By LANDON THOMAS Jr. FEB. 19, 2014 New York Times.
Prospecting for oil in Brazil, manufacturing steel in Russia, erecting skyscrapers in China: Global bond investors have financed some of the grandest investment projects taken on by emerging economies in recent years.
But as growth falters in a number of developing nations, economists and regulators have become increasingly worried about the consequences of this borrowing frenzy and the risk that the mutual funds and hedge funds that have largely replaced more stable commercial banks as global financiers might all decide to rush for exits at the same time.
“It’s fair to say that the market got a little overexuberant,” said Scott A. Mather, the head of global portfolio management at the mutual fund giant Pimco. “Many years of private sector credit growth have created serious vulnerabilities.”
Analysts point out that compared to the Asian financial crisis in 1997, the borrowing binge this time is being funded largely by global bond investors and includes companies outside Asia as well. Unlike two decades ago, governments of developing countries have built up substantial foreign exchange reserves and are better able to weather any crisis. Still, fears remain that any panicky selling of Chinese, Russian or Brazilian bonds could turn into a financial rout. And over a longer stretch, the broader question is the potential effect from a closing of the once-welcoming global bond market to borrowers in regions of the world that have been driving growth in recent years.
The underlying problem, Mr. Mather said, is that bond investors with little or no experience in emerging markets piled in to pursue higher yields than they could get from safer government securities in the United States and elsewhere, snapping up the bond issues of companies with even riskier credit profiles.
The stampede has led to a so-called mirage of liquidity in which many investors may have been misled into thinking that selling the securities will be as easy as buying them was.
“The liquidity is much worse now than before the crisis,” Mr. Mather said.
Bonds Over Banks
In the five years since the Federal Reserve began taking extraordinary measures to stimulate the U.S. economy, emerging markets have relied more on global bond markets than banks to help finance their growth.
External debt of emerging market countries
IN THE 5 YEARS BEFORE QUANTITATIVE EASING (Sept. 30 ’03 – Sept. 30 ’08) Bank lending $1,097 Billion Bond issuance = $432 billion Total: $1,530
IN THE 5 YEARS AFTER QUANTITATIVE EASING (Sept. 30 ’08 – Sept. 30 ’13)
Bank lending $855 Billion Bond issuance = $1,0e2 billion Total: $1,898
its aggressive bond buying program, driving interest rates in the United States to lows not seen in decades, high-yielding international bonds issued by nongovernment emerging market borrowers have doubled.
Total bonds outstanding are now at a record high of $2 trillion, according to a new report by Merrill Lynch that warns of the consequences of this explosion in emerging market debt and the shift away from traditional bank loans.
Bond market veterans like Petrobras, the Brazilian energy concern that has issued close to $30 billion worth of foreign currency bonds in the last four years, are still leading the parade.
Petrobras is an investment-grade issuer; it issues bonds at relatively low interest rates because its oil and gas projects are considered to be ultrasecure.
But more worrisome are the high-yield or junk bonds, issued by, among others, steel companies in Russia and property developers in China. One particularly popular borrower has been Country Garden, a Chinese developer that has issued $4.2 billion in bonds since late 2009.
Most recently, in the autumn, the company raised $750 million by issuing seven-year bonds at an interest rate of 7.5 percent; the deal was so popular, bankers say, that it was oversubscribed by $18 billion. Like other risky bonds, Country Garden securities sold off aggressively in recent weeks, with the yield hitting 8.4 percent before regaining some strength in recent days.
As growth disappoints and profits suffer, some of these borrowers are defaulting on their debts. Among the largest defaults was the implosion of OGX, a Brazilian energy conglomerate that went bust recently; others include Mexican home builders and Kazakh banks.
“I think this is definitely coloring the expectations of investors,” said Richard Segal, an emerging market bond analyst at Jefferies in London.
Of late, the issue has received a public airing in Washington, after the Office of Financial Research, a newly created analytical body within the Treasury Department, came out with a report drawing attention to the lemminglike tendency of global asset managers to “crowd or herd into popular asset classes or securities regardless of the size or liquidity of those asset classes or securities.”
The report said that more than $1.5 trillion had flowed into bond funds in the last five years — far outpacing other segments like equities and money markets — and pointed out that large asset management entities such as Pimco, BlackRock, Capital Research and Fidelity had been the main beneficiaries of these inflows.
For a financial industry that already saw itself as over-regulated, the O.F.R. study came as a shock. The main trade group for asset managers, the Investment Company Institute, has aggressively contested the agency’s suggestion that too much exposure to risky emerging market bonds by American fund managers poses a broader financial risk.
By contrast, the agency’s decision to highlight this risk factor has drawn the support of several influential economists, including Hyun Song Shin, a financial economist at Princeton and the incoming head of research at the Bank for International Settlements, the idea factory based in Basel, Switzerland, catering to global central banks.
In a recent paper, Mr. Shin warned of the risks that prevail when bond investors, who traditionally have a shorter-term approach than commercial lenders, pile into and out of the same markets at the same time.
“We have never seen anything like this before,” he said. “It is unprecedented, and it is dangerous.”
Mr. Shin also worries that regulators, in pushing hard for big banks to increase their cash reserves, are missing the more critical issue: Aggressive borrowers in some of the larger emerging markets have been relying on fickle bond investors to fund their investments. And those investors are becoming nervous about their exposure to these economies, threatening to choke off the funding pipeline.
“It may not be an acute crisis,” Mr. Shin said. “But it will be slow and simmering and the impact on global growth will be damaging.”