After the subprime crisis erupted and began taking a large toll on the entire credit market, the American government rushed to rescue those hardest hit. Stimulus packages and bailouts ensued, attempting to limit both the economic and political damage. Now another crisis might soon arrive, and Washington might find it more difficult to address:
U.S. and European banks, already reeling from persistent losses on mortgage investments, are facing a new hit as the global financial crisis spreads to deteriorating corporate debt.
UBS AG and Credit Suisse Group last week announced the write-down of a combined $400 million in the value of leveraged loans as part of their fourth-quarter earnings reports. That signals more misery right around the corner for banks that barreled into these low-rated corporate loans — typically issued by banks and sold to investors like junk bonds — and now are stuck holding them on their books. Leveraged loans served as buyout-related debt that fueled a merger boom until the credit slowdown. ….
The credit crisis that has gripped global financial markets since last year has been centered on the plunging value of securities tied to subprime mortgages extended to the riskiest borrowers in the U.S. Write-downs of more than $100 billion on subprime mortgage holdings has forced some of the world’s largest commercial and investment banks to raise billions of dollars in capital from the Middle East and Asia.
Now, the crisis looks to be entering a new phase as the value of corporate loans and bonds that banks hold comes into question. The extent of the damage is likely to emerge as banks file their annual reports next month and report first-quarter results in April.
Normally, this would get resolved by finding new investors to alleviate the debt. Unfortunately, the banks holding the paper have already tapped into these investors to survive the subprime crisis. They may not find enough liquidity left to avoid the kind of write-downs that could shake the markets again in the coming weeks.
If corporate debt rattles the economy, will the government give the same response it did to mortgage lenders? The Bush administration and the Democratic-controlled Congress don’t agree on much, but both Republicans and Democrats rushed to find ways to avoid large-scale foreclosures through government action. Homeowners get a lot more sympathy from the press than corporations, however. A bailout for corporations will not get nearly the amount of support, even if the potential damage to the economy could be significant.
A corporate-debt crisis will certainly test the populist rhetoric being heard now in the presidential primaries. Barack Obama and Hillary Clinton have challenged each other in demonizing corporations over the last few weeks. If corporations suddenly have to start cutting costs to deal with debt overload, it will throw plenty of people out of work. Will they use that to even further castigate corporations, or will both have to work on a corporate bailout in the Senate?