Here’s a record that was broken recently.
In the early ’80s, Michael Milken pointed out that junk bonds could be more profitable than those with an AAA rating. The junk bond market was tiny…with total issuance only rising to about $30 billion in the mid ’80s. Milken was basically right, as subsequent events proved. But that didn’t stop the feds from putting him in jail in 1990.
The junk bond market continued to grow. At the end of the ’90s, issuance was hitting records – at around $150 billion. Then, bond issuance collapsed with the tech bubble. But unlike tech stocks, high-yield bonds were soon flying higher than ever.
In the middle of the 2000-2007 period, annual junk bond issuance rose above the $150 billion mark. But in 2013, the junk really topped the charts, with about $330 billion of new bonds issued.
Why so much junk?
Ah…for that…as for so much else, we have the central bank to thank. Lower yields caused lenders to stretch beyond their comfort zones for higher rates of return in lower quality issues. In 2007, they were driving into bad neighbourhoods to get what they needed. And by 2013, they were dumpster diving for a measly 5%.
Can you blame them? As more and more liquidity became available, there were fewer reasons for anyone to default. A mismanaged, zombie business didn’t need to stop paying its coupons; it just had to borrow more money. Borrowers and lenders were both deceived; the former found lenders unusually motivated; the latter believed borrowers were uncharacteristically solvent.
All of which just serves to highlight our latest dictum: the Fed’s $4.1 trillion balance sheet is a standing invitation to trouble.
Mr Trouble walks through the door every morning and into a party every night. But he is a master of disguise. One day, he comes with the healthy mien of a robust high-yield debt market.
The next day he is crumpled over, as if depressed by unusually low consumer price inflation. And on the weekend, here he is again, a big shot from Wall Street with the highest profit margins in 60 years.
Yes, dear reader, Mr Trouble has many disguises. Of course, an honest, properly functioning economy spots him immediately and shows him the door. But a trumped-up, highly manipulated and mountebank economy is like a Carnival hoedown. You can find anything you want…but nobody is exactly who they appear to be.
Economists refer to this as the problem of ‘distortion’. The real cost of real capital is usually signalled by the prevailing interest rates. When Mr Market is permitted to function normally, investors can take the facts at face value.
When the Federal Reserve intervenes, on the other hand, the effect is to distort the economy and the markets. Manipulating interest rates downward makes capital seem too cheap. It is borrowed too easily and spent too readily. The result is over-speculation…and over-investment.
That is why we have a record issuance of junk bonds. It is just one more of the many drag queens and carnival kings that have been corrupted by the Fed’s heavy-handed meddling in the markets.
On display too is the ‘recovery’ itself – it’s the weakest ever! Never before has such a strong recession been followed by such a weak bounce-back. Quarter after quarter, jobs growth, GDP growth and consumer price growth substantially under-perform every recovery since WWII.
Another record! And just one of the many jolly revellers who opens the door for Mr Trouble when he shows up.
for Markets and Money