Global Credit Crunch May Widen

In this morning's "Wall Street Journal", it is being reported that we may be seeing a new phase in the global credit crunch that goes beyond the risky mortgages that have cost banks and investors more than $100 billion in losses and helped push the U.S. economy toward recession. 
 
In the past few days, low-rated corporate loans -- the kind that fueled the buyout boom of recent years -- have plummeted in value. As a result, banks are expected to try to unload some of those loans this week at fire-sale prices. 
 
Nervous buyers also have retreated in recent days from the market for securities backed by student loans and municipal bonds, roiling some corners of the short-term money markets. Similarly, investors have recoiled from debt backed by commercial real estate, such as office buildings. 
 
Over the weekend, the world's top banking authorities warned that the U.S.-led economic slowdown and continued uncertainty about securities could lead banks to further reduce their lending, and choke off economic activity. 
 
One sign of investors' anxiety: Standard & Poor's said its index of the prices on high-risk corporate loans fell to a record low of 86.28 cents on the dollar at the end of last week. 
 
Few market participants expect defaults on any of this debt to match the elevated levels seen in last year's rout in the market for risky, or sub-prime, mortgages. But collectively, they threaten to deepen the financial system's wounds and create a growing pileup of shaky assets on the books of banks. 
 
Behind the latest problems are some common themes: Investors bought some of these debt securities with borrowed money, or leverage. As prices have declined, lenders have forced the sale of some of these securities. The cash being pulled out of the market by these sales has magnified the losses from rising defaults. 
 
Meanwhile, the Federal Reserve's interest-rate cuts, which were designed to reinvigorate the slowing U.S. economy, may be having unintended consequences in some quarters: sending investors fleeing from investments that do poorly when interest rates fall. 
 
After years in which banks and investors have lent money on especially easy terms, "You've had the biggest credit bubble -- probably the biggest credit bubble we have ever had," says Jim Reid, credit strategist at Deutsche Bank AG in London. Part of the bubble has already been unwound, he says. The problem is, "nobody quite knows where that ends." 
 
Especially hard hit: the market for loans to big U.S. companies with low credit ratings. Problems in this market have been percolating for months. These loans, known as leveraged loans, were a popular way to finance the multibillion-dollar private-equity buyouts of recent years that have wound down amid the credit crunch, like the takeovers of Freescale Semiconductor Inc. in 2006 and TXU Corp. last year. Investors started to shun buyout loans last summer, causing a buildup of the debt on bank's balance sheets. 
 
During the past two weeks, prices on many of these loans have fallen to levels that in a normal environment would indicate that the market expected the corporate borrower to restructure or seek bankruptcy protection. But, though they are creeping up from record lows in 2007, the default rate on leveraged loans is still very low, at around 1% in January, out of the more than half-trillion dollars of these loans outstanding. 
 
Investors are also fleeing leveraged loans because the payments they make to investors are tied to short-term interest rates. With short-term rates falling, thanks to the Fed's rate cuts, those payments are shrinking.