New Bank Debt Bubbles Head for Crash

November 28, 2013 • 1:43PM

The $3.5 trillion poured by the Fed into systemic banks ($1.4 trillion still held as excess reserves by the European big banks, $1.1 trillion by the U.S. big six) is not only bailing out masses of toxic securities, but creating new bank debt bubbles over the past 18 months, which are building toward a crash.

Today both the Wall St. Journal and the New York Times DealBook column cover the bundling and securitization of "leveraged business loans" into collateralized debt obligations (CLOs) and "synthetic CLO" derivatives. These leveraged loans are the more-or-less exact equivalent, in terms of small and medium-sized business, of the sub-prime, variable-rate mortgages last decade. The high-yield underlying loans are closely related to junk bonds (that bubble has tripled since early 2012 to $180 billion), but are taken by companies whose credit is not (yet) impaired, but whose debt load is far too high.

"Dealbook" reports one example in detail, of a U.S. media company borrowing eight times its annual revenue, with no bond covenants (scheduled repayment requirements), at an 8+% variable, rising rate, with the loan going into Deutschebank bundles for securitizing. The volume of the CLOs issued by the likes of Deutschebank with these leveraged loans, has quadrupled in two years to $80 billion. The Wall St. Journal described the very rapid growth of the mutual funds specializing in buying these securitized loans and derivatives (often hidden or disguised from the funds' investors).

A Federal Reserve presentation at a Washington conference last week (by Fed governor Daniel Tarullo) showed that the new real estate equivalent of this, known as "mortgage REITs", constitute a bubble which has also quadrupled in less than two years, to $400 billion in securitized debt. An IMF presentation at the same conference showed that the role of the unregulated "shadow banking" sector in funding these mortgage REITs, has leaped up in the same period from 12% to 45%. The IMF director presenting this was worried enough, to have a serious discussion of Glass-Steagall and leave contact information to continue it.

Another explosively growing bubble is U.S. "subprime auto loans", also securitized by banks and investment banks. Auto loans to buyers with credit scores in the 650 range or lower have jumped up to constitute 27% of an auto-loan debt volume of about $1.1 trillion. Interest rates are significantly higher than other loans; terms are longer (frequently six or seven years); the loans are regulated by the relatively inert Federal Trade Commission. And about half of the roughly $300 billion in subprime auto loans have been securitized by banks