THE WOLF STREET REPORT

Will this Scheduled Bloodbath in Corporate Debt Deter the Fed?

The path to a somewhat “normalized” interest rate environment, after a decade of central bank emergency measures and credit-market manipulations, is not going to be pretty. And in some areas, a credit bloodbath has been scheduled. But will it deter the Fed? (12 minutes)

At the Fed, the “up to” exacts its pound of flesh. Read…  The Fed’s QE Unwind Hits $321 Billion  
 

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  46 comments for “THE WOLF STREET REPORT

  1. Howard Fritz
    Nov 4, 2018 at 6:47 pm

    Short Answer: no
    Long Answer: when push comes to shove someone else (taxpayers) have been conditioned to pick up the tab.

    • MC01
      Nov 5, 2018 at 3:15 am

      All civilized countries have bankruptcy laws, many of which deal precisely with debt restructuring and defaults. Over the last five years even Europe has made some significant modifications to her archaic bankruptcy procedures: for example Germany introduced “securities for equities” swaps in some cases and France introduced a more balanced concept of personal bankruptcy. There’s still a long way to go to make bankruptcy more equitable, but it’s a start.

      So why are taxpayers on the hook at all? Why is the Italian government still promising to use tax revenues to make bank bondholders whole? It goes against the very principle of “rule of law”.
      We have laws, so why not use them? If politicians really want to make themselves useful they can just help improve existing procedures, not just charge in guns blazing, hoping for some cheap (for them) PR.

      • Nov 5, 2018 at 9:11 am

        MC01,

        Yes, thank you!

        Bailouts in the US happened during the financial crisis because credit froze up, and even stable companies couldn’t borrow anymore and ran out of juice. That’s when the Fed stepped in as lender-of-last-resort (with its alphabet soup of bailout programs, not QE … QE had another purpose). But thousands of companies filed for bankruptcy, and hundreds of smaller banks were shut down. The biggest banks got bailed out. And the biggest industrial companies received emergency loans.

        This was a fairly unique situation in my lifetime.

        However, a series of defaults as interest rates go up will just make bankruptcy lawyers rich… they’re already licking their chops. This won’t trigger any bailouts by taxpayers or the Fed. This happens routinely, even with big companies such as Toys ‘R’ Us, Sears, or Enron, no bailouts involved.

        This is in the US where the bankruptcy process is just another business and financial activity involving firms that specialize in it. But in countries like Italy, as you have pointed out before, this appears to be a lot more complex, including the repossession and disposition of collateral. That’s one of the reasons why it’s so hard to clear out zombie companies in Italy, and for banks to shed their NPLs.

        I’m not sure what it will take to fix the process in Italy, but this should be one of the top priorities of any government.

        • Michael D.
          Nov 5, 2018 at 1:15 pm

          Wolf, excellent points. Back in the day I used to work for the Archon Group, a Goldman Sachs affiliate, and we spent our days and nights figuring out how to repossess and dispose of a lot of valuable (along with sh*t) collateral in France and Italy. It was challenging work, but a very interesting experience from a personal standpoint.

        • MC01
          Nov 5, 2018 at 1:41 pm

          First of all allow me to thank you for your excellent podcast.

          Second, it seems that almost every country I am involved with considers that once any firm reaches a certain “critical mass” it becomes automatically eligible for a bailout of some kind.
          I am giving away a spoiler of my next piece, but since the beginning of the year there have been very clear signs giant low-cost carrier Norwegian Air Shuttle may soon hit the insolvency wall. The calls for a taxpayer-backed bailout have already started, despite the fact the Norwegian government has been trying for a while to get out of the brutal airline business by selling their share in SAS and the two public pension funds are openly forbidden from investing in risky assets such as Norwegian is.
          And the less I say about how the French government dealt with the Areva “bankruptcy”, the better. They basically changed the name to Orano, sold Mitsubishi the only remotely profitable parts of the group for cents to the euro in return for a modest €500 million investment (backed by the State-owned Japan Nuclear Fuel Ltd) and papered over losses with public funds. None of the managers who had run Areva into the ground, mostly Grandes Écoles alumni, was held remotely accountable. Ops, I’ve already said too much!

          PS: I’ll send you the piece nce I double-check it as it was composed during a bout with insomnia. ;-)

  2. Sporkfed
    Nov 4, 2018 at 6:52 pm

    The FED wants the market to fear them. So no,
    it is full steam ahead.

  3. Beverley L Kennedy
    Nov 4, 2018 at 7:18 pm

    This will be the death knell for Canada’s very fragile and landlocked energy economy
    Medias focus has been on consumer debt rather than corporate debt and my concern is that this blind eye silo focus will prove very problematic for Canada’s economy apart from our banks
    We talk about carbon tax but the basic infrastructure for delivery has corroded rather than been kept current during the down cycle when basic infrastructure mends are prudent and cost effective.
    We in Canada are killing off our energy industry due to neglect of practicalities while spouting high minded theory. Our companies are fragile so persistent rate hikes to signal all is well now does not bode well for nonbank enterprises
    Richters item refers to the US situation and is an excellent reminder that debt isn’t just an issue isolated to consumers.

    • Unamused
      Nov 4, 2018 at 9:26 pm

      ->We in Canada are killing off our energy industry

      Oil from tar sands costs more than it can be sold for. It’s a money-loser that only continues because the industry has corrupted the government.

      • Paulo
        Nov 4, 2018 at 10:41 pm

        @ Unamused

        A little info: My son works in the Oil Sands and they are doing okay considering the downturn (2014) due to excess shale producrion on borrowed money and delivery bottlenecks that need to be addressed.

        He earns +200k per year + expenses and bennies as an industrial electrician working 2 weeks on and 2 off. If he worked locally he would earn 1/3 of that working more days with less time off.

        I’m not too sure how the Govt is corrupted with workers paying some pretty solid taxes on income and purchases.

        As a large mining operation, once the infrastructure is in it is cheaper to keep running than to shut down. Still, they are making money.

        From cited article:
        “In its latest quarterly report, Suncor, the world’s largest oil sands producer stated its oil sands operations cash operating costs for the second quarter of 2018 was $28.65 per barrel. This varies from quarter to quarter. Interestingly, it reported that its In Situ cash operating costs averaged $7.90 per barrel (bbl), the fourth consecutive quarter below $10.00/bbl.

        In-situ operations use steam injection into horizontal wells drilled into the oil sands to produce oil, rather than the mining techniques used at its oil sands mines. Obviously, the in-situ method has become a lot cheaper than mining. It’s also looks like its a lot cheaper than fracking for shale oil. This is an interesting development.

        Its Refining and Marketing (R&M) unit delivered funds from operations of $884 million with an average refining margin of $27.40/bbl. Suncor has the advantage that it both produces oil sands and refines and markets the production. If the price of oil is low, it makes money on its refining and marketing unit rather than its oil sands unit, and vice versa if it is high. At current oil prices, its refining unit is doing really well.

        Suncor owns the Petro-Canada brand of service stations. If people are wondering why their gas prices are so high while oil prices are so low, see above. The refineries are making money hand over fist.

        Suncor recorded second quarter 2018 operating earnings of $1.190 billion. It increased because of improved crude oil pricing and increased refinery margins, higher In Situ and Syncrude production, and the addition of production from its new Fort Hills and Hebron projects.

        Fort Hills is a new open-pit truck and shovel mine it opened recently. Operating costs were $28.55 per barrel. Mine life is expected to be in excess of 50 years based on current mine plans. Hebron is an East Coast offshore field 350 km southeast of Newfoundland.

        Suncor has a lot of strings for its bow. It has come a long way since it opened the world’s first oil sands mine in 1967. It has become very good at controlling the costs of oil sands production.”

        from: http://theamericanenergynews.com/markham-on-energy/alberta-oil-sands-shale-09aug17

        • Unamused
          Nov 4, 2018 at 11:41 pm

          ->I’m not too sure how the Govt is corrupted with workers paying some pretty solid taxes on income and purchases.

          Canada paid $C 3.3 bn in 2016 from just one program to one company and that was expected to double this year. Total subsidies are known to run many times higher.

          Globally fossil fuel subsides are at least $US 5 trillion per year and rising. Economies and militaries run on fossil fuels, so countries will pay anything so long as they can hide the true costs.

  4. Unamused
    Nov 4, 2018 at 8:11 pm

    ->Will this Scheduled Bloodbath in Corporate Debt Deter the Fed?

    Probably. They’re already getting blamed for wobbly stock markets, but aren’t blamed enough for making them so bubbly in the first place. I’ve already predicted the Fed will have to reverse course, firewall the latest load of toxic waste with the last one, and just hope the containment unit doesn’t fail. It’s lit up like a pinball machine and making fizzing noises and icky smells already.

    It won’t matter either way. A decade of central bank emergency measures and credit-market manipulations can only mean that the emergency itself was never resolved and is still pending, forestalled by only ballooning debt – which in turn only maximizes the inevitable disaster.

    In time it will no longer be possible to forestall it. The problems should have been dealt with when it was still possible to do so, but all the incentives run the other way because that’s what the dominant interests want. This is despite the apparent but phony ‘economic recovery’, little more than a debt binge. Spending a lot of borrowed money makes you bankrupt, not rich. Under more ‘normal’ circumstances debt would be paid down with economic ‘growth’, which you can tell isn’t happening because debt is increasing much faster than ‘growth’.

    This feeds into a far larger problem. Maximizing ‘growth’ to save the real economy and the financial sector also maximizes the rate of ecological depletion, until now civilization is on a certain path to ecocide, and from that path it cannot and will not be deterred. It simply won’t be allowed because TPTB are prepared to sacrifice everything to forestall their own demise, likewise inevitable.

    In the meantime, this sort of chaos is bound to create opportunities which are historically exploited by the ambitious for the worst possible motives and to the worst possible conclusions.

    For some problems there are no solutions.

    The good news is that I’ve decided to withhold the bad news. Therefore there is no bad news. This is so people can enjoy their remaining time in a state of escalating dread instead of immediate and utter panic. There will be time for that later.

    Post lux tenebras.

  5. HB Guy
    Nov 4, 2018 at 8:34 pm

    Wolf, great insight as always. You mention that some loan types won’t draw much concern from the Fed. Have any US public or corporate pension funds invested in these because of their perceived (admittedly, a mirage) yield, or does their junk rating preclude US institutional investors from buying them?

    • Nov 4, 2018 at 9:10 pm

      Pension funds are fairly heavily into leveraged loans, CLOs, and the like. They like the higher yield and the fact that their tranches of these structured products are highly rated.

      • RD
        Nov 6, 2018 at 10:40 am

        LOL. Where have we heard that before?

    • Petunia
      Nov 5, 2018 at 10:46 am

      It seems that there are many BBB’s out there which were purposely bought for their higher yields and are investment grade, which could eventually be downgraded as interest rates rise. So what looked good in the recent past, might not hold up, as interest rates rise. Watch out for those.

      • Dave Chapman
        Nov 5, 2018 at 4:17 pm

        Agree. Tranched securities have a long history of downgrades.

        Oddly, there never seem to be upgrades. . .

        • RD
          Nov 6, 2018 at 10:41 am

          As th old saying goes: “there have never been AAA defaults.”

          No, they get downgraded first….

  6. Javert Chip
    Nov 4, 2018 at 9:06 pm

    A different view:

    Inflation happens; sometimes faster, sometimes slower. Over the long-haul, this somewhat ameliorates accumulated debt. But that’s the long-haul.

    I was born in 1946 (72 years ago). $1 of 1946 purchasing power now equals about $13.60. The average US inflation rate since WWII has been 3.75%/year.

    During 15-years of the Bush & Obama financial debacles, an incredible pile of useless financial underbrush has accumulated (the usual suspects: Uber, Netflix, Sears, JC Penny, LYFT, BITCOIN et al, SNAP, plus GE, maybe IBM, undoubtedly some other surprising names), and the underbrush needs to be burned away.

    Now that some semblance of Capitalism’s normal & vital “creative destruction” function is about to happen, it remains to be seen how intense the flames will be. We’re about to see at least a few of those who’ve been swimming naked.

    This is part of the painful price you pay when governments over-control the business cycle.

    • Unamused
      Nov 4, 2018 at 9:21 pm

      ->This is part of the painful price you pay when governments over-control the business cycle.

      Governments have no control over any ‘business cycle’. The NYT reports that the US government no longer prosecutes corporate crime, much less enforce any regulation on destructive externalities. On the contrary, businesses control governments, obviously.

      • Javert Chip
        Nov 5, 2018 at 3:37 pm

        Both of your statements are incorrect:

        1) “Governments have no control over any ‘business cycle” – what the hell do you think has been happening the last 10 years?

        2) “businesses control governments, obviously.” – US criminal conviction requires proof beyond reasonable doubt that a each defendant committed offenses with a culpable state of mind (Mens Rea). That’s why corporations are heavily fined; since 2010, US banks have been fined $245 billion (that’s with a “B”).

        • Unamused
          Nov 5, 2018 at 3:51 pm

          ->what the hell do you think has been happening the last 10 years?

          Businesses have been controlling the government.

          ->US banks have been fined $245 billion

          And the Fed channeled it all right back to them, with interest. Such a con.

          How many high-level bankers went to prison? I’m sure they threw a handful of small fry under the bus, just to make it look good.

          ->US criminal conviction requires proof beyond reasonable doubt

          To the guilty, all doubt is reasonable. And easily manufactured.

          Remind me again how buying up politicians with billions in dark money is ‘free speech’, and not institutionalized corruption. That joke wasn’t funny the first time and doesn’t improve with age.

        • Javert Chip
          Nov 5, 2018 at 9:52 pm

          Uhnnn huh…

    • Sporkfed
      Nov 4, 2018 at 9:22 pm

      When Glass-Steagall was abandoned the wheels were set in motion
      for lending to go hog wild. Combined with Greenspan’s hubris and
      we never stood a chance.

  7. michael
    Nov 4, 2018 at 10:07 pm

    Those without debt will be just fine.

    • Unamused
      Nov 5, 2018 at 3:56 pm

      Unless they’re not.

      Just because you’ve paid off your mortgage doesn’t mean Chase isn’t going to start foreclosure proceedings anyway. It’s happened. So have a lot of similar cases.

      Let’s not go that way. We won’t finish before the universe ends.

  8. Joe Marinara
    Nov 5, 2018 at 7:33 am

    Thoughts on Berkshire Hathaway’s buy backs? $928,000,000 in buy backs??

  9. max
    Nov 5, 2018 at 8:33 am

    if interest continue to go up, Trump is going to be responsible for recession and he is going to lose next election.

    We are going to see how independent is Fed.

    it is show time be ready.

    • Gandalf
      Nov 5, 2018 at 10:17 am

      The Fed is damned if it does and damned even worse if it doesn’t- so much asset inflation has occurred and so much bad debt accumulated that if it continues to raise rates, the bad debt bubble will explode. If it doesn’t raise rates, the bad debt bubble will get even bigger before exploding

      As I said before, there’s no such thing as letting the air slowly out if a bubble, they are so flimsy that they always pop

    • Petunia
      Nov 5, 2018 at 10:19 am

      Here’s how the show looks like on the ground:

      We ventured out for dinner this weekend to an average place. We got the last space in a very large parking lot and had to leave because the wait time was too long. At the second place the parking lot was full, with cars parked on the grass. Passed the fanciest place in the neighborhood on the way to the third place, and its parking lot was full, I had never seen it that full. Finally got a table at the third place, one of only two available. In the three years we have lived here we haven’t seen anything like it.

      I do admit the malls are not busy, but I think the online numbers might be way up, from what I saw this weekend.

      • IdahoPotato
        Nov 5, 2018 at 11:18 am

        Spending up, wage growth down. With growing inflation real wages will deteriorate. Not a good sign for the future.

        https://www.reuters.com/article/us-usa-economy-spending/u-s-consumer-spending-rises-wage-growth-slows-in-second-quarter-idUSKBN1KL1SR

        • Setarcos
          Nov 5, 2018 at 12:56 pm

          That link is not for a current report.

          Today the WSj reported “Strongest Wage Growth In A Decade”.

      • Setarcos
        Nov 5, 2018 at 1:08 pm

        I have also been observing retail business activity and finding parking spaces very hard to find.

        My part time business was the strongest it has been since I started it in 2001. Had to reduce pricing in 2014 due to soft demand and last year I was able to get pricing back to what I would consider “normal”. Now demand is strong enough to raise prices. Jay Powell has taken on a heckuva tough job.

  10. viny1l
    Nov 5, 2018 at 9:23 am

    The Fed won’t care if only investors are hurt – but what if the contagion spreads? Nobody knows how tied-together the system is. The stock market will certainly be hit when leveraged-loan investors are forced to sell stocks in sound companies to raise capital, and then the market will probably react by further sell-offs. What happens then?

  11. petedivine
    Nov 5, 2018 at 10:36 am

    Didn’t we see similar extreme levels of debt acquired during a low interest rate environment followed by rising interest rates and tariffs during the Hoover administration? How did that work out? Let me also mention that Hoover was 10x more accomplished and moral then anything we see in U.S. political circles these days. I don’t think this time around will be any different for the U.S. population or for the banks. History repeats. The only difference this time around is that the internet has allowed more of us to see and understand the rot and fraud.

    • Setarcos
      Nov 5, 2018 at 1:18 pm

      When trading partners kick off their tariffs from mid-field, it helps when we refuse to kick off from our goal line. And If Hoover had a FED that took rates to 0% and left them there, history would be quite different.

  12. Rcohn
    Nov 5, 2018 at 10:41 am

    Credit spreads have moved up this year, but are still far too low.
    The Fed actively wants to see higher credit spreads and a higher yield curve.

  13. Nov 5, 2018 at 11:16 am

    Raising interest rates while providing liquidity is not new. The Greenspan Fed tried it, using the REPO window, and a policy of gradualism and telegraphed rate hikes large investors could game the system. They are still focused on liquidity and not solvency. It’s a bit inane to suggest that 100 companies going bankrupt one company at a time is different in the aggregate. USG rather than pushing these companies into insolvency should take up a new QE and swap the old corporate debt for new Treasuries. They can QE and raise rates.

  14. Prairies
    Nov 5, 2018 at 11:28 am

    Looks like Lowes is in debt trouble or the construction growth has come to stop. More companies will be closing their doors, who will they blame in the end?

    • TheDona
      Nov 5, 2018 at 1:12 pm

      Lowes is closing underperforming stores. Only 20 in the US. The one store in my state that is closing is ancient and should have closed 15 years ago when Sams Club moved and the mall died.

      Nothing wrong with pruning the deadwood.

  15. Dave Chapman
    Nov 5, 2018 at 1:45 pm

    “The Fed will just nod approvingly.”

    Ouch. That is cold.

    • RD
      Nov 6, 2018 at 10:42 am

      Its also right. They have the Non-banks right where they want them–in harm’s way.

      As Biggie used to say, “somebody got to die.”

  16. Unamused
    Nov 5, 2018 at 3:59 pm

    I’m not sure how we got through three dozen comments without anybody saying ‘Minsky moment’, and I thought it would be a shame to let that oversight go uncorrected.

    • HowNow
      Nov 5, 2018 at 7:46 pm

      “Minsky moment” – A Minsky moment is a sudden major collapse of asset values which is part of the credit cycle or business cycle. Such moments occur because long periods of prosperity and increasing value of investments lead to increasing speculation using borrowed money. (WWW).

      • sierra7
        Nov 6, 2018 at 11:26 am

        “Roadrunner” (Beep-Beep) going off the cliff!! LOL!!

  17. WSKJ
    Nov 8, 2018 at 2:21 pm

    Wolf, I like the podcasts. I will have to listen to this one another time or 2.

    You rarely (never ?) mention whether debt is callable or not; has the “call” feature of some debt been almost entirely replaced, with the adjustable rate feature ?

    Finally, I am much obliged to you for an edit you made on an earlier comment from me.

    • Nov 8, 2018 at 6:33 pm

      Most debt today is non-callable.

      To sell a callable bond, the issuer has to pay a higher coupon/yield to compensate bond buyers for the risk that the bond gets called, and they’d have to replace the bond with a lower-yielding bond. After decades of declining yields — which made callable debt a good deal for issuers and a bad deal for bondholders — it’s difficult to issue callable debt these days without paying a pretty good premium.

      The biggest chunk of callable debt these days is MBS (backed by the GSEs). These are different animals anyway because they’re repaid constantly as principal payments of the underlying mortgages are passed through. These pass-through principal payments can become a torrent when interest rates drop and homeowners refinance. The callable feature allows the GSEs to redeem those MBS and repackage mortgages into new MBS at lower yields. And thus they minimize their loss.

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