Are Rating Agencies Complicit in the Creation of the Corporate Debt Bubble?

Are Rating Agencies Complicit in the Creation of the Corporate Debt Bubble?

The corporate debt bubble that threatens to burst and take down the economy is an enormous but highly underrated problem. With corporate debt issuance over 50% higher than before the last financial crisis, corporations are in far worse financial shape than they were a decade ago. Yet despite that financial weakness, very few corporations thus far have been downgraded to junk status. They continue to cling to their BBB credit ratings, despite falling revenues and rising debt. When the dust finally settles, will we find that rating agencies were complicit in the creation of this bubble?

One aspect of the housing bubble and financial crisis that became apparent only after the fact was the role that rating agencies played in helping to allow it to grow as big as it did. Mortgage-backed securities that were made up of mortgages issued to subprime borrowers were sliced, diced, and packaged into securities sold to investors and rated AAA. Anyone who did any due diligence realized those ratings were a joke, as the quality of the debt underlying those securities was poor.

When the bubble finally burst, rating agencies came in for a lot of grief for rating those securities as AAA, with investors having trusted those ratings as they gobbled up those overrated securities like there was no tomorrow. There was widespread speculation that rating agencies were being paid to lavish those high ratings on subprime securities, and the resulting scandal drastically diminished trust in credit rating agencies.

But here we are again in a similar situation. Are credit rating agencies rating corporate debt today higher than it really should be? And is that exacerbating the growth of a corporate debt bubble that continues to grow and grow?

When all is said and done and the corporate debt bubble finally bursts, we may very well find out that much of the corporate debt issued in recent years shouldn’t have been rated as high as it was. Investors will feel deceived, although it isn’t as though they couldn’t do their own due diligence.

We’ve been through a lot of this before, and anyone who continues to invest in corporate debt is playing with fire. As the financial crisis demonstrated, is is far better to invest in gold and benefit from the safety that gold offers than to continue pouring good money into questionable and likely overrated financial assets.

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