The Daily Update - Fed's Debt Warning

In the Fed’s latest semi-annual Financial Stability Report, it has again warned that companies with already large amounts of debt are continuing to borrow at a breakneck pace, prompting fears that if the trend continues there could be a risk to the financial system. The warning mirrors that of the one issued in November, however, now the report stated a record 40% of loans to the most highly indebted companies went to those who are the most indebted of all. Fed governor, Lael Brainard, who chairs the committee, cautioned ‘With financial volatility easing since the end of last year, the Federal Reserve Board’s Financial Stability Report suggests stretched asset valuations and risky corporate debt merit continued vigilance against a backdrop of low- to moderate-vulnerabilities in the household and banking sectors’.

As it stands, companies with already large outstanding debts and in the majority of cases a low credit rating, added 20 percent to their leveraged lending in 2018, to USD1.1tn. Whilst the economy continues to perform the default rate remains low, however, if things start to weaken, the risks could exponentially grow. The share of new loans going to riskier companies is now greater than the levels previously reached in 2007 and 2014.

The report warned the leveraged loans have ‘intensified, as a greater proportion are to borrowers with lower credit ratings and already high levels of debt’ adding ‘Any weakening of economic activity could boost default rates and lead to credit-related contractions to employment and investment among these businesses’.

The former Fed chair, Janet Yellen, is also on record warning that if the economy was to take a downturn, things could go south for those highly indebted companies very quickly. In February she told an industry group ‘I have expressed concerns about leveraged lending, I do think non-financial corporations have run up, really, quite a lot of debt’ adding ‘What I would worry about is if the economy encounters a downturn, we could see a good deal of corporate distress. If corporations are in distress, they fire workers and cut back on investment spending. And I think that’s something that could make the next recession a deeper recession’.

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