The Imminent High-Yield Debt Catastrophe

High-yield debt investments, which are often called junk bonds, are investments that typically have lower credit ratings and higher risks, but many investors choose these vehicles to receive higher yields when traditional stocks and investments are only generating modest returns. China’s economic problems and heavy investments in high-yield debt have exacerbated the problems of investors tying up too much money in one kind of investment — especially one as risky as junk bonds. A report posted on money.usnews.com places the blame for this trend on the Federal Reserve Bank because “investors have been forced by the Federal Reserve’s policy to take on more risk to obtain yield on their investments.” Before 2008, for example, investors could earn 5 to 6 percent interest on CDs, but yields have since dropped to almost nothing due to record-low interest rates.

Junk Bonds Could Generate Catastrophic Consequences that Mirror the Mortgage Meltdown

Regardless of investment type, there are always winners and losers, but catastrophic changes invariably hit low-income families the hardest because they have fewer resources and almost no resource diversification. Investors are currently selling off their junk bonds at discounted rates, which further depresses bond prices in a vicious cycle. According to fortune.com, “collateralized loan obligations (CLOs) have fallen 50% (at) the end mid-December (2015) since mid-year, and are now trading at $0.25 for every dollar.” Market losses like this could cause another crisis similar to the 2008 banking and real estate collapse.

How High Is Too High, and How Low Is Too Low?

Unfortunately, the world’s marketplaces are extremely volatile and often generate catastrophic results for investors even if they’re cautious. Almost any paper investment can be completely lost due to market turmoil, stock crashes and manipulation by governments and economic powerhouses that are “too big to fail.” Everything in economics is fueled by many factors such as supply and demand, market conditions, inflation rates and other key performance indicators. Any business or investment can fail, and any individual or business could need ready cash to survive during the downturn. That’s why capping interest rates for the payday lending industry is so disingenuous and dangerous. During catastrophes — which are often engineered by investor excesses and financial malfeasance by big banks — people can take some comfort in the ability to get cash to tide them over during economic upheavals. Choosing how people spend their money and with whom they can do business challenges the basic principles of free enterprise under which most of the world operates.

Natural disasters, stock market crashes, banking crises and failures of major business organizations and governments can change how people perceive inflation and interest rates. What seems high or low today could be normal tomorrow. The same holds true for what people think about political leaders, traditional lenders, Wall Street operations and the banking industry. It would be unfair to target any of these groups based on their legal business practices, how they operate within the free enterprise system or the shortcomings of a few aberrant criminals, and it’s equally unfair to paint the payday industry with similarly broad brush strokes.

Payday lenders charge higher interest rates because their advance loans cover only short periods of a week or two instead of years of interest charges that mortgages, auto financing and credit cards generate for banks and their investors. Payday lenders also provide a necessary service to a broad coalition of demographic types including people who have poor credit scores or no credit history, and they have a fiduciary responsibility to generate profits for their investors. Approving riskier loans means defaults are more likely to occur, but that’s just part of the cost of doing business. Payday lenders should be allowed to charge what they need to make a profit or even charge more if they feel the market would support these rates. People always have the choice to do business or not, and payday lenders shouldn’t draw targeted attacks on their businesses when they’re dealing with the same regulations and laws of supply and demand that affect mainstream lenders in the traditional “financial establishment.”

Free enterprise is only free if it’s administered fairly and not subject to special regulations every time some group doesn’t like the way that targeted companies conduct their businesses. It’s not just payday lenders that can cause financial difficulties for their customers if they get too far in debt — the same applies to any lender or customer. Some financial practices, such as high-yield debt speculation or mortgage lending to unqualified borrowers can create explosive situations that affect everyone and not just the customers. If you want to know more about the high-yield debt catastrophe, visit us at http://personalmoneystore.com/ where thoughtful articles explore economic issues and how these subjects relate to payday lending.

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