Felix Salmon

The horrifying AAA debt-issuance chart

By Felix Salmon
July 15, 2011

This is why I love FT Alphaville in general and Tracy Alloway in particular: she’ll dutifully read 14 pages into something entitled “The Basel Committee on Banking Supervision Joint Forum Report on Asset Securitisation Incentives” before coming across this chart and immediately realizing just how important it is.


I’ve put a bigger version here for people who want to pass it around in all its horrifying glory, but it’s also worth spelling things out, because it might not be immediately obvious.

The big-picture thing to remember when looking at this chart is something which I’ve said many times before — that it wasn’t an excess of greed and speculation which led to the financial crisis, but rather an excess of overcaution, with an attendant surge in demand for triple-A-rated bonds. On a micro level, triple-A securities are safer than any other securities. But on a macro level, they’re much more dangerous, precisely because they’re considered risk-free. They breed complacency and regulatory arbitrage, and they are a key ingredient in the cause of all big crises, which is leverage.

At the left-hand side of the chart we see that global issuance of triple-A bonds was more or less nonexistent back in the early 90s. All those Treasury bonds, all those agency securities from Fannie and Freddie, all that Japanese debt — add it all up, and it still comes to essentially zero by the standards of what seems normal today. Check out the left-hand y-axis: it goes up in $1 trillion increments. And we’re not talking stock, here, we’re talking flows: this chart is issuance per year.

(It’s pretty easy to see, looking at this chart, how a company like Pimco can find itself with over $1 trillion in assets under management: that’s now just a small fraction of the bonds issued each year.)

Now zoom back, and look at the chart as a whole: it’s going up and to the right, which says two things. Firstly, the amount of debt in the world is soaring. That’s a bad thing, because debt is much more systemically dangerous than equity. And secondly, the amount of triple-A debt in the world is soaring as well. Which is a worse thing, because triple-A debt is much more systemically dangerous than most other debt.

Then look at the green line. Triple-A debt wasn’t a huge part of the bond market back in the early 90s, but for the past decade it has invariably accounted for somewhere between 50% and 60% of total global fixed income issuance. That’s possibly the most horrifying bit of all: it simply defies credulity for anybody to be asked to believe that more than half the bonds issued in any given year are essentially free of any credit risk.

Finally, look at the way that the maroon bars — structured products, basically — have given way to a scarily large purple bar at the far right of the chart. That’s sovereign debt, and it tells you all you need to know about where the next crisis is likely to come from.

In a nutshell, triple-A debt is dangerous; there’s far too much of it; its growth seems out of control; and the triple-A problem has now become a sovereign-debt problem, in a world where sovereign-debt crises are the most damaging crises of all.

All that said, there are two things worth bearing in mind which make the chart slightly less horrific. The first is that for reasons I don’t understand, the chart ends in 2009, a crisis year when sovereigns pulled out all the stops in their attempt to prevent a global Depression. We’re more than halfway into 2011 at this point, there’s no good reason why the chart couldn’t include 2010 as well. And that might show 2009 as being a bit of an aberration. Does anybody have the numbers for total triple-A bond issuance in 2010, and how much of that was sovereign?

And secondly, any kind of debt-issuance chart is likely to go up and to the right to some extent, just because borrowing needs never go away, and old debt needs to get rolled over. The total stock of triple-A debt isn’t increasing by this many trillions of dollars per year, and it would be great to see a second chart of how much that is increasing, and how much of it is sovereign.

Still, flows matter. If sovereigns start being downgraded from triple-A status, debt is going to get a lot more expensive, and those rollovers — which cost very little in the current interest-rate environment — will really start to bite. And the invidious thing about debt is that it doesn’t go away. Deleveraging is painful, and is often accompanied by inflation or default. And the more debt you have to start with, the more painful deleveraging is going to be. Prepare yourselves.

25 comments so far | RSS Comments RSS

unspoken, THIS is too big to fail… THIS is why the banks were bailed out – because everyone owns this “riskless” paper…

Posted by KidDynamite | Report as abusive

This is related to your second “bear-in-mind”, but it would be great to see something like this broken down by duration. If there were some sort of general shift toward issuing shorter-term bonds, it could have a pretty wild influence on this chart.

Posted by absinthe | Report as abusive

So why the corporate bond market explosion? Because of the unwillingness of banks themselves to lend? Are they only really sold by big corporations? I seem to remember that something happened to the commercial paper market during 2008 or so, but my memory is failing me on the specifics.

Posted by Foppe | Report as abusive

” it wasn’t an excess of greed and speculation which led to the financial crisis, but rather an excess of overcaution, with an attendant surge in demand for triple-A-rated bonds. ”

If a lot of people want to buy food, and there isn’t enough of it to meet everyone’s demand, companies generally don’t repackage dog $hit and say it’s food. If they did that, they would be greedy, and the people who would buy the fake food, even thought they knew it might not be food, would be speculators. and when people got sick and died from eating the dog $hit, it wouldn’t have been from overcaution and demanding more food, it would have been because the people selling thedog $hit said it was food.

There was no overcaution. The AAA junk bonds were paying rates well above what AAA normally pays. It was greed, combined with incompetence and wishful thinking.

Posted by KenG_CA | Report as abusive

It would also be interesting to see the sources of sovereign issuance. You’ve got to think the Japanese would have accounted for a lot in the 90′s and then the Americans must have played a bigger role in the 2000s.

Posted by AndrewMeyer | Report as abusive

From a macro perspective, why was there a shift into debt? For every borrower, there must be a lender? Rather than asking why the amount of AAA debt ballooned, we should ask why investors switched from investing in equity to investing in debt? Perhaps there is a dearth of good equity investment options?

Posted by Kosta0101 | Report as abusive

I dunno – I see the jump from 2008 to 2009 of about $1.5T in sovereign debt which was roughly how much America ran up on the credit card with the stimulus and deficit over the year before, so…

Posted by CDN_Rebel | Report as abusive

Incidentally, are you requesting a chart showing (e.g.) how much outstanding debt in 2009 was rated AAA in 2009, or how much outstanding debt in 2009 was rated AAA when it was issued?

Posted by dWj | Report as abusive

Or perhaps this AAA issuance reflects the rise of China and the emerging markets, with these countries preferring to save (ie buy debt) than to invest?

Posted by Kosta0101 | Report as abusive

“But on a macro level, they’re much more dangerous, precisely because they’re considered risk-free. They breed complacency and regulatory arbitrage, and they are a key ingredient in the cause of all big crises, which is leverage.”

Absolutely. But they also breed FRAUD, etc. when there is a lack of such products & a huge financial reward to providing them. & this is also where Implicit Govt Guarantees come in, as there’s a kind of wink & nod kabuki that goes on in which people Imply/Infer that the Govt has their backs. &, as it turns out, some of them were right. This is a form of Govt Insurance bought by companies through Lobbying/Donating. It’s very effective & cheap by any standard. Still is, Mate.

Posted by DonthelibertDem | Report as abusive

Wow, this commentary is misleading on so many levels. Yes, debt can be dangerous, but when we look at aggregates it’s not that meaningful. This is debt the ENTIRE WORLD owes to itself…that means the net of all of these claims is zero. My asset is your liability!

What we really are showing here is the financialization of world output. That may be a problem for a number of reasons (overexpansion of the financial sector, possible reduction in underwriting standards, etc.) but the volume of issuance alone does not suggest increased risk.

The two main drivers of the increase were sovereign debt and ABS. On the first point, it’s pure accounting. Consider Japan’s huge public debt, most of which is held by local governments and hence owed to itself. During this period, world nominal GDP increased from 20T in 1990 to 30T in 2000 to 60T in 2009. For the sovereign piece, we’re merely denominating the government spending portion of that in terms of rated bonds (potentially a good thing) rather than current tax revenues. Issuing 10% of GDP per year in debt doesn’t worry me.

As for the rest, we all know what happened with ABS. It wasn’t a good thing that mortgages previously held at banks (and hence not showing up on the chart) started getting securitized to the point that underwriting went downhill. But packaging those loans into rated bonds didn’t increase the amount of debt in the world.

Posted by loudnotes | Report as abusive

For more than one decade we considered “financial services” as the driving force of US economy, i.e. inflating the global balance sheet without creating anything new.

Now we realize that manufacturing is gone abroad and we r holding an heavy amount of debts coming due.

Posted by robb1 | Report as abusive

@dWj, I’m looking for debt which was AAA when it was issued.

Posted by FelixSalmon | Report as abusive

What’s particularly interesting is that global growth hasn’t kept pace with the leveraging up, which one would expect is a desired outcome. That’s what’s most concerning.

Posted by FDum | Report as abusive

The reason for focusing on issuance is that there is no reliable source for outstandings of every relevant asset class by original credit rating. If anyone knows of such a database, please tell!

Posted by Kiffmeister | Report as abusive

Foppe, corporations could borrow much much more cheaply in the market than from banks. It is just locking in of ultra-low rates. The real question is why buysides are buying this debt….

Kosta0101, what makes you think China is “saving”? They are buying the debt to manage their currencies.

Kiffmeister, Bloomberg…

Posted by Danny_Black | Report as abusive

Triple A are not “safer” than other investments. There is one thing and one thing only that triple A says and that is that the issuer of the obligation is very very likely to meet the terms of the obligation, ie make the right coupon payments on time and return the promised principal on time. It says absolutely nothing else about other risks. You hold Zimbabwe bonds and Mugabi prints worthless money to pay them then that is still AAA as long as he making his coupons. The idea that AAA is ultra-safe is a hold-over from the fixed rate bond issuance of the gold standard era, where the major risk was credit risk.

Posted by Danny_Black | Report as abusive

I’m glad I’m not the only one calling Felix out on his pinning the 2008 crisis on “overcaution: – Yves Smith responded to that point with an entire post:

http://www.nakedcapitalism.com/2011/07/f elix-salmon-misreads-aaa-bond-demand-to- say-overcaution-caused-crisis.html

Come on. Felix, this isn’t like you to make excuses and re-direct criticism for greedy, negligent parasites. Time for an update.

Posted by KenG_CA | Report as abusive

KenG_CA, by “greedy, negligent parasites” you mean investors right? The same people now trying to claim they were too stupid to invest?

Posted by Danny_Black | Report as abusive

Danny, the greedy, negligent parasites were the ones peddling the junk as AAA, or buying it with other people’s money, because they were going to get big bonuses for their imaginary profits. The people now trying to claim they were too stupid to invest were just too stupid to invest. Two different groups, scammers and suckers.

Posted by KenG_CA | Report as abusive

I don’t buy this “overcaution” line either. More like an inability to conceptualize risk when something has never happened, at least within recent memory. I just finished reading Tony Judt’s Postwar, written before 2005, and he discusses at great length so many of the problems of Greece, Italy, Spain, Belgium and others that the markets are finally worrying about today. The debt problems are not something that just magically appeared in the past year or two, like a black swan. The risks have been with us for years but markets chose to ignore them. That is less overcaution than willful ignorance.

Posted by wpw | Report as abusive

Dunno about the chart data. 1990 issuance of almost zero AAA debt, including sovereign? The US budget deficit in 1990 was almost $280B, which would show up on a graph denominated in Trillions.

And in 2008 the US Budget deficit was about $1.3T, of the total shown here of just under $2.0T. The rest of the world’s sovereign issuers was just 1/3 of the global total?

US budget year runs Oct – Sept, and the figures above are for calendar years, so that might throw things off a little. But the data doesn’t look right. Which doesn’t mean the data is wrong, but it might mean the data doesn’t mean what you think it means.

Posted by MGCC | Report as abusive

Could the buyside come from the increased need for pension funds to have long term assets?

With ageing populations and increasing pension liabilities these funds might have been running out of suitable assets to buy. As they cannot make loans, then the banks securitised their loans so that pension funds could buy them. Then they had to be rated AAA because of pension fund rules.

Bit of a chicken and egg thing, or I might be talking pure drivel.

Posted by SSarson | Report as abusive

@Kiffmeister — is there a database of outstandings by current credit rating?

Posted by FelixSalmon | Report as abusive

KenG_CA, something is either AAA or not. Again AAA does not equal risk free nor does it mean there is no fluctuation in price before maturity. What percentage of AAA bonds have actually defaulted?

Posted by Danny_Black | Report as abusive

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