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The $3 Trillion Traffic Jam: "It's About Time We Started Worrying About The Next Financial Crisis"

"It’s about time we start getting worried about possibly the next [financial crisis]," warns BlueMountain's James Staley explaining that, "the lack of liquidity that currently exists today, is something that people on the buy side, sell side and regulatory side need to be focused on." In an effort to quantify just how big that 'issue' is, Bloomberg reports that the U.S. corporate-bond market has ballooned by $3.7 trillion during the past decade, yet, as Citi's Stephen Antczak warns, almost all of that growth is concentrated in the hands of three types of buyers, "we used to have 23 types of investors in the market. Now we have three. In my mind, that’s the key driver."

 

As Bloomberg reports, for all the concern that Wall Street’s shrinking balance sheets will fuel a liquidity crisis when investors flee credit markets, Citigroup Inc. strategist Stephen Antczak says investors may be overlooking an even bigger catalyst.

Almost all of the $3.7 trillion growth is concentrated in the hands of three types of buyers: mutual funds, foreign investors and insurance companies, according to Citigroup. That combination could lead to more selling than the market can absorb when the Federal Reserve raises interest rates for the first time since 2006, Antczak said.

 

 

“All the money is going to the same place, and when something adversely impacts one, chances are the same factor adversely impacts everyone else, and there’s nobody there to take the other side,” Antczak said in a telephone interview. “We used to have 23 types of investors in the market. Now we have three. In my mind, that’s the key driver.”

 

The three investor groups hold almost two-thirds of total corporate debt, Citigroup data show.

Adding to the worries, as we have discussed in detail previously, dealer inventories of corporate bonds plunged more than 76 percent in the years after the financial crisis as tougher banking regulations made it more expensive for them to hold risky assets.

“The low levels of dealer balance sheets suggest that dealers will not be willing to make purchases to offset the selling flows,” Jim Caron, a money manager at Morgan Stanley Investment Management, which oversees $406 billion, said in an e-mail. He called liquidity a “known unknown risk” for bond markets.

 

The world’s biggest money managers, including Pacific Investment Management Co., BlackRock Inc. and Vanguard Group Inc., have been discussing the issue as part of a Securities Industry & Financial Markets Association group. Last month, they asked the U.S. Securities and Exchange Commission to form an advisory committee to focus on liquidity -- the ability to buy and sell easily without greatly affecting the price of a security.

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“The size of that corporate bond market, with the lack of liquidity that currently exists today, is something that people on the buy side, sell side and regulatory side need to be focused on,” James E. Staley, a managing partner at the $21 billion investment firm BlueMountain Capital Management, said last week at a conference in New York. “If financial crises tend to happen every seven years, it’s about time we start getting worried about possibly the next one.”