No Folks, It's Not Over... (Junk Bonds)

No Folks, It's Not Over... (Junk Bonds)

Market Ticker, September 18. 2009

Let me guess - record levels of junk bond defaults are positive for the economy going forward?

NEW YORK (Reuters) - About 40 percent of all U.S. junk bonds outstanding in late 2008 will likely default by 2013 as government aid measures end and a wall of corporate debt comes due, Bank of America Merrill Lynch said on Thursday.

By contrast, the cumulative five-year default rate was about 30 percent in the last two default cycles, Bank of America said in a report.

But the real damning part of analysis isn't the front-line - its the last paragraph:

Many so-called distressed debt exchanges are only postponing defaults and will also contribute to the second wave, the bank said. In a distressed debt exchange, companies buy back debt at steep discounts, usually replacing it with longer-maturity debt. About 40 percent of distressed debt exchanges typically default anyway within three years, the bank said.

No, really? You mean that we can't "extend and pretend" and actually fix anything? It's all a game to try to claim that something that has blown up really hasn't blown up?

Yes, that is what the bank said - this is nothing other than a thinly-disguised game - yet another means of gaming the accounting (which should be illegal, but heh, we don't bother prosecuting stuff like that, right?)

The better question is this: If the economy is healing, if demand is improving, if corporations have seen the bottom and business conditions are in fact improving as final demand is rising, then why are defaults going up?

Debt defaults when the cash flow is inadequate to meet service requirements. But cash flow is a "high frequency" thing - it rises immediately when final demand increases.

So what is this, along with the default rates on credit cards and FHA mortgages telling you?

The claims of final demand improvement are in fact false.