We live in a world awash in debt.
But that’s the risk we can see. There is plenty of additional risk hiding in the undisclosed obligations of private companies and in the “shadow banking system,” nonbank financial institutions that have sprung up in the past decade to hold the risk that the Federal Reserve insisted, after the 2008 financial crisis, that Wall Street avoid.
So what would happen if interest rates did increase slightly, or if the economy dipped into a recession, and some of those overleveraged companies could no longer meet their interest payments? It wouldn’t be pretty.
We got a taste of that, briefly, last December, when interest rates ticked up just a bit, and there were suddenly no buyers for high-yield debt. Not a single high-yield debt deal got done in that month. When companies with the poorest credit can’t get financing, it sends a chill throughout the credit markets, but it also means that hiring slows, factories don’t get built and innovation stalls.