The next asset classes to default

By Felix Salmon
May 22, 2009

I had an interesting lunch with Vipal Monga of The Deal this afternoon, and he came out with a rather startling datapoint: apparently there’s roughly $500 billion of leveraged loans out there which mature between 2012 and 2014. Is there any conceivable way those loans will be able to be refinanced?

But now go back and read your Lucian Bebchuk: he says that under the stress tests, Treasury didn’t even try to guess the value of assets on banks’ books which mature after 2011. Let’s say I’m a bank with a $10 billion portfolio of leveraged loans maturing in 2012. Under Treasury’s adverse scenario, that portfolio will be worth a lot less than $10 billion in 2010 — and if they’d run a solvency calculation using a reasonable value for that portfolio, the results might well have been very ugly. But under the stress tests, Treasury just ignored any drop in value of those assets. Yikes.

Is this the mechanism behind a coming W-shaped recession? Just as today’s fabled green shoots start growing into something viable, we’ll be hit by a massive new spike in defaults in newly-toxic asset classes: not just leveraged loans but also munis, sovereigns, and other things which have yet to blow up enormously. And of course the banks will be hit all over again, and will require yet another round of monster bailouts. If the crisis in structured finance grew to become a broader economic crisis, then the economic crisis might well yet swing around to bring down asset classes on the finance side which have been largely default-free to date, if only because they’re long-term loans which got locked in at low interest rates at the height of the credit bubble.

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