Amid Market Viral and Spiral

Update 417: Amid Market Viral and Spiral,
A Survey of Business and Consumer Debt

In the midst of the coronavirus panic, the Dow plummeted 1,191 points yesterday — the biggest single-day point drop in history. This past week, the S&P 500 dropped 12 percent, making this a full-blown market correction from nowhere in just six trading sessions, a record. 

While people have their eyes on equities this week, let’s not overlook risks in the debt markets. As we know too well from 2008, bad debt can accelerate an already suffering economy towards disaster. Below, we examine the historic levels of business and consumer debt and their impact on financial stability.

Good weekends, all…



In 2019, household debt reached $14.15 trillion after 22 consecutive quarters of increases, per the Federal Reserve Bank of NY. Non-financial business debt topped $16 trillion last year. These numbers got headlines and reveal worries that companies and consumers, fueled by cheap financing, are again marching the economy to the leveraged ledge. 

Since not all debt is created equal, we examine not only the levels of debt but its composition and who is introducing the most risk into the financial markets. Below, we survey the current state of debt from both the business and consumer perspectives. 

The Rise of Risky Business Debt

In nominal terms, non-financial business debt has been steadily on the rise since the Great Recession. But the $16 trillion milestone is not a cause for alarm in and of itself. What’s notable about trends in business debt is not the overall debt level but what types of financial instruments are driving businesses’ borrowing. In its February 2020 Monetary Policy Report, the Fed pointed to the growth of business debt among the riskiest borrowers as a threat to financial stability.

  • Leveraged and Covenant-Lite Loans: Leveraged loans are loans extended to companies that already have high levels of debt and poor credit. Currently, over $1.2 trillion, the market for leveraged loans has more than doubled since 2013. WSJ reported in 2019 that nearly 80 percent of outstanding leveraged loans were so-called covenant-lite (cov-lite) loans. In 2006, cov-lite loans were just six percent of outstanding leverage loans. Cov-lite loans place fewer, if any, restrictions on borrowers. 

The sharp rise in cov-lite loans has been a boon for businesses but has also arguably increased risk within the broader business debt market, particularly for banks issuing cov-lite loans. It isn’t hard to see parallels between the leveraged loan market and the subprime mortgages that ignited the 2008 financial crisis.

Share of Leveraged Loans That Are Covenant-Lite:

Source: The Wall Street Journal and LCD – S&P Global Market Intelligence

  • Collateralized Loan Obligations: Collateralized loan obligations (CLOs) are securities comprised primarily of leveraged loans of varying maturities and quality. In 2019, the market for CLOs totaled $660 billion — 54 percent of the leveraged loan market. This market has grown considerably since 2014, when outstanding CLOs totaled only $350 billion. Similar to the collateralized debt obligations (CDOs) that fueled the 2008 financial crisis, CLO managers slice the CLOs into tranches based on risk and market those tranches to investors with various risk appetites.

    In 2018, a federal appeals court ruled that CLOs are not subject to the Dodd-Frank risk-retention requirements. Prior to the ruling, CLO managers had to hold at least five percent of product value before selling, in effect retaining “skin in the game.” In September, Sen. Warren wrote to the SEC saying that pairing leveraged loans with complex CLO structures “creates significant risk to the financial system and the American economy.”

Swelling Consumer Debt

In 2019, consumer debt rose by $601 billion, the largest single-year increase since the financial crisis. 

Total Debt Balance for Households:

Source: FRBNY Consumer Credit Panel/Equifax

Consumer debt can be broken down into housing and non-housing debt (student loan debt, credit card debt, and auto loan debt). 

  • Housing Debt: The New York Fed’s Quarterly Report on Household Debt, released this month, showed mortgage delinquency rates continuing to decline and fewer homeowners underwater on their mortgages. Mortgage debt accounted for 62 percent of the rise of all consumer debt in Q4 2019. 

Non-bank origination of government guaranteed mortgage lending is an area of concern. The number of non-bank mortgage lenders such as Quicken Loans and Freedom Mortgage has risen exponentially since 2008. These lenders are not subject to the same liquidity standards as other banks, and their failure would be catastrophic to the financial system. 

  • Student Loan Debt: Student loan debt levels are the most concerning of all non-housing debt, with $1.6 trillion in student loan debt outstanding owed by 45.1 million borrowers. The average debt held by a recent graduate is over $37,000 — $20,000 more than it was a decade ago. The average monthly student loan payment has skyrocketed over 70 percent from $227 in 2005 to $393 in 2019. 
  • Auto Loan Debt: Auto-loan debt increased by $16 billion in Q42019, and Americans currently hold $1.2 trillion total of auto loan debt — double the amount of auto loan debt held a decade ago. Auto loans account for nearly 9.5 percent of all consumer debt in America, making it the third largest debt category. While the number of delinquent buyers remains low, in the case of an economic downturn, auto consumers are at risk of over-extending themselves. 
  • Credit Card Debt: Last quarter, credit card debt rose by $46 billion, an amount economists admitted was larger than expected. For the last three years, Americans have paid more than $100 billion (over $400 per American adult) in credit card interest annually. In comparison, Americans paid around $84.9 billion in credit card interest in 2016 (around $339.60 per American adult). 

Consumer debt tends to rise as the economy improves—consumers have more confidence, so they borrow more. But what goes up must come down, and the amount of debt is nearing unsustainable levels. 

Systemically Risky Debt

Debt helps the economy grow — mortgage loans enable families to buy homes. Companies grow by issuing bonds. During this period of low interest rates, taking on debt can be a wise financial decision. But the Great Recession made clear that sufficiently obscured or ignored weak credit quality can pose systemic risks to the broader and real economy.

After the last recession, regulators focused on the mortgage market. But now business debt markets are taking on riskier debt again. Unlike individual defaults on a mortgage, a firm defaulting almost invariably has ripple effects — job losses, missed paychecks for multiple families. We’re reminded by recent history that time shoring up the business debt market is a vital market self-correction of discipline before the Fed or Congress calls for another TARP.  

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