Fed's Powell: Corporate Debt No Subprime Crisis But Still Merit Reflection

ATLANTA (Reuters) – Federal Reserve Mayor Jerome Powell on Monday dismissed comparisons between the rise in corporate debt to record levels in recent years and conditions in US housing markets that led to the economic crisis for 2007 to 2009, yet cautiously justified.

FILE PHOTO: Federal Reserve Board Chairman Jerome Powell speaks at his news conference after the closed two-day Federal Open Market Committee meeting in Washington, USA, May 1, 2019. REUTERS / Yuri Gripas / File Photo

Comparison with the years before the financial crisis is "not entirely convincing," Powell said at an Atlanta Federal Reserve banking conference on financial markets, as debt growth seems to be in line with economic growth, debt spending remains low, and the financial system is better positioned to absorb losses.

Despite that, he pointed to the lack of transparency about the sources of finance and the ultimate holders of corporate debt, and to the risk that an economic downturn could worsen if debt borrowers begin to fail as reasons for caution.

"Corporate debt has apparently reached a level that should give companies and investors reason to pause and reflect," said Powell, with record-level corporate loans of around 35 percent of the company's assets.

Although corporate debt growth has slowed in the past, another sharp increase … can significantly increase vulnerability, Powell says.

That concern is another reason why the Fed may be reluctant to cut interest rates, as lower borrowing costs may cause companies to take on more debt.

High levels of corporate debt, along with the pace of lending to the most risky borrowers, have emerged in recent months as the Fed's main financial stability concern.

It is something that the central bank has immediately attempted to flag as uneasy if an economic downturn causes the most indebted borrowers to fail. Nevertheless, it has also tried to keep the risk in context. Powell said he did not see corporate debt as the same type of systemic threat as the subprime housing market turned out to be.

"From now on, debt obligations do not present the kind of elevated risks to the stability of the financial system that will cause great harm," he said.

Nevertheless, comparisons with the mortgage market have been inevitable, driven by the popularity of secured loan obligations that bring corporate loans to securities.

While the concept resembles the security obligations that spread bad mortgages throughout the financial system, Powell CLOs said "are much healthier than the structures used during the mortgage loan."

In addition, the fact that only $ 90 billion of the $ 700 billion CLO market is held by large commercial banks is "good news", with less risk to the core financial system companies.

Nevertheless, it means that much of the loan is financed negligibly, outside the banking system, Powell says. "Regulators, investors and market participants around the world will greatly benefit from more information about who carries the ultimate risk."

Reporting by Howard Schneider; Editing by Leslie Adler

Our Standards: Thomson Reuters Trust Principles.

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