Will There Be a New Credit Bubble?

by Inya Ivkovic, MA

In my previous editorials, I wrote about world governments and other decision-makers moving too slowly on the regulations front. And that snail pace towards the regulation reform seemed to be the only type of risks discussed on many important agendas these days. By the looks of it, the return of the excesses of the boom years does not appear all that forthcoming, at least not in the near term.

Granted, it is easier to get to the money as of late, but it is nowhere near as easy as it used to be during the last boom years of 2006 and 2007. Banks are much more careful these days when giving loans and they are charging more for the privilege. Here is an example. About three weeks ago, the Canada Pension Plan Investment Board bought Internet phone service Skype from eBay Inc. for about $1.9 billion. During the credit bubble, paying for Skype with debt would have been possible in its entirety. But in 2009, even the government-administered pension plan could barely secure about one-third of the total bill from a number of lenders.

It is also true that securitized and derivative products are returning gradually, but their prevalence is not even close to 2006 and 2007 levels. In fact, leverage, liquidity levels, structuring and complexity of securitized and derivative products, the kind that created all this mess in the first place, have not really returned. What has returned is more plain vanilla than ever.

But that is still short-term thinking, while the wounds are still raw and still hurting. Human nature is amazingly resilient…and forgetful. The signs are already here indicating that appetite for risk is increasing. We are still a long way from the kind of stampede into the capital markets of the boom years when even my grandmother could have made money trading stocks.

But that day may not be too far away either. Eventually, the investing fever will start up again, competition will up the ante, pricing will go down the toilet and, with it, today’s stringent risk metrics, fiduciary standards, and regulation reform. We have seen it happen before, during the credit boom, which, lo and behold, ended up being the credit bubble.

Why do I fear a credit bubble in the longer term? Well, we are already seeing the record run this year in corporate debt, which has pushed premiums so low to boost investor demand back to pre-Lehman’s fall levels. And, as premiums are being cut, the average interest rate has gone up. For example, the current interest rate on a five-year, triple B-rated corporate bond is about 3.4% higher than on a five-year U.S. government bond. That is about at the same level as before Lehman Brothers’ collapse. In other words, as government issues become more expensive, prices of corporate debt issues are falling under pressure from investors who care little about corporations trying to get out of the recession. Obviously, it is far too easy to fall into the same old pattern.

I’ve said it before…people tend to forget unpleasant events far too quickly. Perhaps some remember the Great Depression and some still remember the 1950s. But memories of most of the fiascos and busts that have happened since have been blurred and marginalized. I admit; I also just about forgot what my computer screens looked like when the tech bubble burst almost a decade ago, bleeding red left, right and center. Alas, we are repeating the cycle of remembering and forgetting again, to our own detriment, of course, for no amount of remembering seems enough, while no amount of forgetting is be too little.