Rationalizing Those Peak-Cycle Numbers, Part 1: Investors “Unconcerned” About Record Corporate Debt

A branch of journalism that might be called, “don’t worry, be happy, because this time is different” tends to pop up at the peak of cycles when imbalances that caused past crashes start to reemerge. Eager to keep the gravy train going, business publications send reporters out to interview industry experts (who are making fortunes from the ongoing expansion) on why this batch of imbalances is actually no problem at all. And sure enough they find all kinds of plausible-sounding rationalizations.

In the 1990’s dot-com bubble, for instance, stratospheric P/E ratios didn’t matter because for New Age tech companies earnings were “optional.” In the 2000’s housing bubble record mortgage debt didn’t matter because home prices would always rise faster than the associated borrowing, keeping homeowners above water and banks ever-solvent. Subsequent events proved this to be nothing more than insiders trying to keep the deals flowing.

Now, with pretty much every major indicator signaling a peak for the latest cycle, “don’t worry, be happy” is once again a popular journalistic beat. Here’s an excerpt from yesterday’s Wall Street Journal on why investors fine with record corporate debt:

One of the fun ways to read this kind of journalism is to count the sentences likely to come back to haunt the reporter and/or his source a few years hence. The above article has a ton of them, but here are three that stand out:

“Banks’ bondholdings have shrunk drastically since the financial crisis, in part because of Dodd-Frank banking reforms but also because investors are more willing to buy the securities they underwrite. This signals an improved capacity within the economy to handle the present level of corporate borrowing.”

If there are record amounts of corporate bonds in circulation and banks don’t own them, who does? Bond ETFs and pension funds, neither of which will react well to the next downturn. ETFs will see outflows which require them to sell existing positions, thus pushing prices down even further. Pension funds will fall into a black hole of underfunding if their current investments lose value when they’re supposed to rise by a steady 7% per year. Both ETFs and pension funds are every bit as fragile and systemically dangerous as big banks were prior to the Great Recession.