The Seedy Underbelly of Debt Collection

You are bringing a leveraged buyout (what Zell's purchase was) into a discussion about the terms unsecured loans typically carry. It's a bit of a different discussion, but. ... Presumably the only thing that can go wrong with a leveraged buyout is if someone allows you to overleverage yourself and secure their money. Think about why there were so many overleveraged entities in the mid 2000s (including the Trib, a large percentage of home owners, trading desks at Wall Street banks, etc.). ... What caused lenders to take on risk way beyond the risk premium they were getting paid and make what turned out to be ridiculous loans -- and in the case of several large banks, caused them to go belly up?

The reason the Wall Street banks were willing to underwrite the Trib's debt (even though there wasn't enough collateral underlying those loans) was that there was a huge bubble in the corporate lending market in the mid 2000s. That wasn't a problem with the market itself. It was a problem with who was interfering with that market and how. Interest rates were being rigged downward -- forcing people to take on outsized risk to earn anything on their money.

The Federal Reserve was rigging rates in its misguided attempt to create what turned out to be false prosperity that everyone loved in a short-sighted way (everyone can be a home owner and drive a new car! We can finance expensive wars!), and it allowed people to borrow more and more money and create huge debt loads. ... it ended -- temporarily -- in the financial collapse in 2008. Before they started to reinflate the bubble to where we are today because of further interest manipulation (rather than allowing the market to correct itself, they have created an even bigger mess -- they didn't allow the pain they caused in the first place to filter through so we can get back to health).

It is precisely what I was talking about in my post in which I said that external factors can skew a market (when our central bank messes with the market and puts in price controls). In the case of the lending markets, they caused participants to miscalculate the risk involved by suppressing interest rates and incentivizing people to take riskier and risker behavior as a result (in order to get any yield and keep up with inflation). That led to subprime mortgages and a ridiculous junk bond market that enabled Sam Zell to take out billions of dollars worth of loans to do a leveraged buyout. If rates aren't being manipulated artificially low by the Fed, there would have been no lending market for the Trib (The Trib would have gone bankrupt either way, but at least it wouldn't have dragged its lenders down with it).

Price controls invariably turn out bad, and bubbles caused by central bank intervention in the market are particular scary, as we are learning. That is the story of the Trib's debt load.

In the case of the interest rate market, that market hasn't been free for a long time. As long as the Federal Reserve (and every other major central bank) has its thumbs on the scales of finance, as Jim Grant says, interest rate markets are being subject to their manipulation -- and creating huge inefficiencies that put our financial system at risk. Ostensibly they believe in a paternalistic way that they can guide the economy somehow with intervention and price controls. But in reality, we have put ourselves so much in debt, starting with governments around the world, that central banks really exist to suppress interest rates for as long as they can play this game, to keep everyone from defaulting on their debt. Those defaults will actually be a good thing in the long run (but a mess in the short run), because it will fix the skewed incentives they have created and allow lenders to get back to using real price discovery in an unrigged market to determine an appropriate amount of risk / reward premium.

Since 2008 the way the interest rate market has been rigged by the central banks has been way more extreme than what caused the financial collapse in the first place, and it has created a mess. Right now we are in a world of bubbles (starting with our debt markets across the board) that goes way beyond even the corporate lending bubble that the Trib was symptomatic of.

 

That is kind of the point. Without rates being suppressed (and the Federal Reserve incentivizing risky behavior -- trying to steer lenders to take huge risks), there was NO market for a company already as heavily indebted as the Trib already was, and as leveraged as Zell took it. And certainly not at such a low interest rate, given the liklihood of eventual default.

If you came to me looking for a million dollar loan, were already heavily in debt and your income was only $30,000 with no prospects of earning more in the future (as you struggled to make principle on your existing loans), I wouldn't lend to you period. ... let alone at a low risk premium IF I was a gambler. ... The only reason anyone would consider making that loan is if someone was manipulating the economy to make it so you lose money by doing nothing or staying with the safe alternatives.

When cranberry was likely congratulating Alan Greenspan in the early to mid 2000s for creating a world without booms and busts (without him a plague of locusts would have descended on us!) -- just endless rainbows and unlimited candy canes -- that was exactly what Greenspan was doing. He was destroying the value of the dollars in your pocket, and pushing you to have to take what now seems like crazy risks if you simply preserve your wealth. If you weren't willing to take on that risk, you were out of luck.

But look at the bright side. It allowed our government to run up a massive amount of debt. So we have that going for us.