As the possibility of a recession seems more likely than ever, various economic experts have warned that there’s a ticking time bomb in the U.S. economy that many have overlooked.
One industry expert went on to warn that levels of corporate debt are at such high levels that the resulting implosion could hit the economy harder than even the subprime mortgage crisis in 2008.
In an exclusive interview with MarketWatch, former head of the Federal Deposit Insurance Corporation Sheila Bair went on to say that she is seeing a number of similarities between the current levels of corporate debt and the subprime mortgage crisis over a decade ago.
The FDIC was one of the main policy makers which oversaw the collapsing investment banks after the 2008 financial crisis, and Bair’s familiarity with how the situation unfolded at the time – alongside her warnings of the current economic situation – has led investors to become more worried about the future.
“I do think that we are going to see distress in the corporate market, which can have a very strong and significant impact on the real economy,” she told MarketWatch in an interview. “With subprime, at least you had a bit of a flow-through. It took a while. There was a market shock. But in terms of the real economic impact, it was more gradual.”
However, she went on to add that Wall Street is operating on the sense that the main banks will be insulated from a potential collapse in the corporate sector.
This, she argues, is a risky assumption to make and reminds her of the kind of assumptions made back in 2007/2008 when everyone thought real estate prices could never collapse. “The parallels to the subprime crisis, are pretty striking, except you are dealing with corporate borrowers instead of households. There seems to be a lot of hand-wringing about this. But nobody is really doing anything.”
Bair also warned that the big banks don’t have enough capital to expand their balance sheets and instead were pulling in credit lines because they were over-leveraged. She warned that regulators would do well to ramp-up their stress-test assumptions should a corporate debt crisis unfold.
This flies in the face of what the Federal Reserve said last week, where they said that the nation’s largest banks had enough capital on hand to withstand even the most severe recession predictions as part of its annual “stress-test” of large lenders.
According to the central bank, the top 18 U.S. big banks could absorb a cumulative total of $410 billion in losses should a global recession occur and the U.S. unemployment jump by more than six percent.
Either way, most investors are looking at this development as another reason to be fearful for the future. With multiple signs of an economic recession looming on the horizon, whether it be weakening industrial commodity prices, poor manufacturing data from China, or even the fact that the U.S. has avoided a recession for over a decade, investors are beginning to flock to traditional sources of safety, such as gold.
While it’s uncertain when exactly this downturn will happen and how severe, soft, or long-lasting it will be, most people are expecting 2020 to be the year when things turn sour.