Fed urged to take US debt risks more seriously

NEW YORK / ST. LOUIS (Reuters) – Bankers, executives, and investors warn Federal Reserve officials in camera that leveraged loans to companies in poorly regulated areas of Wall Street could complicate business management. an economic slowdown.

With the second-longest expansion of the US at its advanced stages, it is feared that a critical part of the credit market is particularly vulnerable to a slowdown, as highly indebted firms are at risk of default. most important.

Some of those involved in the debate who spoke to Reuters expressed frustration that the Fed is not taking the risk seriously enough.

"The Fed feels that it needs to monitor this area, leveraged credit, but it's still in its infancy and we do not know how far it will go," said an economist at the US. makes the efforts of the Fed.

In the worst-case scenario, which would resonate weakly with the financial crisis a decade ago, defaults could worsen any recession by destabilizing large non-bank lenders, such as private equity firms and hedge funds, and harming the financial markets. Employment in American industries. Leveraged loans are generally made to already indebted and low-rated companies, and there is concern that it will be difficult to recover or resell them during downturns, thus putting both the debt and the debtors in the mix. borrower and the lender at risk.

"The sheer size of the market-based financial intermediation is very different (compared to previous years) and we do not know how it's going to be in a downturn," said Tobias Adrian, director of the US Department of Finance. Monetary and capital markets at the International Monetary Fund, said in an interview.

Few people think that leveraged loans would trigger today a crisis similar to that triggered by a wave of delinquencies in the US sub-prime mortgage market in 2008, since they are concentrated on a smaller part of the economy than the sprawling housing market.

However, they risk handcuffing businesses and lenders to try to respond to an economic downturn, possibly making it more painful.

On Wednesday, the Fed is expected to release for the first time a new semi-annual report on financial stability badyzing the situation at different levels of the financial system, including leveraged borrowing.

BURNING SUBJECT

The central bank itself may have contributed to the US $ 1.12 trillion lending market swelling by keeping interest rates close to zero for seven years following the recession to 'encourage loans and investments.

In comparison, secured debt securities, or CDOs, which pay off toxic housing debt through the global financial system, amounted to about $ 61 trillion in 2007, according to the Bank for International Settlements.

The total leveraged loan market is now about double what it was in 2008, and it has risen by 17% since the beginning of the year, based on the number of loans. S & P / LSTA leveraged loan index.

A record 59% of these "undesirable" loans are rated B + or worse, according to S & P Global. "The risks attributable to this debt frenzy are significant," said last month. (Graphic: tmsnrt.rs/2DAQPl4)

According to Fed policymakers who spoke to Reuters, those who spoke to central bankers and the minutes of recent Federal Advisory Council meetings, private discussions are increasingly focused on leveraged credit growth. and its risk for overall financial stability. The board is composed of bankers appointed in the 12 regional districts of the Fed to consult the central bank.

For example, some regional Fed presidents have asked business leaders whether they see leveraged borrowing using debt structures that would seem particularly dangerous in the event of a credit crunch. Loans that need to be renewed and repaid frequently, for example, may fall into this category.

In Washington, a banker of the advisory council told Fed governors that unregulated lenders were "running aggressive structures" and removing heavily regulated banks, according to a report from a September advisory council meeting.

"SO EXTREME"

Scott Minerd, managing partner at Guggenheim Partners, said that President John Williams and some of his colleagues at the New York Fed had been "taken aback" when he had said at a consultative meeting that he was not going to talk about it. he did not think the Fed could safely avoid a disorderly recession. credit accumulation and other risks.

"Because the situation is now so extreme, any attempt to curb credit expansion will ultimately fail," Minerd said at the Reuters 2019 Global Investment Outlook Summit this month -this.

Credit spreads – or the difference between government and corporate borrowing costs – have already reached record levels in two years for high-quality, high-yield debt. For what might be a taste of what's going to happen, General Electric Co's (GE.N) bonds fell this month as they struggled to raise funds.

Minerd said the Fed and other regulators have not yet seriously considered a scenario in which credit spreads would increase much by prompting regulators to impose liquidations on insurers and other companies that have purchased credit-backed loan bonds. security interests. Like CDOs at the origin of the housing crisis, CLOs group business loans into one single title.

"They do not really know where this risk exists," he said.

For example, one question for which regulators and bankers have little clarity is who provides the money that non-bank lenders invest in leveraged loans.

The central bank has paid more attention to the increase in the number of leveraged loans this year. Fed Chairman Jerome Powell said in front of a public forum earlier this month, "There is a lot of corporate borrowing, and we have an eye on that."

However, Powell pointed out that the risks were "rather moderate" in the broad sense: badet prices, bank leverage, and household and corporate borrowing.

St. Louis Fed President James Bullard echoed this sentiment this week. Bullard told Reuters in an interview that the bursting of the tech bubble at the turn of the century was a more appropriate point of reference for today's corporate debt markets, rather than the real estate market around 2007 because it was a case where individual investors were in danger but not the economy as a whole.

"The first has exploded without major macroeconomic consequences … Most investors were licked wounds and returned home. It's a case where you let the markets work, "Bullard said.