Saturday, 16 July 2011

World is drowning in supposedly risk free debt -but is AAA risk free?

The chart above was shown in a very good article from FT Alphaville from July 15th written by Tracy Alloway. To cut to the chase the main point of the piece is to expose the complacent manner in which so much debt is being piled up with AAA ratings which, at least according to canonical notions in finance, is supposedly risk-free. Whether or not one can have confidence that all of this annual issuance is without risk is left for the reader to judge.

Here is an explanation of what the chart shows from Felix Salmon.

At the left-hand side of the chart we see that global issuance of triple-A bonds was more or less nonexistent back in the early '90s. All those Treasury bonds, all those agency securities from Fannie (FNMA.OB) and Freddie (FMCC.OB), all that Japanese debt — add it all up, and it still comes to essentially zero by the standards of what seems normal today. Check out the left-hand y-axis: it goes up in $1 trillion increments. And we’re not talking stock, here, we’re talking flows: this chart is issuance per year.

(It’s pretty easy to see, looking at this chart, how a company like Pimco can find itself with over $1 trillion in assets under management: that’s now just a small fraction of the bonds issued each year.)

Now zoom back, and look at the chart as a whole: it’s going up and to the right, which says two things. Firstly, the amount of debt in the world is soaring. That’s a bad thing, because debt is much more systemically dangerous than equity. And secondly, the amount of triple-A debt in the world is soaring as well. Which is a worse thing, because triple-A debt is much more systemically dangerous than most other debt.
Then look at the green line. Triple-A debt wasn’t a huge part of the bond market back in the early 90s, but for the past decade it has invariably accounted for somewhere between 50% and 60% of total global fixed income issuance. That’s possibly the most horrifying bit of all: it simply defies credulity for anybody to be asked to believe that more than half the bonds issued in any given year are essentially free of any credit risk.
Finally, look at the way that the maroon bars — structured products, basically — have given way to a scarily large purple bar at the far right of the chart. That’s sovereign debt, and it tells you all you need to know about where the next crisis is likely to come from.

In a nutshell, triple-A debt is dangerous; there’s far too much of it; its growth seems out of control; and the triple-A problem has now become a sovereign-debt problem, in a world where sovereign-debt crises are the most damaging crises of all.
All that said, there are two things worth bearing in mind which make the chart slightly less horrific. The first is that for reasons I don’t understand, the chart ends in 2009, a crisis year when sovereigns pulled out all the stops in their attempt to prevent a global Depression. We’re more than halfway into 2011 at this point, there’s no good reason why the chart couldn’t include 2010 as well. And that might show 2009 as being a bit of an aberration. Does anybody have the numbers for total triple-A bond issuance in 2010, and how much of that was sovereign?

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