This Time Is Different, but It Will End the Same Way: Unrecognized Secular Changes in the Bond Market since the 2008 Crisis That May Precipitate the Next Crisis

Abstract

The US bond market had over $42.39 trillion of outstanding debt at the end of the third quarter of 2018, eclipsing the US stock market’s approximately $30 trillion in market capitalization. The sheer size of the bond market provides ample opportunities, as well as risks, for institutional investors. Some of these risks escape investors’ radar because of the nature of fixed income securities: low transparency, illiquidity, and over-the-counter (OTC) trading. In this article, the authors present our concerns regarding five secular changes wrought by the over-regulation of the marketplace after the financial crisis of 2008 and investors’ persistent thirst for yield. Further, although painful lessons were gleaned after the punishing 2008 financial crisis, the authors present empirical evidence that suggests that many sectors, such as auto loans and collateralized loan obligations, that were largely unscathed by this crisis may be at risk in the next downturn. This article is based on original data sources and academic research. The authors are in continuing dialogue with other experts that may further the research, and welcome interested parties to get in contact. TOPICS: Financial crises and financial market history, statistical methods Key Findings • Lack of market-making and other regulatory changes that will impede price discovery in the next downturn. • Masking of the deterioration of underlying collateral and rearview mirror analysis. • New versions of the old games played by the rating agencies. • Explosion in number of Asset-Liability mismatched structures. • Regulatory changes in compliance of financial institutions.