A group of top U.S. financial officials met last week to discuss what risks the recent surge in corporate borrowing might pose to global markets.
According to the US Treasury Department, the Financial Stability Oversight Council had a closed-door session led by Treasury Secretary Steven Mnuchin.
Although no details were provided as to specific topics discussed during the session, it concerned fears that the economy might be headed for another disastrous slowdown.
The potential catalyst for this emerging crisis: corporate credit and leveraged lending.
In the past, banks have practiced leveraged lending to loan money to poor credit ratings.
More recently, with relaxed leverage loan standards, this practice has been adopted by investment firms in the corporate lending space.
The last decade has seen the unpaid amount of these debt loads rise to over a Trillion dollars.
There had also been a rise in lending to companies with only a slightly better credit rating known as triple-B ratings. These loans have amounted to over $3 Billion!
What would happen if the economy were to slow down and these companies were to begin experiencing financial problems?
The consequences would be none other than corporate debt defaults on a massive scale.
Earlier in the year members of the Treasury Department worried that even the debt incurred by companies without poor ratings could have a credit-rating downgrade of $300 Million to $1 Trillion during the next economic slump.
As 2019 unfolds, President Trump’s escalating trade war with China is increasingly affecting global markets.
Experts suggest that these tariffs could add up to $800 to the average American household’s annual costs which would, in turn, hurt consumer-driven businesses.
This scenario could push the U.S. into its first recession in ten years.
Recently, 10-year U.S. Treasury note yields have fallen below those of shorter-term notes.
This “yield-curve inversion” is a rare occurrence since investors generally look for higher returns to counteract for the increased risk that comes with a lengthier payback period.
A yield-curve inversion is seen as a classic sign of a forthcoming recession.
This massive increase in borrowing is receiving a lot of attention from investors.
In short, it is highly likely that it will, in a matter of time, set off another financial crisis.
At the very least they know that any economic downturn will seriously stress these highly-leveraged debt-burdened businesses.
Firms like Blackstone and Apollo Global Management are driving this poor credit lending boom to pay for their corporate acquisitions.
Years of eased underwriting regulations coupled with economic growth are allowing them to do this.
Furthermore, the repackaging and selling of these debts are very similar to what happened with the subprime mortgages that eventually led to the 2008 financial crisis.
Because the 2008 crisis was caused by the banks’ lending to individuals, they have seen much tighter regulation.
Private-equity business lending, on the other hand, has remained largely unchecked.
While the Trump administration is trying to continue to allow these firms to operate as they have been and currently are, there is opposition from some powerful former Treasury Secretaries and Fed Chairs.
Time will tell if regulation can stem this tide but most signs point to a major problem on the horizon.
For investors seeking protection from this economic powder keg, hedging across the board with a combination of stocks, bonds, gold, and silver seem to be the best solution for total protection from this looming crisis.