The Folks Who Missed the Last Financial Crisis Are Warning About the Next One

September 15, 2018

This NYT piece is so confused it is difficult to know where to begin. It starts with student debt. Student debt is a serious burden for many recent grads and even more so for people who did not graduate. But how does it lead to a financial crisis? As the piece notes, most of the debt is owed to the government. Also, defaults won’t lead to the value of the underlying asset (earnings) spiraling downward.

Then we get corporate debt. Yes, this is high, but debt service as a share of corporate profits is low. That is the relevant variable. Yes, this can rise as interest rates rise, but not very rapidly. Many companies took advantage of extraordinarily low interest rates to borrow long-term. Also, even when companies find themselves in trouble meeting their obligations, they can sell off stock or assets. It’s rare that investors take a complete bath on corporate debt.

Then we have junk bonds. Yes, investors are probably underpricing risk. Will this lead to a financial crisis? See the previous paragraph.

The piece then goes to emerging market debt. Here also investors likely underpriced risk. Could be bad news for many investors and people living in places like Turkey and Argentina. It’s not a financial crisis.

Finally, we get to the growing share of mortgages being issued by non-bank institutions. This should raise concerns about lending behavior and possible abusive practices by less-regulated lenders. Absent a bubble, it is not the basis for a financial crisis.

I talk about these issues briefly in my paper on the 10th anniversary of the collapse of Lehman.


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