It's easy to vent against excess speculation. On the flip side, most in the investment industry deplore excessive regulation. Honest observers recognize clearly, however, that with implicit guarantees against failure, giant investors have aggressively assumed increasing levels of risk the farther away they move from the 2008 financial crisis. In order to continue such behavior, they have lobbied -- largely successfully -- to prevent potentially damaging incursions onto their turf by such forces as Dodd-Frank and the Volcker Rule.
Last Wednesday, Greg Roumeliotis reported on Reuters that the Office of the Comptroller of the Currency:
"… has already told banks to avoid some of the riskiest junk loans to companies, but is alarmed that banks may still do such deals by sharing some of the risk with asset managers ... Among the investors in alternative asset managers are pension funds that have funding issues of their own."
It's a longstanding truism on Wall Street that the longer a bull market persists, the junkier the deals that come to market. In the current zero interest rate environment, orchestrated by the Fed and other central bankers, the quest for yield is venturing into increasingly dangerous territory.
U.S. leveraged loan issuance hit a record $1.14 trillion in 2013, up 72% from 2012, according to Thomson Reuters Loan Pricing Corp. And the riskiness of these loans has simultaneously risen year over year, reaching the highest level of debt to EBITDA since 2007, preceding the economic collapse and 57% stock market crash.
Because regulators' efforts are more readily designed to limit excessive risk-taking by banks, there are potentially greater levels of systemic risk in the shadow banking sector, including such non-bank financing sources as hedge funds, private equity funds and money market funds. As they did in the early years of this century, these entities are stretching for return in the highest risk deals and frequently levering them up imprudently. The last crisis unfolded when many such deals imploded.
When left to their own devices, as bull markets get long in the tooth, investors lose fear and stretch for return, and Wall Street is ever ready to meet such demand with increasingly suspicious product. Such behavior recurs in cycle after cycle and is a compelling reminder that lessons of the past are readily discarded as we travel farther from the most recent financial crisis. Current behavior is certainly waving a warning flag.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.