When Bonds Collapse, The Party Is Over

Bond Distress Highest Since ’09 as Sales Vanish: Credit Markets

By Bryan Keogh and Kate Haywood

May 27 (Bloomberg) -- The percentage of corporate bonds considered in distress surged this week to the highest since 2009 as investors dumped debt of the neediest borrowers on concern Europe’s fiscal crisis will make it harder for them to refinance.

More than 17 percent of junk bonds yield at least 10 percentage points over Treasuries, up from 9.2 percent last month, Bank of America Merrill Lynch’s Global High-Yield Index shows. The jump is the biggest since the distress ratio rose 11 percentage points in November 2008, two months after Lehman Brothers Holdings Inc. collapsed. Bonds of MGM Mirage and Freescale Semiconductor Inc. joined the list this month.

U.S. distressed bonds have lost 10 percent in May, according to the indexes, as credit markets seize up amid speculation Greece and other nations in Europe with rising budget deficits won’t be able to meet their debt payments. Junk bond sales plunged this month to the lowest level since March 2009, data compiled by Bloomberg show.

It’s going to be really difficult for some of these companies to address their debt piles,” said Mark Dewar, a London-based senior managing director at FTI Consulting who advised lenders to Lehman Brothers after the U.S. bank filed for bankruptcy. “It becomes a downward spiral.

The 5.875 percent notes of Las Vegas casino operator MGM Mirage due in 2014 yield 11 percentage points more than Treasuries, becoming distressed on May 20 for the first time since December, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

We are getting much closer to the end of the road for the sovereign debt market.  Investors have been duped into believing that high yielding junk bonds are profitable and are beginning to realize the gravity of both highly levered corporations and countries.

The riskiest debt is losing favor with investors after returning about 70 percent from March 2009 through last month as credit markets and the economy recovered from the worst financial crisis since the 1930s.

Junk bonds globally have lost 4.4 percent in May, on pace for the first monthly decline in 15 months and the biggest drop since November 2008, Bank of America Merrill Lynch indexes show. Investors pulled more than $1 billion from high-yield funds during the third week of May, after redeeming $2.1 billion the previous period, according to EPFR Global, a Cambridge, Massachusetts, research firm that tracks fund flows.

Investors are unloading risky assets on concern European governments won’t be able to coordinate a response to surging levels of debt from Greece to the U.K. Spain became the focus of the crisis this week as four of its savings banks said they plan to combine to form the nation’s fifth-largest financial group, while the Washington-based International Monetary Fund said the country’s financial industry “remains under pressure.”

Debt restructuring may be needed for one or two fiscally weak euro members,” Nobel Prize-winning economist Robert Mundell said yesterday at a conference in Warsaw.

It is quite entertaining to listen to various "prize winning" economists talk about debt restructuring (aka default) for one or two countries.  When one studies the numbers, it becomes quite apparent that many developed countries are already at the point of insolvency even when unfunded liabilities are excluded.   The only prize these economists should be receiving is the booby prize.

This is not a matter that will be resolved quickly or easily as the media implies by carrying nonsense stories that we will "grow our way out of debt".

Consider the following chart courtesy of Michael Pollaro:

As we see from the chart, the United States, based on its % deficit compared to GDP, and its % gross debt to GDP, belongs in the PIIGS club.

What seems to be glossed over in media reporting, is when a country's debt to GDP exceeds 80%, the party is over as the amount of interest payments on the debt typically exceed the growth rate of the economy!

The bond market will sort this out with severe discipline.

Perhaps not immediately, but soon.

And then, printing press or not, deflation will correct the misdeeds and malinvestments as the velocity of money collapses along with the supply of credit.  

It will be TEOTFSAWKI.

The end of the financial system as we know it.

Gold and farmland are two of the few assets that can weather this type of storm.