The markets weakest links
Debtor countries are driving inflation. Creditor countries are not immune. Inflation flips the narrative – US dollar reserves are a captive tax against creditors, savers. China gross national savings is 45% of GDP versus 18% for the United States. Chinese households flocked to what they could – physical assets are an extreme 69.3% of their wealth. Real estate dominates. Underwriting is weak. Highly indebted builders are funded by presale deposits. Credit downgrades are now rampant. Demographics are a severe headwind. Regional economies are unbalanced, fueled by coal. Political, financial, and environment threats are acute.
The leverage lending market – high yield bonds and leveraged loans – exploded to $3trln in 2021, double a decade earlier. Underwriting standards eroded. Covenants to protect creditors vanished. Opportunistic refinancing surge.
The clues for the next crisis are usually found in the solutions to the previous one. The post-GFC macro megatrend was to issue more debt and less equity. Less equity is less principal risk. Less principal risk lends itself to weaker underwriting. That trade was funded through capital markets after the GFC, not by banks who were in a regulatory penalty box. Dealers now have less than one-tenth the credit inventory than 2007. Fragilities are now in capital markets and liquidity channels. March 2020 was a preview. Policy either accommodates or intervenes.
The leverage lending market – high yield bonds and leveraged loans – exploded to $3trln in 2021, double a decade earlier. Underwriting standards eroded. Covenants to protect creditors vanished. Opportunistic refinancing surge.
The clues for the next crisis are usually found in the solutions to the previous one. The post-GFC macro megatrend was to issue more debt and less equity. Less equity is less principal risk. Less principal risk lends itself to weaker underwriting. That trade was funded through capital markets after the GFC, not by banks who were in a regulatory penalty box. Dealers now have less than one-tenth the credit inventory than 2007. Fragilities are now in capital markets and liquidity channels. March 2020 was a preview. Policy either accommodates or intervenes.
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