When this debt bubble bursts, retirement savings for ordinary Americans will take a hit
This added indebtedness creates two related concerns. Many companies could go bankrupt if thebecause they can no longer pay their substantial debt burdens – interest and principal. This could make a recession worse because companies that otherwise would stay in business won’t. In addition, if banks come under stress from both their direct and their indirect exposure they have to high corporate debt risks, they could also pull back on their lending activity in general.
The chance of banks ending up with a growing number of bad loans is not the only way the fallout from these risky loans could spread throughout the economy and worsen a recession. These loans are made by banks andfinancial companies. They are then frequently repackaged and sold to investors such as mutual funds and pension funds. This process is akin to the repackaging of subprime mortgages prior to the Great Recession.
Moreover, a lot of the loans are repackaged as high-quality debt to sell to retirement savers. This could lower final investors such asand pension funds to unwittingly trust these risky investments. Importantly, the approval of these loans as high-quality debt rests on the current financial situation of the borrowers, which can severely underestimate so-called systemic risks that could emerge when the economy turns into a recession.
Finally, lenders often allow borrowers to misstate their earnings, a practice that sounds too close to the so-called “liar loans” of the subprime boom when borrowers could misstate their incomes and lenders turned a blind eye. The result then were and are loans that ultimately sound too good to be true – because they are.
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