The Day The Big Fat Junk-Bond Bubble Blew Up

Wolf Richter's picture

Wolf Richter

My friends in the corporate restructuring industry aren't breaking out the bubbly just yet. But with one eye, they’re gazing wistfully into the distant horizon where they’re seeing the first signs of a glimmer of hope. And with the other eye, they’re gazing at the screens of their smartphones and computers where they’re seeing a brutal junk bond rout.

Junk bonds had a phenomenal run. With each truckload of free money that the Fed and other central banks delivered to the markets, junk-bond valuations soared and yields plunged. The St. Louis Fed’s BofA Merrill Lynch junk-bond yield index, which was deep into the double digits during the financial crisis, hit a low on May 9 of 5.24%, down from 6.19% at the start of the year. Yields on some of the least bad junk in the index were well below 5%.

Before these crazy times that the financial crisis brought, you could buy an essentially risk-free 1-year FDIC-insured CD with an interest rate of 5%. But recently, desperate investors, mauled by the Fed’s zero-interest-rate policy and losing ground to inflation, were furiously grabbing yield wherever they could, taking on risks no questions asked, any risks no matter how large, to get to that 5% yield. A feeding frenzy for junk. Companies took advantage of this Fed-induced desperation and bamboozled investors into gobbling up $187 billion in junk bonds so far in 2013, a record!

One of the losers of the Fed’s policies was the corporate restructuring industry. With endless amounts of nearly free money available, even teetering companies with too much debt and money-losing operations could borrow more to cover up any holes. So my friends and their restructuring outfits branched out into performance-improvement consulting and financial advisory, and some have left the business altogether.

Bubbles balloon to an absurd magnitude. But one day the feeding frenzy dies down, and gradually, or sometimes suddenly, the risks, the silliness, the illogic, the whole nonsensical nature of the bubble move into the foreground for all to see, and more and more people open their eyes and see it. Some of them will try to get out somehow, quietly at first, by looking for the greater fool. And there are plenty of them, for a while. But new investors want to be compensated for the risks they’re now seeing, and they’ll demand higher yields in return for taking on those risks. That day might have been May 9 – when the air started hissing out of the junk bond bubble. What came afterward was a rout. And a spike in yields:

In less than a month, average yields, according to the FRED BofA Merrill Lynch index, jumped from 5.24% on May 9 to 6.34% on June 6, from the lowest to the highest level of the year.

Risk is a matter of perception; and during bubbles, no one perceives it. Junk bonds have a relatively high probability of default, and when they default, the entire principle tends to go up in smoke. They’re called junk for a reason. When the easy money dries up and the chase for yield is over, companies might have difficulty issuing new junk bonds, and when they can issue them, it will be at a higher cost, and some companies might not find any buyers at all.

But that day hasn’t come yet. The spike in yields since May 9, as brutal as it has been, represents that ridiculously tiny hook at the right-hand corner of the long-term graph below:



That’s how far the pendulum can still swing the other way! Easy money covers up a lot of holes, but when money gets more expensive, these holes turn into traps. Then debt blows up, and creditors kick out entrenched executives, and restructuring specialist are brought in to save the company – at the expense of stockholders and junk-bond holders. Creative destruction might finally take its course.

That’s what the Fed is afraid of. Banks and insurance companies have loaded up on junk. Their balance sheets are infested with risk. Fed governors have fretted publicly about it, citing junk-bond yields as symptom of excessive risk-taking. Yet junk bonds are a small outgrowth of the most magnificent credit bubble ever that these same Fed governors have so proudly created, and that they’re now trying to figure out what to do with. Merely their polite musings about “tapering” their bond purchases have taken junk-bond holders on a wild and unpleasant ride. As the chart shows, it may be just the beginning. A harbinger of things to come in other markets.

Dallas Fed President Richard Fisher has been warning about excessive risk taking for a while. But this time, he outdid himself in the dreadfulness of his warning and in the humor of his presentation. Read.... Fed’s Fisher Hilariously Slams Fiscal-Policy Chaos, Slugs QE, And Throws In Video Spoof of Congress

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ebworthen's picture

The home equity loan commercials are back, along with the reverse mortgage ones.

Back also are the home-flipping shows and infomercials.

Debt Bubble Part Deux.

Paracelsus's picture

I have a theory. The Big Banks have made a ton of money selling derivatives,which they know will never be cashed. The profits from the derivatives trade has been used to prop up their money losing short on PM's. Once this derivatives bonanza dries up,they are screwed and they know this.They will not be able to suppress the prices of precious metals,which will explode higher,and the Dollar will tank. I agree that the time frame has shortened with Japan megaprinting.Six months or less.My only hope is that the populace does not start fighting eachother.The movement towards secession in parts of USA will accelerate. My only question is why hasn't there been any mention of import tariffs in the media? Usually when this happens there is a movement towards protectionism in the world press.

Shad_ow's picture

"My only hope is that the populace does not start fighting eachother.The movement towards secession in parts of USA will accelerate."  They will, it is the reason for race baiting, illegal immigration pushes, and demonizing big business and the rich.  The Pols want segments of the population to blame anyone but them.

Zero Govt's picture

Junk Bonds today, Govt Bonds tomorrow

the squeeze is on, shaken not stirred, Licensed to Kill a politico's wildest spending ambitions stone cold dead

about time too, bloody parasites

world_debt_slave's picture

Everyone knows how small a porfit margin is in the grocery industry. We had a new director take over our store in a corportate ran grocery chain and started remodeling the store again that was remodeled over a year ago. No clue.

MeelionDollerBogus's picture

Yup, just bonkers.

How hard can it be to quickly re-arrange a few items to push up profits?

Just keep the higher-priced things on end-caps and at eye-level and the lower-priced things in temporary sale harder out of reach / sight and keep the shelves stocked as per the typical out-flow of those items.

You fucking don't need to remodel the entire store to put in new fancy graphics painted on the walls every year or giant fake vegetables and so on and so forth. Do it once, fine, but keep wasting money and see where that gets you.

(worked in a grocery store, night crew)

Downtoolong's picture

One curse of ultra-low interest rates is that once they start rising from a low base (like they have in the last few weeks) the value of underlying investments falls much more quickly. A half percent hike in interest rates from 5% to 5.5% is not such a big deal to the underlying market value of a bond. A half percent rise in interest rates from 1.5% to 2.0% is a very big deal to the underlying bond market value. The Fed is holding trillions in Treasury and Junk Bonds on its balance sheet which it purchased at relatively low interest rates. I’m curious, what interest rate rise across the yield curve could make equity on the Feds balance sheet go negative, even by their own valuation models? I wish one of those Congressmen at the next hearing with Bernanke would ask him that question, instead of just complaining about all the money he is printing for them to spend.

enloe creek's picture

bunnyswanson is right ,  except this ain't gonna happen.  the city state and conty law will be completly on the defensive as the numbers of protesters/rioters or just angry people swell, the calls to the national gaurd will not be answered except to provide security in a small number of vital areas. so there won't be any patrols or checkpoints just defensive positions at the government centers and corporate headquarters etc..  IMO it will be   hell. if you are 20 miles out from the city then fine you have a little time to work something out. if not you are going to be dislocated and in fear for your life. people today are oing to go wild. there is much rage and little understanding. there is no community to speak of anymore .

bunnyswanson's picture

Thank you for your assessment of the potential outcome.  I believe the politicians would be sacrificed to the people in the "Blame Game" humans take part in when unexpected tragedy occurs.  Blaming the politicians of course will be encouraged by the media and they will be put onto the crosses and we will be allowed to feel justice.  I agree with that.

There will not be a life in this country worth living.  The agenda is to remove Americans off the planet.  It's a boiling point of rage being created against americans to gain support from the globe (Americans are the reason, it was the Americans who are responsible for this.  Americans are the bad guys.  Israeli public figure stated same...).

This is not a fight against america and their so called imperialism.  This is a reset.  The wealth given to the middle class is being taken back and the standard of living will decline in all 1st world nations. 

Now that everyone is aware of the shell game, I am only concerned about the children and the old/sick folks who will suffer enormously.  A decade of chaos may ensue.  But revenge will not let you sleep at night when your future has been stolen.  They have no idea what is in store when revenge is accompanied by passion.  They think they have all the bullets until the building they are stored in is blown to smithereens by one of their drones which has been hacked and reset.

Ability to know what is happening is necessary.  What if internet is taken down or voices that are loud are banned for accessing it.  There are clubs (veterans, gun clubs, Moose clubs)  in every town just as secret as the Bilderberg group.  Dismantling communities through foreclosure fraud has broken the spirit of the american community but memories are enough.

MeelionDollerBogus's picture

um, is that before or after the staged drill becomes a staged false-flag Chechnyan bombing?

q99x2's picture

Dance while you can. Even the Bitchez are doomed.

bunnyswanson's picture
TALKING HEADS LYRICS Send "Life During Wartime" Ringtone to your Cell

"Life During Wartime"

Heard of a van that is loaded with weapons,
packed up and ready to go
Heard of some gravesites, out by the highway,
a place where nobody knows
The sound of gunfire, off in the distance,
I'm getting used to it now
Lived in a brownstore, lived in the ghetto,
I've lived all over this town

This ain't no party, this ain't no disco,
this ain't no fooling around
No time for dancing, or lovey dovey,
I ain't got time for that now

Transmit the message, to the receiver,
hope for an answer some day
I got three passports, a couple of visas,
you don't even know my real name
High on a hillside, the trucks are loading,
everything's ready to roll
I sleep in the daytime, I work in the nightime,
I might not ever get home

This ain't no party, this ain't no disco,
this ain't no fooling around
This ain't no mudd club, or C. B. G. B.,
I ain't got time for that now
Heard about Houston? Heard about Detroit?
Heard about Pittsburgh, P. A.?
You oughta know not to stand by the window
somebody might see you up there
I got some groceries, some peant butter,
to last a couple of days
But I ain't got no speakers, ain't got no
headphones, ain't got no records to play

Why stay in college? Why go to night school?
Gonna be different this time
Can't write a letter, can't send a postcard,
I can't write nothing at all
This ain't no party, this ain't no disco,
this ain't no fooling around
I'd like to kiss you, I'd love you hold you
I ain't got no time for that now

Trouble in transit, got through the roadblock,
we blended with the crowd
We got computer, we're tapping pohne lines,
I know that ain't allowed
We dress like students, we dress like housewives,
or in a suit and a tie
I changed my hairstyle, so many times now,
I don't know what I look like!
You make me shiver, I feel so tender,
we make a pretty good team
Don't get exhausted, I'll do some driving,
you ought to get some sleep
Get you instructions, follow directions,
then you should change your address
Maybe tomorrow, maybe the next day,
whatever you think is best Burned all my notebooks, what good are
notebooks? They won't help me survive
My chest is aching, burns like a furnace,
the burning keeps me alive
Try to stay healthy, physical fitness,
don't want to catch no disease
Try to be careful, don't take no chances,
you better watch what you say

bunnyswanson's picture

There is a guess but I would not give up until the day they come for the guns.  American soldiers are the toughest.  They fight for the life they already have.  Going back down into the depths of despair, due to admitted fool trickery?  Not on your life does a man fall to his knees and give his life his grandparents and parents gave him to high rollers who cheat to win.  Death would be preferable.  And by the time the broadcasts hit the air, there will be

20 million people around every capital of every state and every politician will need guards and there will be a cessation of mobility but make no mistake, there is more resolve in the heart of the American man and woman, untapped but just below the surface, the need for justice, a clear sense of right and wrong.  Casey Anthony is still in hiding goddam it.  And you had better fucking believe the US politicians had better prepare to do the same if this goes down the way these rich brats have dreamed up.  We'll all be dead.  No other option.  This isn't a novel or a Hollywood script.  We all know very well the day the stock market crashes is the day the baby boomers have nothing to lose.  We will see them go to the front of the line and we'll see why America is a country people dreamed of coming to.

Everyone has waken up.  They are watching more closely.  They look excited for the first time in years.  Because they finally know, can verbalize it...we are in a ponzi scheme and the people orchestrating this are ruthless thieves and k.i.l.l.e.r.s. who will stop at nothing.  Well,they met their match.

You want a life of freedom and choices, privacy and freedom of expression, a just court system, safe neighborhoods with a source of revenue for taxes, industry. 

That   IS  NOT  asking for much.

The disguises have already come off.  The ability to verbalize:  "I have no representation" is difficult when you are a patriot, difficult to believe that politicians have gone this far, allowed this coup to advance to the point it has, without taking a b.u.l.l.e.t. for the nation they professed to protect in exchange for the job.  It's a 007 movie and it is about to end.  Who the fuck do they think they are? ... that is what the signs will say.

This ain't no party, ain't no disco, there ain't no fooling around.  Talking heads.

There are people who are going to live to see the look on the face of the man who k.i.l.l.s. him...sparing him for having to do it himself, because the road ended before his heart stopped beating.

Fuck that.

MeelionDollerBogus's picture

It's a good thing soldiers aren't being sent back for so many consecutive tours they die in action or come back so glitched they kill themselves.
Oh wait...


willwork4food's picture

That was absolutely beautiful.

willwork4food's picture

No they're not. Perhaps some of the young high rollers might be, but when you can get the best off-the-books financial/social study groups money can buy you damn well know what is going on. They're evil, not stupid.

WhiteNight123129's picture

It is a NOT credit contraction, it is ripple effects of the treasuries´ duration inverting for good kicking the junk debt in the balls.



DeadFred's picture

But while the junk debt follows treasuries on the ride to insanely low interest rates, the Fed will not backstop junkbonds to keep the economy from imploding. Likely they will try keep treasuries from falling too far with asset purchases

andrewp111's picture

That little spike could be nothing more than a correction. Yields could continue to go lower for years before this thing blows up.  The biggest thing about bubbles is the unpredictability of  the timing of their pop. My best guess is some unexpected big bankruptcy will eventually pop the junk bond bubble, but the recent spike is just a correction.

WhiteNight123129's picture

FOr yield to go lower, you would need a slow increase in base money like Japan between 1992 and 2011 at an annualized rate of 5% while debt increases at the same speed to that the ratio of credit to base money is unchanged. In the US the ratio of credit to base money shrinks fast right now (the debt on the Fed´s balance sheet, because it is not roll-over is not debt anymore).


Winston Churchill's picture

Months now.TPTB know it as well.

You can smell the desperation ,as the sheeple start stirring before the powers are

ready.That only leaves WWIII as their only option out.

MeelionDollerBogus's picture

as long as it's world-wide CIVIL war & unrest, not wars between nations, they don't give a fuck.
They'll happily add to GDP and trade selling tear-gas and nerve-gas cannisters to each other.

Colonel Klink's picture

That nervous appearance just before the full panic and ensuing stampede?

Vegetius's picture

"gazing wistfully into the distant horizon where they’re seeing the first signs of a glimmer of hope"


Sorry Wolf the light they see at the end of the tunnel, thats an on-coming train. No doubt some people will get out alive but it is going to be a bloodbath, a real one with real blood. The time is coming to go to the mattresses as the Mafia would say, guns, food and gold or silver. The situation that is developing across the globe is slipping out of control and no good will come out of these days that are changing the world.

Still could be worse as most ZHedger's already have guns food and gold.

Men willingly believe what they wish.

- Julius Caesar

"Si vis pacem, para bellum"

Bastiat's picture

If general societal disruptions are coming you'd better hope there are emergency plans to tend to the energetic and mechanical needs of the spent fuel pools around the world.  Based on the International response to Fukushima, I'd say it doesn't seem like a priorty for the TPTB.  If they start lighting up, it's a matter of time for humanity, guns, supplies or not.

MeelionDollerBogus's picture

All is going according to plan!
The sheeple will be herded into those hot zones and told that radiation is good for you, like vitamin R.


willwork4food's picture

I believe they've already figured that out Bas. In a financial meltdown not many people will have enough money for food let alone the electric bill. There is a good possibility that the government will set aside critical areas that are guarded and habitable provided you have clearances, money, gold or some talent they want. Older people need not apply. That includes guarding critical areas like power plants, near by farms and processing centers. As far as the people on the outside that know what is really going on and refuse to be Fema Camped, then all bets are off. Stored food and squirrels last for only so long.

disabledvet's picture

Again it's the bailout of sovereign credits that is breath taking...not the "to be expected" speculations on Wall Street. My guess is the Fed really did bear it's teeth at the last meeting...but I would find this good for credit quality not bad as the weak hands get shakin out. Junk debt? Sure. But bigger still is the funding for welfare programs in Europe or the war effort in the Middle East. The "invasion of privacy" actions as news is no accident. The noose is closing on those who bankrupted the country in 2008. Don't get caught short here.

groundedkiwi's picture

And who or what are supposedly tightening this noose?

hootowl's picture

TPTB will cannibalize their own useful idiots to stave off personal annihilation.  That may buy them a little time to make their escape.

Join the underground economy.  Keep what you earn.


Vampyroteuthis infernalis's picture

This is where it is going to go down, Junk bonds. We have all of these medium sized companies that are losing money left and right surviving because they keep borrowing at next to nothing. Not only will the bond holders lose, but the real 800 lb gorilla in the room will be the derivatives market. Give it a couple of months, the crash will come and chairsatan will be impotent to stop it.

Urban Redneck's picture

It's always "junk" bonds that cause the shit to hit the fan.  

In an economy where money is a product of credit creation, and rational price discovery of credit is suppressed - the inevitable outcome is irrational exuberance and then correction (credit collapse).

gorillaonyourback's picture

The plumge protection team has unlimited money. Until u me and the rest stop using the phoney money the show can go on

willwork4food's picture

I understand your point, but if Vamp's point is that this could trigger a derivative crisis then there is NOT enough money that could plug the hole without causing hyper inflation very quickly.

Damn you Vamp, now I am going to have trouble sleeping tonight.

Non Passaran's picture

The idea is ridiculous.
TPTB can print ANY amount of money they deem necessary.
Secondly, they can nullify any laws, contracts and rights to support "rapid economic growth".
So how is the deriv's market a problem?

MeelionDollerBogus's picture

#1 the upper limit to printed money is currency confidence, causing hyperinflation

#2 the derivatives problem is that either YOUR wages will be used to plug the hole or YOUR assets confiscated or the COMPANIES delivering your food & tools will go bust because THEY are put on the line as the "backstop" of such a collapse. The banksters have had many years to put the house of cards together. It was foolish to think they were all living inside of it. They set it to collapse deliberately without being as exposed to it as many think.

hootowl's picture

If ALL the central banksters flood hundreds of trillions/quadrillions of dollars, etc. into world markets to cover the derivative collapse hyperinflation would be unavoidable.  Fiat would quickly become worthless......Bloody end game.


BigJim's picture

I hate to admit it, but it does look like the only logical outcome to the progression of collapses ZIRP will bring about is a complete takeover of financial (and, by extension, all) markets by CB's.

If junk crashes, threatening the stability of TBTF banks, either 'our' regulators will further suspend normal accounting rules... or they'll give the green light to CB's to just buy the crap from the banks at 100%, in order to 'save capitalism from itself' *snort* 

We really could be seeing the beginning of a pan-global, total asset grab by TPTB. This really could be it. And not one in a million people will recognise it for what it is.

Derivatives don't keep me awake at night. It's the cover derivatives provide to TPTB that keeps me awake at night.

MeelionDollerBogus's picture

And so the cycle repeats. Once the price isn't nearly the concern as the concentration of ownership, to "restablize" the "economy" the assets will be sold off to oligarchs.

I'm sure a healthy proportion of those oligarchs will be dual-citizens too.

(nudge nudge, wink wink)

El Viejo's picture

Ask Russia how centralized control worked out for them and their empire.

max2205's picture

No worries, all FIRE is too big to fail. Ask Holder.

economics9698's picture

Your looking at 5 year cycles opps, oh shit.