed warns — “excessive borrowing” leaves businesses “vulnerable to distress.”  And it also issues a poignant warning to those focused exclusively on the surging stock market, saying, “These vulnerabilities often interact with each other. For example, elevated valuation pressures (high asset prices) end to be associated with excessive borrowing because both borrowers and lenders are more willing to accept higher degrees of risk and leverage when asset prices are appreciating rapidly. The associated debt and leverage, in turn, make the risk of outsized declines in asset prices more likely and more damaging.”

In simple terms, the Fed is warning us that there is a high risk of the stock market bubble deflating very quickly.

Wolfstreet calls the Fed’s “lamenting, bemoaning, and begroaning the pileup of business debts” ironic given that it is largely a function of easy money policies that it implemented. And as Wolfstreet notes, it wasn’t by accident.

This debt pileup isn’t an unintended consequence of their policies. It was one of the purposes of their policies. But central banks also know from history that this historically high level of business debts is a powder keg waiting to explode – company by company at first, and then as contagion spreads, all at once.”

This isn’t just a problem in the US. Central banks around the world have blown up massive debt bubbles. And now they’re worried about it.

The German Bundesbank warns that the “risks to financial stability have continued to build up in Germany.” The German bank also laments the growing level of risky loans, saying that “banks’ lending portfolios now include a higher share of enterprises whose credit ratings could deteriorate the most in the event of an economic downturn.”

The European Central Bank’s Financial Stability Review also bemoaned “very low interest rates” and signs of “excessive financial risk-taking,” leading to “higher leverage among riskier firms.”

The Bank of France painted a similarly bleak picture.

Central banks shouting warnings about corporate debt and low interest rates pushes the irony meter to 11. As WolfStreet noted, it’s not just a case of central bank doublespeak.

It’s also a case of central banks getting worried about the effects of their handiwork that could end in a crisis at the business level that would hit the financial system, with not-hard-to-imagine consequences for the real economy.”

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