Washblog

The break in the credit markets came first in the market for leveraged loans. These are loans made to companies that already have a lot of debt so there is very little capital backing them up - hence the leverage. The secondary market for leveraged loans was actually a pretty quiet place until July-August of 2007 when it just blew up. It was, Wall Street later told us, the financial equivalent of a 500-year flood. Those initial levee-breaks at the end of July 2007 were said to be the first sign that subprime mortgage loans were destabilizing the credit markets.

But hang on, what's the connection between loans to companies and mortgages to people with poor credit? Well, the explanation that came out of Wall Street -  very quickly - was that losses in the subprime market were forcing banks to reign in credit activity and so they started this reigning-in in the leveraged loan market. The economy was doing well. The companies were sound. It was a credit crisis in another place that was causing the trouble in these loans. We didn't know that could happen. Interesting

First, Wall Street told us of a global market for debt. That was the explanation. Then they had to admit that the labyrinth of mutual bets the banks all made with each other in the derivatives market - particularly the Credit Default Swaps - made it so that trouble in one area of credit could quickly go to another - but that this was not necessarily a bad thing. Then the story got wonkier. It was all about "mark to market accounting" which had been a very good thing the industry was pushing governments to adopt but was now a very bad thing the government was forcing on them. Wonkier still, they admitted that "actively-managed balance sheets" were moving credit losses from one area of business to another.

In retrospect, they came up with all of it a little too fast. It should have struck me how quickly came explanations, all supporting the narrative about German banks being sunk by California mortgages because we have all been made one big, happy family, by - yes, over-exuberant and certainly geeky, but business-sound - financiers. Wall Street had acted in good faith and with standards that were, if anything, simply too high for crude reality. Everything got ruined because American mortgage borrowers were a bunch of deadbeats.

I should have been even more skeptical and - given the people telling the story - even more cynical

Now it turns out that these maniacs in the financial industry were not only setting records in mortgage lending and derivatives, they were also setting records in risky loans to businesses. It's now becoming clear that the crash in the leveraged loan market has had quite a little bit more to do with the underlying soundness of those businesses than their banks first admitted. It looks like leveraged loans were the Business Class version of subprime.

If so, that's that. We're screwed. And I think it's so.

The only saving grace is that because these loans were made to businesses with plenty of lawyers and accountants, there was probably a lot less outright fraud than there was in the mortgage market. At the end of the boom, I'm not sure there were always even existing houses underneath some of the mortgages people wrote. We know for a fact they lent to dead people in some instances. It's harder to do that with a leveraged loan - but I'll bet they came as close as they could.

And I say we're screwed because it looks like - on top of all the other insanity - the genius-idiots of The City and Wall Street loaded up our most economically-sensitive businesses with piggy-back debt they were at pains to repay in good times. This assures us that as soon as the real economy turns down significantly, a wave of defaults from that supposed "500-year flood" will crash onto the financial sector. I had heard something about corporate loans having hurt one of the large banks recently in the news, but I thought it was a smokescreen for their mortgage losses. Now it looks likely they were getting killed by both mortgages and corporate loans.

And now so are we all.