Could junk debt lead to a new subprime-style meltdown?

Bank of England sparks concern among central banks after revealing the size of the global risky loan market

Canary Wharf is home to some of the UK's biggest banks and corporations
(Image credit: Matt Cardy/Getty Images)

Fears are growing that $1.4 trillion worth of junk debt could spark the next global financial meltdown, after research from the Bank of England revealed the size of the risky loan market.

Financial stability experts at the Bank of England revealed that banks, insurers and pension schemes have amassed a $405bn exposure to collateralised loan obligations (CLOs), packages of the junk-rated debt.

Last week, Mark Carney, Bank of England Governor, warned MPs that leveraged loans have “all the hallmarks” of the subprime mortgage bubble that triggered the 2008 financial crisis.

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The research has “caused shock waves at the world’s top central banks,” The Daily Telegraph says, and “raised fears among policymakers at the US Federal Reserve and European Central Bank”.

Unlike a decade ago, “borrowers in this credit bubble aren’t homeowners taking out mortgages,” The Los Angeles Times says. “They’re hundreds of US companies with weaker credit ratings, many of them well-known like Uber and Burger King, taking out so-called leveraged loans”.

“Everything’s fine while the economy is growing” says the paper, “but when it slows, those borrowers could default, causing problems to cascade through the financial system.”

This was the case with the recent demise of children’s retailer Toys R Us, which was unable to service its large leveraged debt load.

Steve Eisman, the hedge fund manager famous for betting against the US housing market ahead of the 2008 crash, has warned of the rapid rise of poorly rated debt among corporations.

Eisman, who was played by Steve Carrell in the Oscar-winning film The Big Short, told the Financial Times that the rising stock of corporate debt rated at BBB, just one notch above junk status, is a cause for serious concern.

According to the Bloomberg Barclays index that tracks corporate debt issuance, stocks of such debt have more than quadrupled since the financial crisis, standing at about $2.7 trillion.

Earlier this month, Business Insider reported a note from research firm CLSA that warned “the major surge in debt issuance by US corporations through highly levered buyouts and low-interest-rate acquisitions could be a major part of the next financial crisis”.

However, Eisman does not predict an economic slump around the corner.

“You can’t have a recession when consumer credit quality is as good as I’ve seen it in my whole career,” he told the Financial Times.

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