News Release: Subprime Corporate Debt, Hitting $5 Trillion, Brings Defaults, Slower Growth


January 10, 2022

Carter Dougherty
(202) 251-6700

Subprime Corporate Debt, Hitting $5 Trillion, Brings Defaults, Slower Growth
Leveraged Lending Market Demands Policy Solutions

The explosion of low-quality lending has brought debt loads in corporate America to record highs, a development that is likely to bring, in the coming years, a wave of defaults, slower growth, future job losses, and potential instability stemming from the utter opacity of this business, according to a new paper from Americans for Financial Reform Education Fund.

“The U.S. economy is slowing and may even fall into recession as the Federal Reserve raises interest rates to contain inflation,” said Andrew Park, senior policy analyst at Americans for Financial Reform Education Fund. “Amid a combination of higher rates and a weaker economy, companies saddled with debt from frothier times will find the going tougher than it ever needed to be due to abuses in this sector. We need to get ahead of the problem by revamping our outdated rules and laws governing this type of debt and the funds that often issue it.”

The full paper, entitled “A Giant in the Shadows: Subprime Corporate Debt,” can be downloaded here. An executive summary is here.

Subprime corporate debt, often the product of questionable accounting, is a $5 trillion category that includes a variety of instruments Wall Street has created to raise money, seldom goes toward productive uses, such as investment in new facilities, research and development, or training workers. Instead, this debt  is often used to finance private equity buyouts – a major driver of this problem – facilitate corporate consolidation, refinance existing debt, or suck cash out of companies.

Subprime corporate debt was once a niche corner of the financial markets. This category includes leveraged loans, high yield “junk” bonds, leveraged loans packaged into collateralized loan obligations (CLOs), and loans directly extended by non-banks to companies without a regulated intermediary (“direct lending” or “private credit”).

The paper discusses how:

  • Only 3% of the $4 trillion in leveraged loans issued between 2014 and 2019 were used towards further investments by the company while the vast majority was being used to refinance existing debt (but not pay it down), acquire other companies, or pay dividends
  • Subprime corporate lending relies heavily on earnings measures that are not considered Generally Accepted Accounting Principles (GAAP) by the Financial Accounting Standards Board (FASB) and when ignoring many of the gimmicky artificial boosts to earnings, corporate indebtedness is at record highs, even higher than before the 2008 global financial crisis.
  • Insurance companies seeking higher returns, due to both a decade of low interest rates and rising claims from climate-related events, now face some of the greatest risks from losses in subprime corporate credit

“This long-running perversion of finance allows private equity firms to profit even as they render the companies they control less competitive due to the burden of crippling debt,” Park said. “The contrast is striking. Private equity barons get richer at the expense of the economy that gets fewer jobs, less investment for the future, and lower wages as companies prioritize paying down debt, not growth.”

Despite the exponential growth in subprime corporate debt, our laws and regulations have not kept up, leaving policymakers and regulators in the dark as to the exact size of this market and where various risks may exist that could affect other financial institutions, companies, and their workers.

Policy recommendations in the paper include:

  • The Department of Treasury should use all of its available tools to address financial stability such as designating important non-banks as systemically important financial institutions (SIFIs) and bringing them under direct supervision by the Federal Reserve Board of Governors.
  • The Securities and Exchange Commission should propose and finalize several rules that would provide the SEC and other agencies with far more information than the little that is currently available today and allowing the agencies to use this information for further action.
  • Regulators should amend several outdated rules that allow large corporate borrowers to operate in secrecy, allow the most active buyers to pay much lower capital charges when buying subprime corporate debt in securitized form, and finalize new rules that would improve the current shoddy lending practices to subprime corporate borrowers.
  • Congress should pass new laws and amend older outdated ones that have allowed non-banks to escape much needed regulatory oversight and operate unfairly.