It was 10 years ago in September 2008 that the worst of the financial panic crashed through the US economy. Where might the next financial crash be lurking? In a speech last week, Federal Reserve Governor Lael Brainard pointed to some possible candidates. She said:

“The past few times unemployment fell to levels as low as those projected over the next year, signs of overheating showed up in financial-sector imbalances rather than in accelerating inflation. The Federal Reserve’s assessment suggests that financial vulnerabilities are building, which might be expected after a long period of economic expansion and very low interest rates. Rising risks are notable in the corporate sector, where low spreads and loosening credit terms are mirrored by rising indebtedness among corporations that could be vulnerable to downgrades in the event of unexpected adverse developments. Leveraged lending is again on the rise; spreads on leveraged loans and the securitized products backed by those loans are low, and the Board’s Senior Loan Officer Opinion Survey on Bank Lending Practices suggests that underwriting standards for leveraged loans may be declining to levels not seen since 2005”

A few points are worth emphasizing here. As Brainard is pointing out, the last couple of decades suggest that the primary risk of recession in the US economy is not likely to arise from a jolt of inflation. Instead, the last two recessions were associated with financial market stress: the end of the dot-com boom in 2001, and the end of the housing price boom in 2008-2009.

Since the Great Recession, a number of steps have been taken to assure that banks are safer and more resilient (higher capital requirements, stress testing, and the like). But the US financial system is a lot bigger than just the banks, and financial troubles can come from a number of directions. What about the two risks that Brainard specifically mentions: corporate debt and leveraged loans?

The financial press has a number of recent articles on the risk that a corporate debt bubble is happening: for example, here’s a take from Jesse Colombo in Forbes
 (August 29) or here is  Steven Pearlstein in the Washington Post on June 8:

“Now, 12 years later, it’s happening again. This time, however, it’s not households using cheap debt to take cash out of their overvalued homes. Rather, it is giant corporations using cheap debt — and a one-time tax windfall — to take cash from their balance sheets and send it to shareholders in the form of increased dividends and, in particular, stock buybacks. As before, the cash-outs are helping to drive debt — corporate debt — to record levels. As before, they are adding a short-term sugar high to an already booming economy. And once again, they are diverting capital from productive long-term investment to further inflate a financial bubble — this one in corporate stocks and bonds — that, when it bursts, will send the economy into another recession”.