Bond Bubble Watch: Investors Pile Into Junk

bubble 5 Bond Bubble Watch: Investors Pile Into JunkGuess what’s all the rage? Junk bonds, according to The Wall Street Journal. As prices on U.S. Treasury securities and high-grade corporate debt remain inflated, investors are venturing into riskier waters, buying up riskier bonds with fewer protections — all in the name of higher returns.

The Journal says that last week, junk-bond prices hit their highest prices since 2007, and 2010 is already a record year for junk-bond sales. Companies have issued $172 billion in risky debt.

There are some compelling reasons investors are looking at junk. Defaults are down significantly from a year ago, according to Moody’s, and the ratings agency expects the rate to fall even further through the end of the year. Also, even though the price of high-grade bonds has lately slipped, investors still hardly get anything back when they lend to safer borrowers. But The Journal also raises something of a red flag:

The demand for bonds has allowed some of the riskiest borrowers to sell bonds with fewer protections for investors. These provisions, or covenants, prevent companies from taking actions that would hurt bondholders and would protect investors if companies are sold.

Nothing like lending money to a company that’s more likely to default without a contractual safety net! The last time we saw this kind of investor behavior was in the runup to 2008, the year the financial markets were brought to their knees.