Global Debt Markets in 2007: New Paradigm or the Great Credit Bubble?

This article begins by attributing the impressive growth in the high-yield and leveraged loan markets in recent years to the extraordinarily low current default rates, high recoveries, and, until recently, low yield spreads in these markets. Among the main reasons for the low default rates have been the unprecedented growth in global liquidity and the role of non-traditional lenders, including hedge funds and private equity funds, in helping companies avoid or work their way out of financial trouble. But while at least entertaining the possibility, proposed by advocates of a new "credit paradigm" that such factors could lead to a relatively permanent reduction in long-run default rates, the author ends by expressing skepticism. Drawing on his own statistical forecasting methods and long experience with these markets, the author closes by suggesting that, with the recent widening of spreads and collapse of the liquidity bulge, default rates and recoveries in high yield markets are likely to revert toward-if not all the way back to-their long-term averages. And after acknowledging the contributions of LBOs and other highly leveraged transactions to corporate productivity and value, the author argues that the successes of private equity have once again led to overpayments and overleveraging-and that such excesses in turn have produced higher financing costs that are likely to choke off the recent boom.