Complacency Breeds $2 Trillion of Junk

Will investor overexuberance cause debt markets to turn 'very ugly' very fast?

These are boom times for complacency. To gauge just how comfortable the world of debt has gotten, consider:

  • Bond buyers handed $2 billion last month to Ecuador, whose socialist president forced a default during the financial crisis while calling creditors “true monsters.”
  • So many investors piled into a May bond sale by Clear Channel Communications Inc. that the radio broadcaster, with a credit rating that implies default is almost a certainty, more than doubled the offering to $850 million.
  • China’s Logan Property Holdings Co. defied predictions of a slowdown in the nation’s real estate market by selling $300 million of bonds in May. The developer has negative cash flow and total debt almost twice its cash and cash equivalents.
  • Hellenic Petroleum SA in Greece, where the government has needed two bailouts in the past four years, borrowed the equivalent of $444 million last month. Lenders were so enthusiastic that they put in orders exceeding $1.37 billion.
  • Florida’s Orange County Industrial Development Authority issued $64 million of unrated debt last month to fund facilities near Orlando that convert sewage into fertilizer.

“It definitely feels like investors are getting overexuberant, and you can stay in overexuberant conditions for a while,” said Fred H. Senft Jr., director of fixed income and equity research for Key Private Bank in Cleveland. “But when it turns, it will turn quickly and it will turn very ugly.”

The warnings are growing louder and more numerous. Fed Chair Janet Yellen told reporters last month she was concerned about “reach-for-yield behavior.” Bank of England Deputy Governor Charlie Bean said conditions were “eerily reminiscent” of the pre-crisis era. Bundesbank board member Andreas Dombret said last month, “We do see risks, despite the fact that the markets are calm.”

The Bank for International Settlements (BIS) in Basel, Switzerland, said in its June 29 annual report that central bankers shouldn’t moan too loudly about complacency because they’re responsible. Record-low rates and unconventional monetary easing by the Fed, European Central Bank (ECB), and the Bank of Japan reduced price swings across markets, the BIS wrote in the report.

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