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Maria E. Cipollone's Blog

By Maria Cipollone | Agent in Coral Springs, FL

Fed's important effects on the economy.

Fed’s Biggest Win? Bailing Out Subprime Companies.

One of the quieter, yet most emphatic, successes of the Federal Reserve’s long-running easy-money campaign has been the way it has bailed out subprime corporate borrowers. It’s almost as if the Fed has made it “too hard to fail” for mid-sized to large companies with lower credit ratings.

By keeping short-term rates at zero indefinitely and exchanging a fresh $85 billion a month for Treasury and mortgage bonds held by banks and investors, the Fed has stoked investor risk appetites, compressed debt costs dramatically and loosened credit conditions for most decent-sized borrowers.

Junk-bond yields have fallen so far they no longer merit their longtime euphemism of “high-yield debt.” Junk benchmarks now yield around 5.7%, levels that high-grade companies used to be pleased to borrow at. Through most of the 30-year history of the modern junk-debt market, yields were in the double-digits, and in the panic of late-2008 they exceeded 20%.

As a result, the amount of new lower-rated bonds and loans raised by less financially flush companies has been running at record levels. Through October, high-yield bond issuance exceeded $290 billion, according to RBS credit strategists, ahead of last year’s unprecedented pace. “Leveraged loans,” or credit lines extended to lower-rated companies by groups of banks, are likewise being written in amounts previously unseen.

Effects of 'forced generosity'

This “forced generosity” of the credit markets, directed by Fed policy, has a few important effects on the economy and investors.

- Pretty much every company that stands at least a few yards shy of death’s door has been able to refinance its high-cost debt, firming up its financial affairs, buying time and, for many, forestalling balance-sheet distress or even bankruptcy due to still-sluggish revenue and cash-flow production for many.

- As a result, much of the disaster risk has been stripped from the low-grade bond and loan markets. It’s hardly an exaggeration to say that, thanks to this refinancing boom, there are virtually no debt maturities of consequence among “junk” borrowers until 2016, or even 2017. The rush to lock in low rates has been the corporate version of taking advantage of low-rate credit-card balance transfers, hoping their income improves by the time the debt comes due or rates jump higher.

- While this might seem like an unearned gift to riskier companies and their creditors, it’s fair to say the ability of so many borrowers to roll over their debts rather than shrink or fail has saved, at least temporarily, tens or even hundreds of thousands of jobs. This points up the Fed’s broader policy of doing what it can to float the economy long enough for private-sector job momentum to build and consumer finances to recover.

-Trouble is, the policies are keeping many flawed companies alive and independent that should probably fail or be restructured – and the day of reckoning is likely to come in a few years, when interest rates are higher and the financing window has shut for them.

To put some numbers on this “too hard to fail” situation, for the past four years the default rate among both junk issuers and leveraged-loan recipients has been below 2%. Over the next three years, the total amount of debt maturing is meager, with $58 billion due in 2014 and an average of $94 billion a year through 2016 – out of a total of more than $2 trillion outstanding. With no important maturity volume until 2017, J.P. Morgan analysts predict default rates will remain below 2% for the next couple of years.

MARIA CIPOLLONE

www.Flahomespecialist.com

Comments

By Gino Landetta,  Tue Nov 12 2013, 04:37
The Fed's constantly buys and sells US Government securities in the financial markets, which in turns influences the level of reserve in the banking system. These decision also affect the volume and the price of credit (interest rates). This is the interest rates that banks pay on short term loans from a Federal Reserve Bank.
By Arlene,  Tue Nov 12 2013, 08:08
Formally known as the Federal Reserve, the Fed is the gatekeeper of the US economy. It is the Central Bank of the United States. The Fed regulates financial institutions, manage the nation's money and influences the economy. By raising and lowering interest rates, creating money and using a few other tricks, the Fed can either stimulates or slow down the economy. This manipulation helps maintain low inflation, high employment rates and manufacturing output.
By Mark Faccinelli,  Tue Nov 12 2013, 22:47
The Federal Reserve is a government body that acts as the guardian of the economy. An economic sentinel who implements policies designed to keep the country operating smoothly, dictates economic and monetary policies that have profound impact on individuals in the US and around the world.
By silverbox55,  Wed Nov 13 2013, 11:30
The goal of Fed monetary policy are: 1. Support sustainable growth in the IS economy, 2. Support high employment and 3. keep prices stable. The Fed accomplishes these goals through managing the amount of money in circulation and in accounts in commercial banks.

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