The world may face another major financial crisis if growing corporate debt reaches bubble-like proportions similar to the rip-roaring housing market 10 years ago.
The next time, ballooning corporate debt to unsustainable levels might spur the next collapse, according a report by credit rating firm Standard & Poor’s
"A worst-case scenario would be a series of major negative surprises sparking a crisis of confidence around the globe," S&P Global Ratings said in the July 20 report. "These unforeseen events could quickly destabilize the market, pushing investors and lenders to exit riskier positions ('Crexit' scenario). If mishandled, this could result in credit growth collapsing as it did during the global financial crisis."
Corporate debt may rise to $75 trillion in the next four years from today’s estimated $51 trillion, S&P says. Central banks such as the Federal Reserve are encouraging companies to load up on debt by keep borrowing rates near record lows. In Japan and Europe, central banks are even buying corporate bonds to feed the debt monster.
"Central banks remain in thrall to the idea that credit-fueled growth is healthy for the global economy,” S&P says. “In fact, our research highlights that monetary policy easing has thus far contributed to increased financial risk, with the growth of corporate borrowing far outpacing that of the global economy."
The last financial crisis followed a decline in U.S. home prices from a 2006 peak. That property bubble was the result of a complacent Fed
and lax lending standards that allowed people with shaky income and credit histories to buy houses they couldn’t otherwise afford.
Collapsing home values and rising defaults strained financial firms, eventually leading to the record-setting bankruptcy of investment bank Lehman Brothers and the worst recession in 80 years.
Avoiding another financial crisis will require an orderly reduction in debt levels, but such a scenario isn’t guaranteed. The U.K. withdrawal from the European Union was one such shock that even the sharpest analysts didn’t predict.
"A worst-case scenario comprising several negative economic and political shocks (such as a potential fallout from Brexit) could unnerve lenders, causing them to pull back from extending credit to higher-risk borrowers," the report says. "Indeed, the credit build-up has generated two key tail risks for global credit. Debt has piled up in China's opaque and ever-expanding corporate sector and in U.S. leveraged finance. We expect the tail risks in these twin debt booms to persist."
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