Where will the next financial crisis start?

People drinking shots in a bar © iStockphotos
Investors are partying like it’s 2007

The global financial crisis of 2008 was triggered by a bubble in the US housing market. Lightning rarely strikes twice, however, and American residential property seems unlikely to be at the centre of another collapse.

So where might the next crisis come from? Bankers and lawyers say the corporate debt market is the frothiest they have seen since 2007, Oliver Shah points out in The Sunday Times. The most obvious sign of irrational exuberance is the resurgence of “covenant lite” or “cov-lite” loans. This kind of debt, which offers little or no protection to lenders if the loans go sour, boomed in the years leading up to the financial crisis, “with the inevitable outcome”. They then went out of fashion but are now “back with a vengeance”. In the US, cov-lite loans account for a record 75% of the $790bn in outstanding leveraged loans. In Europe, cov-lite leveraged loans doubled in value last year.

Private equity is another area gathering steam rapidly. Funds have been raising money at the fastest rate in more than a decade, says Javier Espinoza in the FT. This includes those that invest in infrastructure and real estate. “Buyout executives are rushing to tap” demand from investors “just as fears grow of a market correction”.

The average time taken for a private-equity fund to raise the money it wants has halved to one year since 2010. This is the fastest pace in over ten years. “None of this necessarily means we are on the brink of Armageddon,” says Shah. But this froth in debt and stockmarkets is at odds with the “drab economic backdrop” and political uncertainty. The disparity has been clear for some time, but “investors and traders have seemed happy to party on”. When it all comes to an end once again, things are bound to be messy