Troajan31 Mar 2019 14:03
Unprecedented Liquidity Crisis
You see, it’s not just borrowers who’ve gotten used to easy credit. Many lenders assume they can exit at a moment’s notice.
We have two related problems here:
Corporate debt issuance, especially high-yield debt, has exploded since 2009.
Tighter regulations discouraged banks from making markets in corporate and high-yield debt.
Both are problems, but the second is worse. Experts tell me that Dodd-Frank requirements have reduced major banks’ market-making abilities by around 90%.
For now, bond market liquidity is fine because hedge funds and other non-bank lenders have filled the gap.
The problem is they are not true market makers. Nothing requires them to hold inventory or to buy when you want to sell.
That means all the bids can “magically” disappear just when you need them most.
In a bear market, you sell what you can, not what you want to. The picture will not be pretty.
To make matters worse, many of these lenders are far more leveraged this time. They bought their corporate bonds with borrowed money. They were confident that low interest rates and defaults would keep risks manageable.
In fact, according to S&P Global Market Watch, 77% of corporate bonds that are leveraged are what’s known as “covenant-lite.”
Put simply, the borrower doesn’t have to repay by conventional means. Sometimes they can even force the lender to take on more debt.
As the economy enters recession, many companies will lose their ability to service debt. Normally, this would be the borrowers’ problem, but covenant-lite lenders took it on themselves.
Another problem is that much of the at least $2 trillion in bond ETF and mutual funds isn’t owned by long-term investors who hold to maturity.
When the herd of investors calls up to redeem, there will be no bids for the “bad” bonds. But funds are required to pay redemptions, so they’ll have to sell their “good” bonds.
Remaining investors will be stuck with an increasingly poor-quality portfolio, which will drop even faster.
Those of us with a little gray hair have seen this before, but I think the coming crisis is biblical in proportion.
Join hundreds of thousands of other readers of Thoughts from the Frontline
Sharp macroeconomic analysis, big market calls, and shrewd predictions are all in a week’s work for visionary thinker and acclaimed financial expert John Mauldin. Since 2001, investors have turned to his Thoughts from the Frontline to be informed about what’s really going on in the economy. Join hundreds of thousands of readers, and get it free in your inbox every week.
http://www.marketoracle.co.uk/Article64519.html
Worth a read !
Sign In
Follow the stocks
