Fed Chairman Jerome Powell warns business borrowing at ‘historic highs’ shouldn’t be ignored

  • There’s a “moderate” risk that “near record levels” of business debt will spill over into the broader US economy and spark another financial crisis, Federal Reserve Chairman Jerome Powell said on Monday.
  • Collaterized loan obligations (CLOs) have been a key funding source for riskier business borrowing, Powell said.
  • “Business debt has clearly reached a level that should give businesses and investors reason to pause and reflect,” Powell said. “Investors, financial institutions, and regulators need to focus on this risk today, while times are good.”

There’s only a “moderate” risk that surging volumes of business debt will spill over into the broader economy and potentially spark another financial crisis, Federal Reserve Chairman Jerome Powell said on Monday.

Business debt is “near record levels” and recent lending has been “concentrated in the riskiest segments,” Powell said at the Annual Financial Markets Conference at the Federal Reserve Bank of Atlanta in Florida. Specifically, he pointed to collaterized loan obligations (CLOs) — actively managed securitization vehicles that buy up riskier assets like leveraged loans — as a key source of funding for riskier business borrowing, given they hold 62% of outstanding leveraged loans.

“Regulators, investors, and market participants around the world would benefit greatly from more information on who is bearing the ultimate risk associated with CLOs,” Powell said. 

Business debt has “clearly reached a level that should give businesses and investors reason to pause and reflect,” Powell said. “Investors, financial institutions, and regulators need to focus on this risk today, while times are good.”

The central bank chief warned overly indebted firms could endure “severe financial strain” if the economy weakens, and a highly leveraged business sector could exacerbate an economic downturn as companies are forced to lay off workers and reduce investment.

However, the build up of business debt “does not present the kind of elevated risks to the stability of the financial system that would lead to broad harm to households and businesses should conditions deteriorate,” Powell said.

“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,'” he added. “At the moment, the truth is likely somewhere in the middle.”

Powell acknowledged similarities between the recent spike in business debt and the lending boom that preceded the global financial crisis. Debt has surged to historic highs and outpaced growth in borrowers’ incomes, lenders have loosened their underwriting standards, and much of the borrowing is financed outside the banking system.

However, Powell argued the increase in business borrowing isn’t outsized given America’s prolonged economic expansion, it isn’t being fueled by a “dramatic asset price bubble” this time around, and CLO structures are “much sounder” than the structures used during the housing bubble.

Powell also emphasized America isn’t as vulnerable to shocks anymore. “The financial system today appears strong enough to handle potential business-sector losses, which was manifestly not the case a decade ago with subprime mortgages,”  he said. The Federal Reserve is also monitoring the issue closely, holding banks to strict risk-management standards, and using stress tests to ensure their resilience to shocks, he added.

The Federal Reserve looks at four key factors in assessing financial-stability risks: borrowing by businesses and households, valuation pressures, leverage in the financial system, and funding risk.

Powell pointed out that business debt has grown slower relative to GDP than household debt grew in the lead up to the financial crisis, and household debt-to-income ratios have steadily declined since the crash. 

Although equity prices have reached new highs, bond and loan spreads have narrowed, and commercial and residential property prices have risen, Powell said borrowing isn’t fueling excessive prices or investment in a critical sector such as housing.

Banks at the core of the US financial system are also “fundamentally stronger and more resilient,” Powell said, as larger capital requirements and stress tests have resulted in them retaining more capital. The largest US banks also hold only $90 billion of the roughly $700 billion in total CLOs, he added.

Finally, the US financial system isn’t as susceptible to runs as before due to large banks having significantly amounts of highly liquid assets, Powell said. CLOs also have stable funding as investors commit funds for lengthy periods and can’t use withdrawals to force asset sales at distressed prices, he added.

The stock market is once again at a crucial crossroads. Here’s what the experts are saying.

The stock market last week followed a familiar path. After getting off to a rocky start following another trade-war escalation by President Donald Trump, equity benchmarks spent the next four days trying to claw back those losses.

And, like the prior week, the S&P 500 was ultimately unsuccessful. It may not have been the worst five-day stretch of the year, but there’s no denying the trade war’s lasting overhang.

The market now finds itself at an important intersection, having weathered the initially shocking gyrations of the reignited trade war. So what comes next?

Morgan Stanley warns that focusing solely on the trade war would be a grave mistake — and outlines four other reasons the stock market will struggle to rise going forward. UBS is also on the bearish train, calling for a 10% drop in the S&P 500 by year-end. The firm says traders should start focusing now on a handful of hedging strategies.

Meanwhile, Vincent Deluard, a macro strategist at INTL FCStone, is closely watching three “black swan” events he says could create major pain for investors and send equities tumbling into a correction.

But not everyone is so pessimistic. Marko Kolanovic — the JPMorgan quant guru whose reports can move markets — actually thinks the S&P 500 will climb 12% by year-end. 

Here’s a rundown of our other main coverage from last week, which — in addition to trade war analysis — featured continued dispatches from the Milken Institute Global Conference, a look at WeWork’s controversial valuation, and your latest warning about massive corporate debt loads.

‘The disruptors will be disrupted’: The man who runs the $100 billion SoftBank Vision Fund offers bold predictions for how different the world will look in 10 years

Rajeev Misra, the CEO of SoftBank Investment Advisers, had a wide-ranging discussion at the recent Milken Institute Global Conference about his investing process. That involved addressing what he thinks the big developments will be in the future.

Misra’s response offered an incredible look into how he sees the world morphing over the coming decade. It also provided crucial context around some of the investments already present in his portfolio.

WeWork’s latest earnings report shows it’s still using a controversial accounting method that reminds experts of tech-bubble shenanigans

WeWork is continuing to report a gauge of profits it created called community-adjusted EBITDA. And some Wall Street experts are calling it an inventive method that reminds them of the 1990s tech bubble.

Those same experts worry that sloppy public debuts — such as those experienced in recent months by Uber and Lyft — are sending troubling signals about the overall sustainability of stock-market health.

The brightest minds on Wall Street warn companies are engaging in risky behavior that could spark a rash of bankruptcies — and make the next recession even worse

A record portion of the investment-grade bond market is sitting just one step above junk status, and the world’s foremost financial experts view this as a ticking time bomb waiting to go off. Attendees of the recent Milken Institute Global Conference broke down their fears around the situation, which are hitting a fever pitch.

“Credit agreements look like Swiss cheese to us,” Bryan Whalen, group managing director of US fixed income at the TCW Group, said during a panel discussion.

Tech-Heavy Nasdaq Continues To Underperform In Mid-Day Trading

After coming under pressure early in the session, stocks remain mostly lower in mid-day trading on Monday. The major averages are all stuck in negative territory, with the tech-heavy Nasdaq posting a particularly steep loss.

Currently, the Nasdaq continues to underperform its counterparts by a wide margin. While the Nasdaq is down 93.24 points or 1.2 percent at 7,723.05, the Dow is down 71.69 points or 0.3 percent at 25,692.31 and the S&P 500 is down 13.22 points or 0.5 percent at 2,846.31.

The early weakness on Wall Street came amid ongoing concerns about the escalating U.S.-China trade dispute after Google suspended some of its business with Chinese tech giant Huawei.

Google has cut Huawei off from business involving the transfer of hardware, software and technical services, complying with an order by President Donald Trump blocking the sale or transfer of U.S. technology to Huawei.

“We are complying with the order and reviewing the implications,” a Google spokesperson said, noting services such as Google Play and the security protections from Google Play Protect will continue to function on existing Huawei devices.

The blow to Huawei added to trade concerns sparked by last Friday’s report from CNBC saying the scheduling of the next round of U.S.-China trade talks is “in flux” because it is unclear what the two sides would discuss.

Two sources briefed on the status of trade talks told CNBC discussions regarding scheduling the next round of talks have not taken place since Trump signed an executive order ramping up scrutiny of Chinese telecom companies.

Selling pressure waned shortly after the start of trading, however, with a lack of major U.S. economic data may keeping some traders on the sidelines.

Reports on new and existing home sales and durable goods orders are likely to attract attention in the coming days along with the minutes of the latest Federal Reserve meeting.

Sector News

Semiconductor stocks continue to see substantial weakness in mid-day trading, with the Philadelphia Semiconductor Index plunging by 3 percent to its lowest intraday level in over two months.

The weakness in the sector comes after a report from Bloomberg said chipmakers Intel (INTC), Xilinx (XLNX), and Qualcomm (QCOM) told employees they will not supply Huawei until further notice.

Significant weakness is also visible among computer hardware stocks, as reflected by the 1.5 percent slump by the NYSE Arca Computer Hardware Index.

Biotechnology and commercial real estate stocks are also seeing notable weakness, while telecom stocks have shown a strong move to the upside on the day.

Other Markets

In overseas trading, stock markets across the Asia-Pacific region turned in a mixed performance during trading on Monday. Japan’s Nikkei 225 Index edged up by 0.2 percent, while China’s Shanghai Composite Index fell by 0.4 percent.

Meanwhile, the major European markets all moved to the downside on the day. While the U.K’.s FTSE 100 Index slid by 0.5 percent, the French CAC 40 Index and the German DAX Index tumbled by 1.5 percent and 1.6 percent, respectively.

In the bond market, treasuries have modestly slightly lower over the course of the session. As a result, the yield on the benchmark ten-year note, which moves opposite of its price, is up by 1 basis point at 2.403 percent.