Having spent the past almost 30 years in and around the financial services industry, I had thought I'd seen it all, but what I have witnessed over the past several months looks like nothing I have ever seen before.
In 2007, at the peak of the global credit bubble, what one saw was both an insatiable desire to lend on the part of lenders and an insatiable desire to borrow on the part of consumers, corporations, and sovereigns. It was hard to tell who was more excited. And you could see it in bank balance sheets as loan-to-deposit ratios were stretched to historic lengths.
What we have today bears no resemblance to that “classic” credit bubble model. Looking at “safe” bank balance sheets (those of financial institutions in the US and northern Europe), what you have is a flood of liquidity in search of credit demand. And the same can be said for the “safe” bond markets, too.
As I look at the world, there is no voluntary consumer credit demand. As evidenced by the pronounced drop in credit card balances during the first quarter, those consumers who are able and should want to borrow, don’t. And the same is true across all categories of residential mortgage credit as well. The only place where consumers are borrowing are in what I call “involuntary” credit transactions: automobile purchases and higher education – two places where any kind of affordability is entirely a function of the availability of credit. Americans don’t buy cars; they synthetically lease them. And so long as college students believe there will be jobs at the end, they will borrow. In both cases, however, it is a “need” and not a “want” underpinning the extension of credit.
For lenders, that then leaves either government debt or commercial credit. And with “safe” government debt now yielding nothing, or at best next to nothing, that really only leaves commercial credit. And here I’d suggest that what we are witnessing makes the frenzy of 2007 look like amateur hour. Yesterday, the Wall Street Journal
reported that European companies have abandoned their historic borrowing relationships with their local banks for the public bond markets where loose credit terms and longer-term borrowing structures prevail. And here in the US, the Wall Street Journal
noted that, having exhausted the supply of investment grade and high yield domestic corporate debt, bond funds are now “gorging on [the] fat yields of emerging market corporate debt” as well.
But appreciate that in the current frenzied state of the corporate bond market, “fat yields” mean (per the Wall Street Journal
) just 5.6%.
Put simply, corporate debt is the only game in town. And thanks to the feeding frenzy, it is not just truly “corporate.” Wednesday morning, the Wall Street Journal
reported that major insurers are aggressively returning to the commercial real estate market, noting that “Northwestern Mutual…made $1.57 billion in real-estate equity investments last year, … up from $1.1 billion in 2010 and more than four times the amount made in 2009.” And as I noted last week (on the Buzz & Banter
, subscription required), "Stronger than Chuck Norris” CLOs are back as well.
While I am by no means suggesting that the current frenzy in corporate credit can’t and won’t turn into a full frothy tidal wave, I feel very confident in suggesting that this will end very badly for lenders. Between the extreme narrowness of available borrowers and the flood of liquidity looking for a home, what we have today is a credit mismatch from hell.
But to be honest, the whole thing makes me sad. By the time we’re done, surplus liquidity will have successfully killed off every credit market segment: secured consumer, unsecured consumer, consumer residential, commercial real estate, sovereign, and corporate.
It took a while, but we’ve now bubbled them all.
Position in SH and JPM
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