Last Two Times this Happened, it was Mayhem

Moody’s Warns about Credit Crunch, Unnerves with Parallels to 2008!

The US bond market has swollen to $40 trillion. Over $8 trillion are corporate bonds, up a mind-boggling 50% from when the Fed unleashed its zero-interest-rate policy and QE seven years ago.

So far this year, $1.34 trillion in new corporate bonds have been issued, up 6.8% from last year at this time, which had already been a record year, according to the Securities Industry and Financial Markets Association (SIFMA). Bond issuance in 2012, 2013, and 2014 set ever crazier records; 2015 is on track to set an even crazier one: close to $1.5 trillion.

That’s a lot of newly borrowed moolah. Much of it is being used to pay for dividends, stock buybacks, M&A, and other worthy financial engineering projects designed to inflate stock prices, though that strategy has turned into a sorry dud this year.

Junk bonds now make up $1.8 trillion of this pile of corporate debt, nearly double the $944 billion in junk bonds outstanding at the end of 2008 before the Fed saved the economy, so to speak.

But what happens when this flood of cheaply borrowed money begins to dry up as an ever larger percentage of that $1.8 trillion in junk bonds begins to default, while ever more high-grade bonds get downgraded to junk?

That’s the end of the credit cycle – and the beginning of financial nightmares. It’s the phase the bond market has already entered, according to a report by John Lonski, Chief Economist at Moody’s Capital Markets Research.

One metric that marks turning points in the credit cycle is the credit upgrade ratio. In Q2 this year, the ratio of ratings upgrades to total ratings revisions for junk bonds was still 49%. By Q3, this upgrade ratio had fallen to 39%, the worst level since Q2 2009 when it was 30%. Halfway into Q4, there have been 18 upgrades and 57 downgrades, a ratio of 24%, the worst since Q1 2009.

Among investment-grade bonds, the ratio is even more terrible: 1 upgrade and 11 downgrades. “A convincing negative trend may be emerging,” the report said gingerly.

To reduce quarter-to-quarter volatility in the metric, Lonski looks at the upgrade-ratio of two quarters combined. In Q3 and Q4 so far, the combined upgrade ratio is 35%, a hair better than the 34% from the two quarters ended September 2009. The ratio had bottomed out in the two quarters ended March 2009 at 13%.

But here’s the thing: the last two times when the upgrade ratio fell from above 40% to below 40% was in Q4 2007 (at 37%) as exploding debt was already putting cracks into the financial system, and in Q4 1998 (at 29%) as the dotcom bubble was approaching its final year.

“Both episodes constituted important turning points in the corporate credit cycle. Thereafter, not only did high-yield bond spreads remain relatively wide, but both projected and actual default rates trended higher,” the report pointed out – a hilarious understatement, given the fiascos that followed.

And these “projected and actual default rates” are already taking off. The Expected Default Frequency (EDF) of US and Canadian junk-rated companies, a metric of future defaults, hit 5.6%, the highest since the 6.4% of August 2009.

Moody’s unnerving parallels to 2008, 2009!

“Given the surge in the number of downgrades, plunging upgrades, and the likelihood of significantly more defaults,” the all-important spread between the yields of junk bonds to US Treasuries is likely to widen, especially given last quarter’s “decidedly subpar showings by business sales and operating profits.”

These dynamics in the bond markets are spooking banks – and bank regulators. They’re seeing them as a deterioration of credit quality. And so they tighten their lending standards, and they widen the rate spreads on business loans. Thus they make borrowed money scarcer and more expensive.

Banks have been pushing risky borrowers into issuing bonds and use the proceeds to pay down their credit lines. This is a way for banks to roll off risk to bondholders. But when companies have trouble issuing bonds at survivable yields, banks get worried about extending loans to them. In turn, when banks get spooked, bondholders panic.

These companies need new money to service their debts, and when the money spigot gets turned off, default rates and projected default rates rise, thus triggering even tighter lending standards….

The vicious circle of the credit crunch sets in.

“Typically, the downward spiral continues until the weak credits have been sufficiently culled and the business outlook improves,” Moody’s explains. Last two times this happened, it was mayhem.

It’s already happening. The Fed reported in its quarterly Senior Loan Officer Opinion Survey of October that banks have begun to tighten lending standards on commercial and industrial loans – the first tightening after three years of loosening lending standards, and after tightening throughout the Financial Crisis.

But the last two times when lending standards switched from loosening to tightening to a similar degree, according to Moody’s, was in, well, the infamous Q3 2007 and Q4 1998.

We know what came after both occasions. Only this time, the pile of debt is far larger, and the risks – thanks to the Fed’s ingenious policies that have encouraged all this – far greater.

Debt is the key in commercial real estate. Low interest rates make it happen. Banks are eager to lend. They repackage this debt into Commercial Mortgage Backed Securities and sell them to yield-desperate investors. It has performed miracles, once again. Read… Fed Trips over Eye-Popping Commercial Real Estate Bubble, Accidentally Looks, Sees “Early Signs” of “Search for Yield”

Enjoy reading WOLF STREET and want to support it? You can donate. I appreciate it immensely. Click on the beer and iced-tea mug to find out how:

Would you like to be notified via email when WOLF STREET publishes a new article? Sign up here.

  28 comments for “Last Two Times this Happened, it was Mayhem

  1. MC says:

    I’ve been reading about both regulators and banking officials worrying about mounting debt volume for at least a year now. Honestly I don’t know if they are just attempting calming the most nervous investors (like myself) or if they have finally understood we are in troubles, and have been since 2009, when far too much unsustainable debt wasn’t rolled over as common sense would have dictated.

    The $8 trillion question is now very simple: what next? Again common sense would dictate an orderly retreat, in form of restructuring of part of that debt and diverting some of those fantastic profits towards reducing the pile of IOU’s. This would have the doubly beneficial effect of also increasing yields as to reflect ratings: financial repression and programs such as the ECB QE (which includes corporate bonds) have completed distorted yields to the point a junk rated Austrian bank can now pay 1.74% on its debt.

    Of course there’s a bigger and closely related problem: sovereign bonds. While corporate bond issuers benefited hugely from monetary policies, they are just junior partners when it comes to the immense benefits these policies had on sovereign debt. Portuguese 10 year bonds now yield under 100bps and even in the midst of this year Greek Crisis their bonds yielded all of a massive 12-14%. And these are just two examples.
    You cannot look at corporate bonds without taking into account their sovereign older and far larger siblings.
    As long as sovereign yields remain so repressed, so will corporate ones because they both draw water from the same spring: the longest period of ZIRP’s and NIRP’s in memory.

    And a final catch: should US rates ever go up again in meaningful fashion (meaning over 100bps), foreign investors, driven beyond the point of insanity by the ECB and the BOJ (whose course is now set in stone) will flood the US market. This may have unforeseen consequences for the whole world.

  2. michael says:

    The bad news continues to expand throughout the economy. This reminds of the flu that gets passed around in a work offcie, just keeps spreading and spreading.

    I would make one change to your article: “thanks to the Fed’s ingenious policies” should be thanks to the Fed’s criminal policies.”

    At some point we are going to get to see exactly how powerful or how impotent is the Fed.

    • economicminor says:

      michael, except that what the FED did was legal under its mandate, even if it wasn’t wise. Who is really to blame is the Congress for not changing the laws that allowed the fraud and abuse. Congress and the Executive Branch are the really the big criminals in all this. The FED was just protecting/helping its member banks like you should have expected.

      The US may have the highest tax rates but they have the lowest collection of tax per income in the world. There are so many ways to hide or distribute money or spend it on things that benefit a few while not doing a damn thing for the company.

      Then there is out and out fraud with virtually no accountability.. Where has the Justice Department been in all this? Slapping wrists and giving out minuscule fines.

      No, actually the FED is the least of the problems except that they facilitated, under their mandate, a system that will bring down the entire US. When this starts rolling over, which it may have begun, then assets start falling and then some old loans will be called and new ones virtually impossible to make. When revenues are not enough to run the company and service existing debt and new borrowing is cut off, what do you think will happen?

      At first restructuring will be attempted but unless the picture is different that what I see, many companies will split and some will just go under. Going to be a mess as far as I can determine.

      • Red Flag says:

        Re the US tax rates, collecting taxes will NEVER solve the spending problem. The problem originates in the Federal Reserve and the fed govt.’s spending policies. There is far too much good info out there on the fact that black market drug money funds the wars and other operations of the wasteful fed govt. The Pentagon is so irresponsible its scorned now. There’s no way the taxpayer can possibly repay any of this debt. I, as a taxpayer, refuse to be liable for it. I never voted for it. It does’t benefit me. The US has refused and blocked the globall money reset and will now pay a price. Check out the Chinese deal with Pakistan on the new port just this week. The greed and hubris of the US elites have cratered their own nest. People say the US people lost control; wrong, the Congress, Senate and rest of the structure lost control. Think they’ll get their own entitlements? I don’t.

        • Red Flag says:

          PS the you tubes of Karen Hudes offer new insights into what could be coming, vis a vis the crashing of the dollar. It may be a different scenario.

        • economicminor says:

          Red Flag, You are right about collecting enough taxes to solve this mess. Didn’t I blame this on Congress and the Executive Branch. They are the ones that make the laws/policies and enforce them. The fact that we haven’t collected adequate taxes for 30 years. This has been compounding .. and got worse during the GWB administration when the government had two wars along with tax breaks for those with the largest incomes..

          At this point, I really don’t think there is a single thing that can be done because we are in waaaaaay to deep. We should have let the system reset itself in 2008/9 but Congress and the Exec Branch decided to bail out their campaign contributors instead.

          Here for an additional point of view read this piece posted on

  3. Petunia says:

    The financial world is like a bad comedy sketch.

    Retailer: I want to borrow money to buy back our stock.

    Banker: How are you going to pay us back?

    Retailer: The stock buyback will boost our earnings.

    Banker: What are you going to sell to make money?

    Retailer: We don’t sell stuff to make money,
    we borrow to increase earnings.

    • economicminor says:

      Until we run out of assets to borrow against and then the bank won’t lend any more. So then we’ll sell bonds to pay down the bank loans and transfer the insanity to CalPers. etc. What a great plan!

  4. Dennis Richmond says:

    I keep hearing about 2008 like the world came to an end ? It was a good year for me ! What ever happened that year had No impact on my life to my knowledge ? I didn’t even know anything happened ??? So if that is the worst it is going to get ? Stop acting like the World is coming to an END !!!

    • Wolf Richter says:

      Do you live on the moon? Gotta be nice up there.

      • meat wad says:


        And I don’t have cancer, so what’s the big deal about cancer?

        Party on, Dennis.

    • Mark says:

      Dennis I also didn’t feel any impact of 2008 crisis or any other before because I kept investing in my education and with every new job I was better off with my pay. Even if we go into new crisis next or year after, it will not concern me considering that I saved most of my money and live mortgage and loans free.
      One is truth: biggest crises are the biggest opportunities.
      To some it might look like we come from different planet (full respect Wolf) but if that is the case I am glad to be an alien.

      • Wolf Richter says:

        Look, about 9 million people lost their jobs during 2008/2009. These people went through enormous misery and hardship. Other workers saw their hours cut. Millions went on part-time schedules. Lots of people got pay cuts. This was a TERRIBLE time!

        Central banks jumped into the fray. They world has changed because of the Financial Crisis.

        OK, I did my thing and was fine. I was in Yosemite, hiking and happy when Lehman blew up – but that doesn’t mean that the country was fine. This whole idea that because I’m fine, the country must be fine, and nothing bad happened … is quite disturbing to me.

        • Petunia says:

          Mark and Dennis haven’t felt the financial impact, but the political impact that is bubbling under the surface won’t be as easy to escape. A paid up mortgage and money in the bank won’t insulate them when the ground shifts under their feet. I can’t decide if them not seeing that is amusing or disturbing.

        • Mark says:

          OK you made point but I don’t agree with you. I was not happy to see many of my friends laid off or fired, but many of them were oblivious to the storm that hit the shore even they had warning lights go on all around.
          We have same situation today. If you try to explain to people that this party is about to end they say: “I don’t care I can’t change anything”. Those are the same people who vote for garbage and stay silent when money and gold is confiscated, health care and insurance increased to the point that they can’t afford it anymore, education system for masses are Kardashians, country is swamped with illegal immigrants and police officers who refuse to “serve and protect” just because they don’t want to be labeled as “racist”. I am very aware of what is going on today and think for myself not pretending to be Jesus and try to save oblivious sheeple crazed by; must have this, must have that and not knowing anything.
          Petunia is right “political impact won’t be easy to escape” but I can assure you it wont shift ground beneath my feet. My escape portfolio is well diversified.

        • Debravity says:

          Wolf, I agree. And the sort of ignorance which tends to accompany this kind of arrogance can only be forgiven of people who DO live on the moon – apart from society, COMPLETELY.
          For anyone to dismiss the diminishments to human freedoms and equality which continue to occur from the unchecked corruption and profiteering that led to GFC, and the subsequent policies to ‘save us’, because they didn’t affect them is fine, now. But, it may come back to bite very hard, in a future when the word ‘freedom’ no longer exists – in Newspeak…

    • buzz says:

      When the feds bailed out the banks , GM and others the natural defaults of Businesses , banks was not allowed to happen last time est to be around 1.8 Trillion. The debt this time is est to be well north of 4 Trillion already with defaults already starting with a record amount of credit downgrades occurring with 4 Shale energy Companies ready to default on 4.8 billion at any second. Starting this qtr into 2017 Millions of lay offs will ocurre and major retailers will be gone along with major businneses bankrupt that have been around for decades as they have incurred so much debt from M and A and have stock buy backs

  5. sargintrock says:

    A lot of knowledgeable fellows on this site.
    Please elaborate on how the fall of the dollar will affect Vets on social security with credit card debt and Will money owed credit debt % go up or remain the same? Trying to figure out if I should squander my nest egg paying for credit card debt or wait till I get more bang for my buck!

    • CrazyCooter says:

      Others might disagree with me, but you need to differentiate between secured debt (e.g. mortgage) and unsecured debt (e.g. credit card). A lawyer might be appropriate depending on your situation. Hell, you might even be able to BK your debt and come out ahead. It just depends and “the system” is anything but simple.

      With that caveat, let’s take my situation as an example. I have an unsecured HELOC from a foreclosure and a credit card (both significant balances) and a small loan on one of our vehicles. I keep cash in a safe deposit box, beyond what float I need in checking/savings. I am hammering away on that vehicle loan. I plan to open Treasury Direct and Bit Gold accounts next year once my vehicle is paid off, as I will have hit my goal for cold hard cash. My plan is to keep my savings out of the banking system and available in 30 days or less.

      When things hit the fan, I can tell the HELOC and CC to go screw a fence post – and my credit takes a hit – but I can then spend my cash on keeping a roof over my families head. Maybe keep the mortgage, maybe I walk, but I do what is in MY best interest.

      Priorities. Think about them and position/plan accordingly.

      That said, work to get out of debt – completely, 100%, totally out of debt. But, make no mistake, if the hammer comes down circle your wagons and tell the lenders to go F themselves.

      Regarding the value of the dollar, if the dollar goes to hell, it just won’t buy as much as it used to (e.g. the price of everything goes up significantly). You need to maximize your free cash flow to weather this sort of storm, so being strung out on payments is no good.

      In this scenario, if you have cash in the bank, it will lose value in what it can buy – but at the same time your debts shouldn’t grow beyond their interest. You have some optionality here.

      Generally speaking, any debts you have now won’t change in nominal value (e.g. if you owe 10,000, you will still own 10k when TSHTF). But that same principal also applies to any pension you might get. Pensions might change in payout due to inflation, depending on your circumstances. This is one reason our official inflation metrics are so screwey – they want to hide inflation in some cases and overstate it in other.

      And when you finally get your ducks in a row, you will be surrounded by folks whose ducks are anything but. So, look around and realize what you are in for when things go sour. Just going into a bad situation with your eyes open can make all the difference.

      I am not advocating “prepping”, as I often like to comment that “people can not adequately prepare for that which they have never experienced.” That said, I did NOT say you shouldn’t think and be reasonably prepared.

      The last thing to realize is that when the gov’t goes broke, it won’t make payments or payments will be significantly delayed. You may lose deposits in the bank or withdrawals may be limited. Pay close attention to what happens in Greece (for example) and you will know what that song is going to sound like.

      Lastly, it is my opinion we are going into a “long emergency” so think along the lines of a marathon and not a sprint.

      Best of luck!



      • sargintrock says:

        Brotherman, thanks for the timely reply and insights. I hear ya!

      • economicminor says:

        I agree about staying out of debt at this point, unless you believe the government will be able to foster inflation but that seems unlikely for a couple of reasons.. For, in order for prices to rise, you must have a higher demand. Artificially raising prices with out higher demand will just shut the system down as it has done with commodities. You could get higher demand via the consumer but only IF the government was willing to give the cash to us and so far they have only been willing to give cash to those who pay their campaign and junket costs.

        As for the value of pensions, there is no guarantee on most of them and they are just as guilty as the PV and PE groups funding this insane rise in debts. After all, a lot of the money funding all the mal investment came from them looking for exceptional returns.. So don’t look for them to even be around when this all is finalized. At least not in the same state they are today. This is going to be one of the big tragedies for many in their tarnished (once golden) years.

    • economicminor says:

      will the dollar fall or will it rise? Seems that there are more reasons for it to rise than to fall.. As debt crashes, won’t the dollar be in high demand? Won’t people be selling everything they can to try and save themselves from the cliff. Won’t dollars buy more and more as they will be in scarce supply.. as there will be few will actual. Won’t loans be hard to get or very high interest?

      • sargintrock says:

        Thanks fer yer input.

      • CrazyCooter says:

        The trick here is timeline. You are correct. But, you can’t take a ruler and draw it out past your death of old age. Initially, the dollar will certainly strengthen, and this will have consequences for sure. And I am all about cash-is-king. 100% on board with you. I want no debt and all the cash I can get my hands on (out of the banking system as stated).

        But there will come a day when I will totally blow that wad buying *something* … I just don’t know when or what.

        Why? Eventually the dollar will weaken and ultimately fail. No one can know what that failure will look like, but if history is your guide, it will happen – we are just debating about how long. 5 years? 10 years? 20 years? All at once or a long, slow slide into oblivion?

        So I just prepare and try to be ready to pull the trigger when I got a good shot at something. Once I get my business, I will shamelessly plug it, so if we are all around these parts when that happens, y’all will know. :-D



        • Nick says:

          All one need do is take a look at the rest of the world. We are in the post-global economy, and it’s pretty fucked up. The USD will stand strong against the tide for a good long while.

        • economicminor says:

          And in the end we all die… But in the mean time, my best guess is that the dollar strengthens for some years as there is waaaaaay more debt than can be monetized by the government unless they go to virtual helicopter drops into the bank accounts of everyone and anyone with a bank account. It won’t work to just put the dollars in the Oligarch’s accounts again because all that does is make the price of art and yachts go up and does nothing for the price of oil or copper and certainly doesn’t put the average worker back to work.

          But Cooter does make a good point, they will try and at some point they will probably succeed, if the existing government system still stands. At that point I imagine that small plots of farm land with water and any productive capacity that actually benefits human life will be in high demand. Things will reset and life won’t end. It will just be a really bad time for a while.

          Unless I’m way off base, I think the urban areas will have the worse time. Just think trucking and how things get into the cities and how much debt the trucking industry is carrying. Maybe the system of foreclosure and repo will just break down and all the trucks will still run and that the overly indebted VC and PE groups will keep the fuel flowing when there isn’t enough actual cash to pay for operations and service their debts…

          The scenarios that spin off out of my head are many and varied. I really don’t think anyone can accurately predict what will happen when this financial house of cards falls other than chaos. I am pretty sure that the US will no longer be a world power as our military will be much like what happened to the one when the USSR failed except worse. Well, that is just one of those many scenarios..

          Who knows, maybe peace and understanding will break out and we will see the real beginnings of the Age of Aquarius. After all, the US has all it needs for all of us to live happy productive existences, everything except understanding and tolerance..

  6. Andrew says:

    I see it is as quite simple.

    In ’08, Central Bankers went for “double, or nothing”.

    Put rates firmly at zero, hit the Keynesian stimulus. The hope was this would kickstart the economy. With the strong growth, interest rates could then be normalised and the Keynesian govt stimulus/debt repaid.

    The alternative was that this hail mary would fail. And we would be stuck with a grotesque, zombified economy ala Japan. Mountains of debt, and the only option to dig deeper into monetary insanity, insanity which is strangling main street (unproductive investment; no returns to savings etc).

    Which camp did we end up in? …

  7. bob roark says:

    I just ran the numbers on HYG as of 11/27/15, 11.46% of HYG is energy. Nothing good can come of this particular exposure at this juncture, if the distress in the oil field continues.
    BTU is also in this portfolio. Basic industry is well represented in this portfolio as well
    It will be an interesting experiment in fluid dynamics when the herd attempts to exit.

Comments are closed.