They're back! According to the Financial Times, bubble-era financing practices that were buried with the crisis have risen from the grave in recent weeks. This resuscitation is more confirmation that the Fed's zero interest rate policy is (once again) stoking a bubble in risky assets. In this case, it's in corporate bonds, but pay attention, share investors, as a similar phenomenon is at work in equity markets, too.
The "zombie" practices that could well end up devouring investor wealth again are:
- Covenant-light bonds, which place very few restrictions on borrowers.
- Pay-in-kind toggle notes. These notes are debt that can be repaid with -- wait for the punchline -- more debt issued by the borrower.
- Dividend recapitalizations. An LBO-boom favorite wherein companies owned by LBO firms issue debt specifically to pay their owners a special dividend.
We can expect the usual suspects -- Morgan Stanley
Avoiding a repeat of the last fiasco
In the minutes of its November 3-4 meeting, the Fed's Federal Open Market Committee noted "the possibility that some negative side effects might result from the maintenance of very low short-term interest rates for an extended period including the possibility... [of] excessive risk-taking." So, there's a possibility of a possibility? Surely, we've strayed beyond that realm into that of "likelihood," or even "near certainty." As such, it is becoming more urgent every day that the Fed stir itself and raise interest rates to avoid a repeat of the atrocious mismanagement of the Internet bubble aftermath, which produced the run-up in home prices and the credit binge.
Stocks are vulnerable to an "early" rate hike
Athough a rate hike would be the best course of action, it would hardly be painless, since equity and bond markets have rallied hard on the conviction -- promoted by the Fed -- that there can be no rate rise until the second half of 2010, at the earliest. Weak financials such as AIG