The same people who denied the existence of a systemic crisis in 2007 are now telling anyone who will listen that the financial markets are doing just fine, no danger of a meltdown. Sure, there were major losses on the stock markets in 2018, they say, but each had its own specific cause, unrelated to the others. For example, the Dow Jones lost about 10%, but that was due to Donald Trump’s so-called “trade war” with China; London was down by 12.4%, but only as a result of Brexit uncertainties, while Frankfurt’s 18.3% drop had to do with problems in the auto industry and at Deutsche Bank, and Milan lost 16.5% because of the “populist” government in Rome. For the biggest drop of all — Athens with 24.7% — there was no obvious cause, so it was attributed it to a “contagion” efffect.
But even more worrying is the state of corporate indebtedness. Non-financial corporate loan debt is now the double of what it was in 2007, up to $9.1 trillion as against $4.9 trillion. Even former Federal Reserve Chair Janet Yellen is blowing the whistle, as she did in an interview on Dec. 10 with Paul Krugman, covered by CNBC under the headline: “Yellen Warns of Another Financial Crisis: ‘Gigantic Holes in the System’”.
Since Nov. 15, the value of high-yield corporate bonds held in investment funds and exchange-traded funds (among others) has continued to fall from an average 98.5 cents to just over 90 cents per dollar of face “value.”
That corporate junk debt has been packaged into Collateral Loan Obligations, in a way resembling the sub-prime debt before 2007. Economist Carmen Reinhart, writing for Project Syndicate Dec. 20, pointed to the dangerous way the major Wall Street banks are using such CLOs to dump increasingly toxic debt on all kinds of investors, and get the junk off their books. To prevent such practices, the most efficient way is to restore banking separation, as set out in the original Glass-Steagall Act in the United States. In that way, the people and the real economy can be protected from bailing out the speculators.
The withdrawal from the corporate bond market has prompted fears that large banks may have liquidity problems. So much so that U.S. Treasury Secretary Steve Mnuchin called the CEOs of the six largest U.S. banks on Dec. 23 to check on their liquidity status, and then reported publicly that he had done so.