Jim Rickards: Junk Bonds Could Set off the Next Crisis

Last month, we reported on troubling signs in the corporate bond market. According to Moody’s, the majority of US companies have a “speculative” credit rating. They are considered high risk. As a result, their debt is “high yield” or “junk. When you combine leveraged loans and junk bonds, the total level of “junk” debt in the US marketplace comes in at around 37%.

In a recent article, investment guru and economic analyst Jim Rickards said we may soon face a devastating wave of junk bond defaults.

 The next financial collapse, already on our radar screen, will quite possibly come from junk bonds.”

In fact, Rickards lists a collapse in the corporate bond market as one of four potential sources for the next big crisis, along with the US student loan debacle, Chinese debt and the emerging-market credit crisis.

According to Rickards, the total number of highly speculative bonds has risen to 58% since the 2008 financial crisis thanks to artificially low interest rates. As a result, there are a lot of highly leveraged businesses out there. There’s currently a total of about $3.7 trillion of junk bonds outstanding globally. Rickards said when the next downturn hits, many corporations won’t be able to service all of their debt. He wrote that “defaults will spread throughout the system like a deadly contagion, and the damage will be enormous.”

Rickards quoted a report written by Mariarosa Verde, Moody’s senior credit officer:

This extended period of benign credit conditions has helped many weak, highly leveraged companies to avoid default… A number of very weak issuers are living on borrowed time while benign conditions last… These companies are poised to default when credit conditions eventually become more difficult… The record number of highly leveraged companies has set the stage for a particularly large wave of defaults when the next period of broad economic stress eventually arrives.”

Rickards said the crisis will start differently than the last one, but the end result will be the same.

Each crisis begins with distress in a particular over-borrowed sector and then spreads from sector to sector until the whole world is screaming, ‘I want my money back!'”

Of course, the mainstream won’t be prepared. As Rickards put it, “regulators are like generals fighting the last war.”

In 2008, the global financial crisis started in the US mortgage market and spread quickly to the overleveraged banking sector. As a result, over the last decade, the central bankers and government officials have obsessed with things like lending standards. As a result, mortgage lenders may be safer, but the system itself isn’t.

It doesn’t matter where the crisis begins. Once the tsunami hits, no one will be spared. The stock market is going to correct in the face of rising credit losses and tightening credit conditions. No one knows exactly when it’ll happen, but the time to prepare is now. Once the market corrects, it’ll be too late to act. That’s why the time to buy gold is now, while it’s cheap. When you need it most, once the crisis hits, it’ll cost a fortune.”

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