Here’s one likely cause of the next crisis

Given the weaker protections, default rates will most likely be higher and losses steeper.

Now that everything has been said about the 10th anniversary of the Lehman Brothers bankruptcy, it’s worth asking how close we are to the next crisis. In the market for corporate loans, investors have fulfilled at least one prerequisite: They’re dropping their guard.

The financial cycle has a lot to do with inattention. When something bad happens, people are careful for a while. Then if all is fine for long enough, they forget that bad things can happen. This false sense of security leads to precisely the kind of behavior that precipitates the next crash.

The corporate debt market has a sort of proxy for inattention: the prevalence of covenants. When lenders are being vigilant, they require that borrowers avoid taking on too much debt or generate ample cash for interest payments. When they loosen up or get desperate for someone to take their money and pay interest, such covenants disappear.

 

 

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