Value context and insight. lkm@koreatimes.co.kr
Deja vu of 2008 financial crisis?
By Lee Kyung-min
Corporate debt in US considered 'ticking bomb' in 2020
By Lee Kyung-min
The recent extreme market turbulence sparked by the new coronavirus begs the question of whether the global economy is about to experience a crisis similar to one in 2008.
Opinions vary on the severity and extent of the possible crisis and whether it will be triggered by a debt-backed structured financial product ― a chief culprit that brought on the 2008 global financial crisis.
But experts say bubbles of “risk-ridden” financing will be the first to pop in times of rapidly elevating uncertainty.
Much more concerning is a rapid negative financial development compounded by the oil price war and the coronavirus, and external shocks that could tank many businesses, leading to a chain of corporate defaults worldwide.
The Cboe Volatility Index (VIX), a gauge of the current volatility felt in the market, has surged over 250 percent year-to-date, a far steeper rise compared to 2008, when the Wall Street's fear gauge rose 130 percent that year.
“The intensifying trading action is pushing up the so-called fear index,” Standard Chartered Bank Korea chief economist Park Chong-hoon.
“The market panic comes chiefly from dreadful corporate earnings outlooks especially in the airlines and travel sectors. This is fueling fears that the businesses could see an increased credit risk.”
Corporate debt in the U.S. will become a major factor that triggers a far-reaching chain reaction if the global economic slowdown continues longer than expected, according to a market expert at one of the economic think tanks in Korea.
“It's a ticking time bomb,” said the expert, on condition of anonymity.
He pointed out that low-credit companies with poor financial conditions have borrowed money through collateralized-loan obligations (CLOs).
CLOs, in which risky corporate loans are packed into safer bonds, allowed financially precarious firms to not only borrow but even leverage, a highly risky decision vulnerable to rapid corporate deterioration.
Some say the structured financial product is emerging as the biggest risk factor that could lead to a major disruption of the global economy, the same way a similarly structured collateralized-debt obligation (CDO) led to a full-blown global crisis in 2008.
Compounding the concern is high-yield bonds issued by them, many of whom are not profitable enough to cover interest payments.
Some triple B minus firms continued issuing bonds and financial services firms including banks, kept buying them for high returns.
“This continued from early 2010 and for half a decade. But few cared about possible default as returns were high and there was ample liquidity in the market thanks to low interest rates,” the expert said.
The alarm was about to go off in 2016 when the U.S. Federal Reserve showed signs of a key base rate hike, but the concern dissipated a few years later as it turned dovish.
How fast the coronavirus is contained will be a decisive factor determining the fate of those firms, and the global economy, he added.
“It is largely considered a matter of when, not if, it is to be seen whether the virus will shut them down or buy them more time.”
Trader Peter Tuchman works on the floor of the New York Stock Exchange, March 16, 2020. / AP-Yonhap
Liquidity crisis
Liquidity and credit crisis, in which businesses fail to make loan interest payments to banks and other firms for their goods and services, is a larger concern, according to a market analyst.
“The situation is quite different from 2008,” said Standard Chartered Bank Korea investment strategist Hong Dong-hee.
Large-scale default of heavy debt will be inevitable if the central bank adopted a tightening monetary policy. But it is less of a concern given the below-one percent rate and even negative rates in other advanced economies.
Similarly, the bubble in the economy popped in 2008 as the interest rate went up, leaving loan takers no choice but to default. But businesses amid the current expansionary monetary policy are not so much concerned about rising debt, but more about a lack of liquidity ― cash.
“Other than monetary policy, businesses need direct financial support to make payments ― to banks and other firms. More fiscal stimulus as well as debt maturity extension are some of what the market expects to stabilize the volatile market,” Hong said.
The much-awaited recovery, he said, hinges on coronavirus containment, and resolution of the oil price war.
“Expectations were high early 2020 that the global economy will recover as the U.S.-China trade feud seemed to find a breakthrough, but the virus and oil price tumbling below $30 a barrel came as a major shock dampening the mood. The market fluctuation is expected to continue for a bit until the global economy recovers.”