Submitted by Jeffrey Snider via Alhambra Investment Partners,
Looking For The Next One; Part 2, Finding Risk Rather Easily
As noted in Part 1, The Fed sees no risks of bubble trouble because they are looking at it all from the 2008 perspective. That is completely wrong-headed; if there is a “next one” it will have nothing to do with subprime mortgages, or even mortgages and real estate. By March 2007, the conventional estimate is that there were $1.3 trillion in subprime mortgages outstanding, all of which caused inordinate decay in liquidity and pricing through wholesale mechanisms that turned out to be disastrously self-feeding and often contradictory (as an example, tranche pricing through correlation trading where correlation estimates were based on CDS prices derived from liquidity in hedging demand which traced back to tranche pricing). Everyone seems to simply assume that the subprime problem ended in 2008, if only by crash.
That is true but only of mortgages. Deleveraging is myth as debt has still expanded, and greatly, just not in the same exact places. There are certainly auto and student loans that have exploded exponentially, especially in subprime categories, but if there is another credit bubble now, the third, it is undoubtedly corporate debt. The FOMC looks at corporate credit spreads being narrow and yields being low as a measure of its own success with QE, but that largely misses the real risks in such a condition – junk bonds are not meant to yield 5% or 6% because there is absolutely no cushion to that price!
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