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.


We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Reuters. For more information on our comment policy, see

Read David Marchick’s May 13 testimony to the Senate Banking Subcommittee on Economic Policy to see the problem with financing maturing corporate debt.

David Marchick of The Carlyle Group told Senators, “Moreover, given the staggering amount of new loans that were issued in the 2005 – 2007 that will come due in 2010 – 2014, it will be essential that credit markets can facilitate refinancing of this debt.” (Carlyle Group press release)

Marchick assessed the current state of credit, saying “Credit markets remain severely compromised. Bank lending remains anemic, particularly to small- and medium-size companies. The non-bank credit system is moribund. Unemployment will likely increase as consumers continue to be very cautious in their spending patterns. Finally, even if we are at the bottom, it will take years to climb out of the hole.” %20Archive/2009/item10681.html

Sorry, but I don’t get the connection between the stress tests and defaults on sovereigns and munis? Perhaps you mean that closed end funds that hold these instruments with leverage will default? Or do you mean the instruments themselves will default. If so, I don’t see how leverage plays into sovereign or municipal defaults. Please explain. Thanks

Posted by maynardGkeynes | Report as abusive

Bebchuk is being a bit misleading. The stress test definitely considered long-lived assets that may default before they come due — after all, they were attempting to value 30-year mortgages. If a loan maturing in 2011 has a 20% chance of default in 2010, the stress testers marked it accordingly. However, if it is an IO loan that comes due in 2011 and there is no chance of default before then, the stress testers accepted it at par value. This is because they were only attempting to measure credit losses during 2009 and 2010. They weren’t attempting to measure the “economic value” or “liquidation value” of the portfolio, just whether the banks would end up failing because of credit issues by 2010. Make sense?

Posted by Andy | Report as abusive

Somebody please throw this Monster into the fiscal crisis.

~ Quote ~

“A tsunami is building and ready to hit future generations, but this one won’t be set off by earthquakes or other natural disasters. Instead, it will be a fiscal calamity created by the failure of government and business leaders to deal with the financial drain of millions of retiring baby boomers.”

—David Walker, U.S. Comptroller General

I had to get out my financial calculator for this one.
Some estimates say 8,000 babyboomers are retiring per day. Others say 10,000, so let’s split it down the middle and use 9,000 per day. Let’s then multiply this figure by an average of $1,000 per person. I’m not even going to include the ridiculous amount of medicaid that will also be consumed instead of the companies that would have paid for this healthcare premium through private insurance while those people were employed. 9,000 X 1,000 = 9 million more dollars per day for that month being sucked out of social security. Per day Per day for roughly eleven years. So by the end of this month, 270,000 more baby boomers will be sucking of of the nipple of the social security system. That’s 270,000 X $1,000 = $270 million more dollars than last month, month after month for 11 years. 3 million 240 thousand more retirees will be sucking off of the system by the end of the year X 1,000 per month so that is 3 billion 240 million more dollars per month, month by month X 11 years = 35 billion, 640 million more dollars per month, month by month until the wave eventually passes over time. How about that for some earth shattering numbers. Still worried about the economic calamity we are trying to work through now? Signed ~ Will We Breathe

Posted by will we breathe | Report as abusive

WWB: Remember the boomers are the first generation to pay their ENTIRE working lives into the TRUST FUND of Social Security UP FRONT. Sucking indeed. What sucks is that trust fund morphed over time into nothing more than another scheme congress has utilized to fund their endless games through delusional equations of structured finance there too; 1 really didn’t equal 10 but is -10 now. Lets put sucking in the right place and not on an entire generation that paid, paid and paid only to discover its spent by those ‘public servants’ who abandoned their fiduciary responsibilities going back over two decades.

Also remember, we paid during this time for our health care by private insurance. Now thanks to a delusional traders market, many who planned and prepared for retirement have lost, no recourse to stay up with the ever increasing inflation as real wages declined other than Wall Street to fund ordinary lives. Those wages and SAVINGS PROVIDED the ENDLESS liquidity for those masters of the universe to RISK without their skin in the game. THANKS!

Posted by NS | Report as abusive