by Peter Schiff, Schiff Gold:

There is a massive corporate debt bubble floating around out there, and when it pops, it will likely take a lot of companies down with it.

Outstanding corporate debt in the US stands at almost $10 trillion, according to SEC Chairman Jay Clayton. That’s nearly 50% of GDP.

In a speech last month Clayton said, “Those are numbers that should attract our attention.” They should. Nevertheless, the mainstream doesn’t talk about it all that much, despite the Federal Reserve issuing a warning about rising corporate debt last spring.

Borrowing by businesses is historically high relative to gross domestic product (GDP), with the most rapid increases in debt concentrated among the riskiest firms amid signs of deteriorating credit standards.”

But some in the mainstream are starting to sound the alarm. An article in Bloomberg recently proclaimed, “Trouble brews for companies that gorged on cheap credit.”

That cheap credit was made possible by the Federal Reserve holding interest rates artificially low for more than a decade.

Bloomberg focuses on a Wall Street creation known as a collateralized loan obligation (CLO). Remember when Wall Street decided it would be a good idea to package a bunch of risky mortgages together in a financial product called a collateralized debt obligation (CDO)? A CLO is the same thing except it cobbles together risky corporate loans. As Bloomberg explained, “It’s a tool used to package a bunch of high-risk debt together so they can be easily sold for investors hungry for juicy returns.”

What could go wrong, right? It’s not like this kind of thing nearly took down the entire financial system.

Oh. Wait.

CLO’s start with leveraged loans. Think subprime loans for corporations. As with any risky loan, they could be difficult to either collect or resell in a downturn, putting both the borrower and lender at risk. To spread out this risk, Wall Street firms package several hundred of these loans together and issue bonds backed by the loans.

What makes it all work is investors hungry for yield in a world where interest rates have been at historic lows for 10 years and billions of dollars of debt with negative yields.”

Negative-yielding debt topped $15 trillion globally for the first time ever in August and it has since climbed to over $16 trillion. This pile of negatively yielding paper includes government and corporate bonds, along with some euro junk bonds. WolfStreet called it a “race to hell.” As the Financial Times put it, negative bond yields were once considered to be “economic lunacy.” Now they are economic normalcy.

The scramble for yield in a zero-yield world made CLOs a popular investment in recent years.

Unlike mortgage-backed CDOs, the CLO market made it through the 2008 financial crisis without crashing to the ground. And since then, it has grown exponentially thanks to the Fed’s easy-money policy. The central bankers wanted to encourage companies to borrow and by-god they have borrowed.

Fueled by the unprecedented $3.5 trillion wave of private equity buyout deals during the past decade, and rock-bottom US interest rates that only stoked investors’ willingness to gamble on riskier assets, the CLO market has more than doubled since 2010, to $660 billion. By providing abundant cheap funding to the less creditworthy end of the market, it’s helped grease the wheels of the longest economic expansion in US history.”

The fear is that a slowing economy and a rising likelihood of a recession could lead to a “stampede of credit downgrades,” and a wave of selling in the CLO market. This would cut a lot of companies off from their only source of cash. According to an analyst quoted by Bloomberg, this would threaten the very survival of a significant number of companies.

If there’s no price support for lower-rated loans, that will be reflected over time in new issue and refinancing markets, which may mean the lowest-quality borrowers lose access to capital markets.”

This could create a ripple effect, spilling over into the high-yield bond market and ultimately the broader economy.

Analysts estimate up to 29% of leveraged loans are rated just one rung above CCC – the last step before default. Meanwhile, corporate credit downgrades by S&P Global Ratings outpace upgrades by the highest level since 2009. According to Bloomberg’s data, companies at or near the CCC zone have more than $508 billion in loans coming due over the next five years. CLOs own about 54% of outstanding leveraged loans. If the CLO market collapses, it will be virtually impossible for these companies to refinance their debt.

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