Stocks Continue to Climb, but Mortgage Markets Look Dire

Chris Gaetano
Published Date:
Mar 30, 2020
Stocks continued to mount strong gains on Monday for the fourth day in a row, on news of upcoming stimulus measures and progress on COVID-19 tests, according to Bloomberg. The S&P 500 gained 2.7 percent, putting it 17 points ahead of where it was last week, while the Dow gained 2.4 percent and the Nasdaq gained 4 percent.

At the same time, trouble seems to be brewing in the mortgage market despite, or even because, of recent actions taken by the Federal Reserve, according to CNBC. The central bank, as part of a suite of recent emergency actions, pledged to begin buying hundreds of billions of dollars worth of mortgage-backed securities. This was meant to drive down interest rates, and it did, but now the mortgage industry is saying this has had the effect of driving tens of millions of dollars worth of margin calls, which happens when the value of an investor's margin account (the one containing securities bought with borrowed money) falls below the broker's required amount, prompting demand from the broker that the investor deposit additional funds to bring the account back up to minimum value.

These calls, said CNBC, are threatening to drive mortgage bankers out of business. The Fed, in response to this industry outcry, cut the number of mortgages it bought on Friday by about $10 billion, and will likely continue reducing purchases in the future. In the meanwhile, industry groups are urging the SEC to discourage broker-dealers from making margin calls in response to rate cuts, or at least limiting them to sums of over $250,000.

The corporate debt market, meanwhile, made a tentative step toward at least some improvement, with news of the first junk bond issue in weeks, according to MarketWatch. Junk bonds, the colloquial term for high-yield debt, are issued by companies considered significant credit risks compared to other firms and are generally considered the lowest of the low in terms of safety save for distressed debt. 

Bloomberg noted that junk bond sales have been effectively frozen since March, as investors looked askance at the issuers behind them, but the latest offering from Yum Brands, the firm behind chains like Taco Bell and KFC, appears to have been very popular among investors, who appear unperturbed by the credit risk. This is reflective of a wider demand for credit, as corporate bonds sales of all sorts have skyrocketed since the Fed's actions. While once only the bluest of blue chips were issuing bonds people wanted to buy, demand has now spread into riskier firms as well. Last week, U.S. companies broke records by taking on $109 billion worth of new debt.

The global economy has been fueled by trillions of dollars in cheap debt since the financial crisis. With interest rates kept to near-zero rates the world over, companies big and small gorged themselves on debt that was practically free. This eventually reached a point where it was estimated by the Swiss Bank of International Settlements that roughly 12 percent of all public companies on Earth could no longer live without constant injections of new credit as companies could simply borrow their way out of situations that would have otherwise killed them. The IMF warned last fall that this has become so common that "in a material economic slowdown scenario, half as severe as the global financial crisis," the amount of debt-at-risk (defined as debt owed by companies whose earnings are insufficient to cover interest payments) would amount to $19 trillion, or roughly 40 percent of all global corporate debt.

The Federal Reserve's actions were meant to prevent this exact scenario from happening. The global pandemic wrecked havoc on debt markets, which sharply increased the cost of borrowing, which was bad news for companies in general but especially for those companies that literally could not live without near-free debt. By pumping money into the corporate bond market, the Fed hopes to lower borrowing costs for the business sector. The Financial Times, though, said this has yet to happen, as the record bond issuances last week were done amid higher than normal costs, indicating that even reliable companies are searching for cash.

Outside corporate debt, sovereign debt has been showing worrisome signs, according to the Wall Street Journal. The number of nations whose debt is trading at distressed levels (the point at which there is doubt they will be able to fulfill their bond obligations) has grown from four at the start of the year to, now, 18. This heightens the risk of a wave of sovereign debt defaults, primarily in emerging markets. For an example of what a sovereign debt crisis in one country looks like, one might turn to Greece or, earlier than that, Argentina. For what a wave of defaults might look like, one might wish to consider the Latin American Debt Crisis of the 1980s which saw several countries in the region declare they were unable to service their foreign debts.

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