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Home | Blog | It's Junk Time Again

It's Junk Time Again


Not to worry 99 percenters, Ben Bernanke’s Fed policy of just-north-of-zero interest rates is starting to gain traction. Sure, unemployment is still elevated, and the number of people on food stamps still enormous, but the news is out that the collateral loan obligation (CLO) market is starting to come alive.

Rest assured that more money rushing into CLOs won’t help unemployed and overendebted college graduates secure employment or make a dent in their student loans, but Grant’s Interest Rate Observer reports the sighting of a commercial mortgage-backed security sporting a loan-to-value ratio greater than 100%. “It was the first such occurrence since credit went to the hospital in 2008,” says Grant’s.

Katy Burne and Matt Wirz make the point in the Wall Street Journal,

Left for dead after the financial crisis, the market for collateralized-loan obligations—pools of loans to “junk”-rated companies—is staging a comeback, driven by investors’ hunger for high-risk, high-return securities.

Sales of CLOs have topped $6.8 billion in the U.S. so far this year, according to S&P Capital IQ LCD. That is the busiest start to a year since 2008 and more than sales for the whole of 2009 and 2010 combined.

Axel Merk notes that it is Bernanke’s “humble” fixation with fighting deflation that creates a lot of debt–

whether that be out of thin air on the Fed’s balance sheet, or potentially across the economy as consumers, businesses and the government alike are enticed to borrow ever more money. So far, businesses are not taking the bait. But the government and some consumers are. What we consider monetary largess, as well as fiscal unsustainability, may ultimately lead to deterioration of the purchasing power of the U.S. dollar.

Businesses may well be taking the bait. One CMBS professional told Grant’s “You’re seeing a re-leveraging of the market pretty quickly.” It may not be 2007 again, but it’s not 2010 either.

While the Fed does all it can to make speaking of interest rates in percentage pointpassé, “Pensioners need to eat, and pension-plan managers must strive to provide them with the necessary income, the zero-percent funds rate notwithstanding,” writes Grant’s.

There is enough of an increase in the issuance of dodgy paper to lead Wall Street insider and CNBC favorite, Wilber Ross to say, “It’s not unduly dangerous, but we’re moving in that direction.”

In a yieldless world, lemmings are enticed off the cliff looking for any sort of yield at all, with no thought to risk below.

As Mark Quinn explains,

Reaching foryield is dangerous for a number of reasons, but mostly because such straining is done at precisely the wrong time. When people are fed up with low yields that the economy, or the profligacy rewarding Fed, provides them, they tend to do things…go out the curve at precisely the wrong time (when rates are low and headed higher) or take on more credit risk when the economy is slow and credit risk is therefore especially salient, as evidenced by the natural or Fed engineered low interest rate environment. The current tidal wave of money into credit sensitive lending is, of course, an instance of the latter.

Some $5.07 billion of CLO paper was issued in April, reports Grant’s, the most active month since November of 2007. It’s projected that CLO issuance may top $25 billion this year. A far cry from 2006’s $97 billion, but more than double 2011’s $12.3 billion.

Here we go again.

Douglas French is former president of the Mises Institute, author of Early Speculative Bubbles & Increases in the Money Supply , and author of Walk Away: The Rise and Fall of the Home-Ownership Myth. He received his master's degree in economics from UNLV, studying under both Professor Murray Rothbard and Professor Hans-Hermann Hoppe.

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