Trump’s policies may be fracturing the bubble in private credit, junk bonds

(Originally published Oct. 10 in “What in the World“) Trump’s policies may not be killing the AI economy. But the real economy?

Companies dealing in real stuff, like auto parts, are suffering big-time because of Trump’s tariffs and immigration policies. A growing list of parts companies is going bust: auto-part supplier First Brands Group is getting lots of headlines for its September bankruptcy, but before it came another car-parts company, Marelli, in June and auto-loan company Tricolor earlier in September.

While lower rates and tax breaks may help well-run companies weather the impact of higher import taxes and lower availability of cheap immigrant labor, others are succumbing to another big problem in the economy—the explosion in recent years of private and off-balance-sheet credit.

The trend is reflected in a recent boom for bonds sold by the riskiest companies—you may remember them as junk bonds. Expectations that the Federal Reserve will cut interest rates have prompted a stampede of investors to buy junk bonds in search of plumper yields as everyone’s borrowing costs go down. The result is that borrowing has been getting cheaper for the riskiest borrowers. The spread between yields on junk bonds and investment-grade corporate bonds has narrowed to almost the lowest since the record low reached in 2007.

Falling borrowing costs would, for most borrowers, help alleviate their funding concerns and make them less risky. But these aren’t normal times. While Trump’s policies have successfully weakened the job market, bolstering the case for the Fed to give in to his demands for lower rates, his unpredictable tariffs and deportations have exacerbated inflation, making it tougher for the Fed to cut. His policies are also pinching companies that depend on either cheap imports of goods or labor, making them the earliest victims of his toxic combination of policy caprice.

Is this a healthy washout or an omen? Time, obviously, will tell, but there are concerns that the boom in corporate credit has created some of the dangerous structural problems that made the mortgage boom so devastating before 2007 and 2008, when its bust triggered the global financial crisis. First and foremost: credit fraud. Tricolor was lending to car buyers without a credit history, which made it the automotive equivalent to a subprime mortgage lender. But worse, it was accused of fraud by one of the banks securitizing its car loans, Fifth Third Bank. If the assets backing the securities underpinning the boom in corporate credit aren’t as valuable as they were supposed to be, the entire market could be on shaky ground.

But the boom in junk bonds and asset-backed securities underpinned by corporate assets is only the tip of the iceberg. As mentioned earlier, there’s been a parallel boom in private credit—loans made not by banks, but directly by big funds to companies, other investors, and even individuals. And default rates by these private borrowers have been on the rise.

This is the sort of situation the International Monetary Fund has been warning about for years now. After tightening up on the riskiest lending by banks after the GFC, the biggest investment funds sought to make up the lost profit by making those risky investments themselves.

Corporate credit isn’t the only neighborhood where investors may be exposed to excessive leverage. Regular readers may recall that, back in April, the markets tariff tantrums exposed massive leverage among hedge funds in the market for U.S. Treasury bonds. Sudden volatility in Treasuries threatened to force the hedge funds to rapidly unwind billions in trades, threatening market contagion. The concern is that rising defaults, or allegations of fraud, could spark a similarly rapid and devastating unwinding of securitized corporate debt.