US Federal Reserve chair Jerome Powell said in a speech on Monday he wasn’t overly concerned about the state of the country’s economy or the level of business debt.
In his conclusion at a financial markets conference sponsored by the Federal Reserve Bank of Atlanta, Mr Powell made 3 points:
- First, business debt is near record levels, and recent issuance has been concentrated in the riskiest segments.
- Business debt does not appear to present notable risks to financial stability, and
- Third, we cannot be satisfied with our current level of knowledge about these markets, particularly the vulnerability of financial institutions to potential losses and the possible strains on market liquidity & prices should investors exit investment vehicles holding leveraged loans.
Mr Powell said the risks in the US financial system were constantly evolving: “15 years ago, everyone was talking about whether households were borrowing too much. Today everyone is talking about whether businesses are borrowing too much…
“In public discussion of this issue, views seem to range from ‘This is a rerun of the subprime mortgage crisis’ to ‘Nothing to worry about here.’ At the moment, the truth is likely somewhere in the middle.”
On the riskiest segment of the market, Mr Powell said: “The rise in riskier business borrowing has been funded principally by nonbank lenders. Collateralised loan obligations are now the largest lenders, with about 62% of outstanding leveraged loans. These lenders are actively managed securitisation vehicles that mostly buy higher-risk assets like leveraged loans. CLOs, in turn, are funded by a slice of equity & layers of debt of varying seniority. After CLOs, mutual funds are the next-largest vehicle for holding leveraged loans, with about 20% of the market. These funds allow investors to redeem their shares daily, although the underlying loans take longer to sell. As a result, investors may react to financial stress by trying to redeem their shares before the funds have sold their most liquid assets. Widespread redemptions by investors, in turn, could lead to widespread price pressures, which could affect all holders of loans, including CLOs & those that hold CLOs.”
Full Powell speech
Attribution: Powell speech.