Will the Corona Crisis Burst the Debt Bubble? (w/ Nouriel Roubini)
ASH BENNINGTON: When you look at the potential for credit shock, when you think about bond yields, what's your outlook on that front? NOURIEL ROUBINI: Well, as I pointed out, even before, for the last two years, we've had the debt bubble in the United States. That debt bubble was mostly in the corporate sector. The last debt crisis was households, mortgages and leveraged banks. This time around, we've been saying it's the corporate sector and shadow banks that finance them. CLOs, leveraged loans, fallen angels in high grade, there are trillions of dollars of high yield junk bond issued in the way that we kept covenants, covenant light, we have a loosening of our lending and credit standards, it was just toxic, it was a crisis waiting to happen. Guess what? When a similar shock occurred in 2016, spread went from 300 to 900 for high yield, but it took about three months, and then they went down back to normal once we realized we're not going to have a global recession. This time around, they've spiked in less than a month from 300 to 1100, and the entire market for high yield, leveraged loans, CLOs as completely shut down. Even firms that had high grade issuing commercial paper, and corporate bonds could not issue them. That's why the Fed and the Treasury have come to the rescue of the high grade. There are two problems. Even if you have a plan to essentially backstop commercial paper and high grade their debt, you're not going to take care of all the firms that are issuing junk bonds, because of course, the Fed cannot take that credit risk. You can backstop high grade, but not high yield. You cannot backstop the mediums or those medium and small firms that don't issue bonds, like small and medium sized enterprises have no access to the capital markets, it's only larger firms, high yield and high grade. You're taking a huge credit risk even for the high grade, because within the high grade, you have a trillion dollar of bonds that are BBB minus, they are on the verge of being downgraded to junk. Ford was just downgraded to junk. A big firm like Ford has been downgraded from BBB to junk. The Fed now is telling us we're going to take and we're going to buy high grade bonds, including BBB minus. To me, it's a mistake. Because most of these guys, even if you backstop them, the fundamental's going to lead to a downgrade, and once they're downgraded, you're taking a market risk, because then there is a spike in the spread and you do a mark to market loss on your portfolio as a Fed, you take a huge credit risk. I would have said if you want to backstop corporate bonds, do it for high grade and exclude fallen angels. Instead, they decided to save the fallen angels. Even by doing that, you still have all their high yield that is essentially not backstopped, you have leveraged loans and you have CLOs and you have every firm that is not even issued debt, that is the majority of firms in the country who are not issuing bonds. They have to use either banks or other forms of lending. We have already a debt crisis, let's speak about it. With oil at 20, most of shale gas and oil producer in a matter of months are going to be bankrupt, completely bankrupt. There's not only them, anybody, hotel, cruise lines, hospitality bars, restaurants and big chains, retail, they were highly leveraged before that segment of the market also is effectively bankrupt. These are not illiquid but solvent firms, we should not bail them out. These are illiquid, at that current economic conditions, they are solvent and if we're going to bail them out, there'll be a massive loss for the Treasury and for the US taxpayer. The whole point is you want to save those are illiquid but solvent, but in the high yield, and in the junk area, there's tons of stuffs that is illiquid and it's insolvent, and you should not backstop them. Otherwise, you're literally privatizing the gains again, socializing the losses again, for equity holders and for other bull holders and a creditors, that would be unfair. We're not going to do it hopefully. ASH BENNINGTON: One of the things that comes up in this context is the risk of moral hazard for backstopping debt and for companies that have effectively been engaging in massive share buyback programs that's generated an incredible amount of angst and blowback against corporate America. NOURIEL ROUBINI: Absolutely. For the last decade, the amount of share buybacks has been huge, has been artificially increasing earnings per share and the growth of earnings per share, boosted valuation. Since compensation of many CEOs, and senior managers are based on valuation, they literally pocketed those gains for themselves, and that's something reckless, because if you do share buyback, you're changing your capital structure. You're reducing the amount of equity in your firm, and you're increasing the amount of debt, because most of these share buybacks were financed for those who are not profitable by essentially issuing debt. You have essentially leveraged up your capital structure with more debt, less equity. You made yourself vulnerable, and now, the shock occurs, and they go bankrupt. There's a huge moral hazard because even if the law says you cannot use this money for a share buyback, that's the minimum, of course that you need to do. The share buybacks were done in the past. You've made yourself financially fragile. You've made yourself near insolvent. Now, you're asking for a government bailout because you screwed up and you've privatized the gains, you socialized the losses for a decade. Now, I'm supposed to backstop the equity holders and the existing creditors by giving you a bailout? It is still bailing out people and socializing the losses even if you say that you get an increased compensation of CEOs, and you got to do more of share buybacks. The damage in the moral hazard occurred for the last decades.