What have we learned? How sound is the financial system today?
Our friends at Kiplinger reviewed the current ever evolving environment we live in a recent article begging the question. Ten years after the financial crisis erupted when Lehman Brothers’ collapse jolted the markets, just how sound is the financial system? The simple answer is that the U.S. is less vulnerable to another crash today than it was when sketchy mortgage securities set off a market panic and led to the Great Recession.
The reason being, banks are better capitalized now than then. Also, regulators have plans in place to respond if another meltdown looms. In 2008, the government was largely making up its policy as it went along but today there are many policies in place.
In recent news, you may hear talk about a new debt crisis that is supposedly threatening to derail the economy. But, most of those worries are overblown. Concerns about consumer debt, for example, which actually shows the average consumer is in OK shape, financially, is one area that is misunderstood or misguided. Household debt including mortgages, auto loans, student debt, etc…is low when measured against household income. Default rates are in check and, in some cases, falling. The same can be said for government debt levels, for now. Though it is anticipated to be a real problem in the long run, the federal debt isn’t likely to spark a crisis in the next few years. And, while some state budgets, like that of Illinois, are in bad shape because of pension woes, most states are actually paring back debt levels relative to their tax revenues.
Still, risks are lurking, particularly in corners of the corporate debt market. Overall corporate debt is high but not necessarily alarming, since profits are strong and companies are starting to slow down their borrowing after years of piling on. Many supposedly safe corporate bonds are starting to resemble junk bonds. Nearly half of investment-grade issues are now only one grade up from junk status. Many new bonds offer fewer protections for buyers in case of default. Worst of all, bond investors aren’t getting high enough yields to compensate for the risks that they’re taking. Some will get burned whenever the economy eventually stumbles.
An even bigger worry is that leveraged loans, which are extended to companies that already have heavy debt burdens, often to fund corporate acquisitions or buyouts. Most are made by banks and private equity groups and sold to yield-hungry investors. And they’re growing rapidly from $800 billion in 2013 to $1.4 trillion currently. Many of the borrowers’ finances look shaky. Again, investors are taking too much risk.
Wall Street is packaging leveraged loans into new securities reminiscent of the years before the housing bust when dodgy home loans morphed into securities with high credit ratings. That can spread the risk around to unsuspecting buyers.
Is another crisis in the making in the likes of 2008? We don’t think so, but some steep losses are coming for investors who are left holding the bag. The booming economy is masking weaknesses the next recession will expose.
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David WB Parker is a principal of Parker Associates of Jacksonville, Florida, marketing consultants to the real estate industry; President of PTC Computer Solutions, IT Specialist, and an active real estate sales professional with PARFAM REALTY based in Jacksonville, FL. He can be reached at 904-607-8763 or via email firstname.lastname@example.org.