Powell Channels Bernanke: “Subprime Debt Is Contained”

I recently discussed one of the biggest potential “flash points” for the financial markets today – corporate debt.

What I find most fascinating is how quickly many dismiss the issue of corporate debt with the simple assumption of “it’s not the subprime mortgage market.”

Correct, it’s not the subprime mortgage market. As I noted previously:

“Combined, there is about $1.15 trillion in outstanding U.S. leveraged loans (this is effectively “subprime” corporate debt) — a record that is double the level five years ago — and, as noted, these loans increasingly are being made with less protection for lenders and investors. Just to put this into some context, the amount of sub-prime mortgages peaked slightly above $600 billion or about 50% less than the current leveraged loan market.”

Every bubble has its own characteristics. The current bubble is no different, and I would suggest that it has the potential to have more severe consequences than seen previously. The reasoning is that the fallout from the sub-prime directly impacted both lenders and the homeowners. This time a “corporate debt bust” will impact a much broader spectrum of companies which will lead to a surge in bankruptcies, mass job losses, and the subsequent contraction in consumption.

Same effect. Different characteristics.

Remember, in 2007, Ben Bernanke gave two speeches in which he made a critical assessment of the “sub-prime” mortgage market.

“At this juncture, however, the impact on the broader economy and financial markets of the problems in the sub-prime market seems likely to be contained.” – Ben Bernanke, March 2008

“Given the fundamental factors in place that should support the demand for housing, we believe the effect of the troubles in the sub-prime sector on the broader housing market will likely be limited.” – Ben Bernanke, May 2007

Of course, the sub-prime issue was not “contained,” and all it required was the right catalyst to effectively “burn the house down.” That catalyst was Lehman Brothers which, when it declared bankruptcy, froze the credit markets because buyers for debt evaporated and liquidity was non-existent.