Loan behold: a global-economy danger

Hey, Ryan Reynolds here for Mint Mobile. You know, one of the perks about having four kids that you know about is actually getting a direct line to the big man up north. And this year he wants you to know the best gift that you can give someone is the gift of Mint Mobile's unlimited wireless for $15 a month. Now, you don't even need to wrap it. Give it a try@mintmobile.com Switch upfront payment of $45 for a three month plan equivalent to $15 per month. Required new customer offer for first three months only. Speed slow after 35 gigabytes. If network's busy, taxes and fees extra. See mintmobile.com. Hello and welcome to the Intelligence on Economist Radio. I'm your host, Jason Palmer. Every weekday we provide a fresh perspective on the events shaping your world. Methamphetamines have become the biggest class of drugs in East Asia. Consumption has doubled since 2013. New markets have been created as refugees were forced to smuggle drugs across borders. And it appears local militias and armed forces are in on the action. And there's a presidential election coming up in Slovakia this weekend. Two months ago, Zuzana Kaputova, one of the candidates, was polling in the single digits. Now the woman known as the Slovakian Erin Brockovic looks set to win the race. First up, though, 12 years ago, the global economy was shaken to its core, thanks in large part to widespread investment in bad mortgage debt. Now the world's back on an even keel. There are hints of a different dangerous trend. My colleague John Pruddo goes looking for what worries economists these days.

The global financial crisis of 2007 and 2008 was the most significant financial and economic upheaval since the depression of the 1930s.

Mayhem, carnage, a bloodbath, call it what you want, but what we saw on global stock markets today was ill disguised panic.

It took almost everyone in the financial world by surprise. Since then, economists, traders and fund managers have watched warily, waiting for signs of the next crisis. Now concerns are growing about corporate debt. The amount of debt owned by American companies runs into the trillions of dollars. That's not necessarily a problem. But a sizable chunk of that debt is owned by companies that are considered to be bad credit risks. Among those to sound a note of caution is Jerome Powell, the chairman of the Federal Reserve.

We've called out corporate debt as a risk.

It's a concern. It's something that we're watching, of course.

Last week, the yield on 10 year treasury bonds fell below that on three month bonds. For the first time since 2007, this so called inverted yield curve has added to some analysts fears of a coming recession Were one to hit, it could further expose that risky corporate debt. The American economy was strong in 2018. Unemployment was very low and businesses made bumper profits. But the economy also looked strong before the crisis in 2007. The trigger then was the collapse of the subprime mortgage market when it turned out that bank banks had been making loans to people who would never be able to repay them.

Lehman Brothers is America's fourth largest investment.

Bank, but with losses totalling billions of dollars.

Tonight, it's close to collapse. Another victim of the meltdown in America's subprime mortgage market.

For some, the similarities between then and now are uncomfortable.

In America, there's about $15 trillion of business non financial debt.

Henry Kerr is our economics editor.

So you take out banks, you take out insurance companies who are sort of in a different category, and you're left with about $15 trillion. And some people are worried because that's at a record high relative to the economy. It's grown a lot since 2012. And the contrast with household debt is quite striking because since the financial crisis after 2007, households which were very indebted then, have been paying down their debts relative to their income. But since about 2012, businesses have been growing theirs. And so there's a question about whether or not it's gone too far, whether or not the fact that corporate debts at a record high relative to the economy is something to be concerned about and whether or not that could leave businesses exposed if economic conditions change.

Just to narrow this concern down a bit, Henry, is it a general concern about corporate debt issuance in America that the growth has been really fast, or are you worried about concentration in a smaller number of fragile companies?

So we looked at this question at the Economist. We crunched the numbers and found that while the averages didn't look too scary, that There is about $1 trillion of corporate debt that's owned by companies which look a bit weak. They've got high debts relative to their income and their capacity to service their debts. That's to pay the interest on their debts. Their doesn't look as strong as it might now that 1 trillion isn't a lot relative to the economy. But the reason why that's an interesting number is in the same sort of ballpark as the subprime mortgage debts you mentioned a moment ago, the housing debts that did cause so much economic damage a decade ago. So then there's a question of what is the Knock on effect that roughly a trillion dollars worth of debt in fragile companies could have.

And what's the answer to that?

Well, then we get into the issue of how that debt is financed and how it fits into the plumbing of the financial system. The reason that subprime debts were so bad for the world a decade ago was because they brought down the banks and caused this huge credit crunch. The part of the corporate debt market that people are most worried about, and in particular that this is attracting the attention of regulators. You've had Jerome Powell, the chairman of the Fed, comment on it. You've had the bank of England put out a report and the IMF's issued a warning, and this is over. The market for so called leveraged loans, which are loans issued typically by a group of banks, two companies, which could be public or private, and they're typically used to finance takeovers. And the leverage in this part of the market has been going up. What's particularly concerned regulators is how these debts are financed resembles in some ways how the subprime mortgage debts were financed a decade ago. And some of the financial plumbing there looks a bit similar.

They're chopped up and parceled out to investors who may not necessarily understand what they're getting themselves into.

Exactly. So listeners who remember their history of the financial crisis remember a lot of concern about instruments such as collateralized debt obligations, which pooled together lots of mortgages into securities that were complex and poorly understood, that were supposed to be safe, but then went bad. And so at first glance, this area of the corporate debt market looks a bit similar because there's these things called collateralized loan obligations which pull together lots of loans to create securities that are meant to be safer than the loans them. So you might think that it's analogous.

I have to say, listening to you and reading your work on this, I'm getting horrible flashbacks to 2008 when I was covering financial markets. Some of the language, the leveraged loans, collateralized loan obligations, covenant light loans, which are when you lend money and suspend some of the normal conditions you'd attach those loans. Those were all that was the vocabulary of 2008. So I'm feeling a bit freaked out here.

Well, the reason not to be alarmed is that on a closer inspection, say the collateralized loan obligations don't look all that similar to what went before them with regard to housing. So let's take on a few aspects of them. They pull together fewer loans. You've got 100 to 250 loans in a CLO, typically compared to the Mortgage securities, which pull together thousands. The companies are somewhat easier to monitor than the finances of just a random homeowner in Nevada. But perhaps the overwhelming reason not to think that there's a direct comparison with the subprime crisis. The CLOs have been around a long time. They're a long standing asset class. They went through the financial crisis, and although leveraged loans experienced losses, I think of about 10% during the financial crisis, the securitization of the CLOs seemed to do its job in that the highest rated securities didn't bear any losses then. So they've got something of a track record. That said, what you said about Covenant Lite and also about some of the regulatory slippage does mean that it's something worth keeping an eye on. It's just that you shouldn't look at it and think, oh, it's exactly the same, therefore we should panic.

Henry, thanks for explaining that.

Thanks, John.

In a lawless swath of Southeast Asia covering parts of Myanmar, Laos and Thailand, people have grown poppies for centuries, turning them into opium and heroin. Now that's changing, as our correspondent Guy Scriven, who reports on the region, found out.

I went to Kukai, which is a town in the north of Myanmar's Shan State, and while I was there, I found this Chinese cemetery. Outside the cemetery kind of lurked handfuls of scary looking young men. And the reason they were in kind of such a state was that they were addicted to methamphetamines and the graveyard had become a place where they had started to kind of stash their drugs and weapons.

So in that part of the world, in northern Myanmar, methamphetamine is a widespread thing.

Well, meth has essentially become the biggest drug in the kind of East Asia and Pacific region. The last time that the UN Office on Drugs and Crime tallied up the kind of value of narcotics in this area was in 2013. And back then, heroin and methamphetamine markets were about the same size at US$15 billion.

Each.

But since then, everything has shifted towards methamphetamines. So Yaba, which is a kind of methamphetamine based pill, seizures of that across the region have doubled since 2013.

So why has this shift happened from heroin towards method?

There was a crackdown on kind of poppy cultivation around 2005, which meant many drug makers needed another way to earn their living. Investment in infrastructure has also helped too. I mean, when I went to visit Kut Kai, the roads around that area, or specifically around the town, were absurdly smooth. And incredibly wide. And you could see how if you wanted to traffic out a lot of lorry loads of methamphetamine and traffic in the precursor drugs that's used to make methamphetamines, these very smooth roads would certainly help that. On top of this, demand is thought to have risen. It's also a good time to do business. Much of Shan State is a kind of lawless conflict zone where militias used to fight each other and the army and kind of insurgency groups. Quite regularly. Since about 2010, there have been a series of peace fire agreements that's kind of reduced the fighting, making it easier to do business.

You mentioned that the lawlessness has reduced somewhat and there is these truces between armed groups and the army. Doesn't that make room for the army to intercede? If things are sort of calmer, why isn't the army putting a stop to this growth?

I mean, that's what you would hope really. But I mean, one thing is it's very hard to find out who exactly is controlling the trade. Because the kind of state of lawlessness, although it's less violent than it was, you know, a decade ago and there's less fighting, the state of lawlessness is still intact. And so it's kind of hard to work out who exactly is controlling the kind of methamphetamine trade. In order to kind of try and find out a bit more, I went to meet one of the militia groups.

We are Namco Gongka People Militia Force.

Their headquarters is this kind of modest looking two story building near cut.

We maintain the territory controlled by the BE info.

To get there you have to kind of pass through several checkpoints, all manned with heavily armed young men in camouflage kind of gear. This is the kind of militia group which has been active in the area for decades and now are kind of partially, you know, essentially on the side of the army. And when I spoke to them, I asked them about, you know, to what extent they participated in the drugs trade and they staunchly denied having anything to do with it.

And do you, do you believe them when they say they're not involved?

Well, essentially no. I mean, it's very unlikely that these groups have no idea what's going on. I mean, the most likely explanation is that in some way kind of militia groups and the army are involved in the drugs trade.

Guy, you've also been reporting in Bangladesh next to Myanmar because many Rohingya Muslim refugees from Myanmar have smuggled meth into Bangladesh as they fled. Does that mean that more people are taking meth there now?

Yes, it's a very rapidly growing market. I went to Dhaka, the capital, which is this kind of bustling city of 9 million people. And when I was there I spoke to, I went to a kind of downtown cafe to meet with a kind of former yabba addict. And they told me that the new route created by the exodus of people has created a huge supply of yabba in Bangladesh. There aren't any official figures that tell you how many people are taking yabba, but it's thought to be around 6 million people, which is about 4% of the population who take meth.

That seems like really worrying growth. A huge number of people affected by this. What can be done to counter things on the Bangladesh side of the border?

What is being done is something which looks very much like the war on drugs in the Philippines. Since last May, there's been a large number of kind of extrajudicial killings committed by police who target people who are kind of accused of taking or dealing drugs.

If extrajudicial killing isn't a good way out of this, is there anything that might be more humane, more effective?

Well, one interesting country to look at in this case is Thailand. Around 2003. They also had a war on drugs which involved huge numbers of kind of extrajudicial killings as well. They also kind of rounded up anybody they thought to be kind of involved in the drugs trade and chuck them in jail. And what they discovered after this was that they didn't manage to do anything to the kind of drugs market. They didn't affect demand for drugs in any way. So more recently Thailand have been looking into less brutal method, ways of trying to stem the drugs problem and they're looking into kind of harm reduction methods and ways in which they can start to think about kind of decriminalizing drugs.

Well, Guy, thank you very much for joining us.

My pleasure.

Slovakia is going to the polls on Saturday to elect a new president. The frontrunner rather suddenly is Zuzada Kaputova, an anti corruption candidate. Victoriseros Hodli me.

The interesting thing about her is basically that she has no formal political experience whatsoever.

Tom Nuttall is the Economist's Berlin bureau chief. He's been avidly following the race.

She is a 45 year old lawyer. She made her name campaigning against an illegal rubbish dump. She's sometimes been nicknamed the Slovak Erin Brockovich and she's about to be elected president of Slovakia.

Tom, the countries in that part of Europe, the Visegrad countries, have nationalist presidents. More from the sort of Steve Bannon school of politics than the Vaclav Havel school. What makes Slovakia different?

Slovakia is an interesting case in the Visegrad context, because Slovakia, unlike any of the other three Visegrad countries, is a member of the eurozone. And even Robert Fico, who was the prime minister who was forced to resign last year, had to acknowledge that was in the national interests of Slovakia to remain at the core of Europe.

Just take us back a bit and explain why the prime minister was forced to resign.

Yeah. So just over a year ago, a young journalist called Jan Kuciak, who was investigating links between organized crime, business and government, was shot dead alongside his fiance in their home outside Bratislava. It led to the biggest demonstrations in the history of Slovakia as an independent nation. Demonstrations against the government and against the. The sort of cloud of corruption that had settled upon it. It forced Robert Fico, the prime minister who had run the country more or less without interruption since 2006, to resign. So then the question was, what was going to happen to the political energy that had been unleashed by these developments? And the answer is this. Young lawyer, Zuzanna Kapowita, was able to harness this political energy and secure 40% of the vote in the first round. She will almost certainly win the runoff on March 30th.

So Ms. Kabotova has come from nowhere, and all of a sudden it looks like after Saturday's election, she'll be president. What sort of campaigning magic does she possess?

What was really interesting about the campaign is that there were all sorts of TV debates and live events. She was heavily provoked by some of her opponents who tried to cast her as this ultra liberal who wanted to open borders, let all of the Muslims in, gay marriage, abortion, all of this sort of stuff. And Slovakia remains, in some respects, a fairly culturally conservative Catholic country. But she did not rise to these provocations, and it lent an air of dignity to her campaign, which a lot of her supporters say is the most attractive thing about her.

Okay, she's against corruption. What's she in favor of?

So I asked her what her priorities as president would be. She said number one would be to restore the faith of citizens in the rule of law, which was so damaged by Fico and his smear party. Number two was climate change and environmental protection, and number three was to anchor Slovakia's position in the heart of Europe.

It sounds like Slovakia is in this sort of parallel universe, in a world before the financial crisis, the election of Donald Trump. Is she too good to be true?

Well, I mean, I think the numbers speak for themselves. She won 40% of the vote in the first round. Polling suggests that she will win over 60% in the runoff. That said, the election also cast a light on some of the darker side of Slovakian politics. The candidates who came third and fourth between them, they took about a quarter of the vote were respectively a rabidly Islamophobic, anti immigrant populist and an outright neo Nazi. These guys will hope to capitalize on the energy that they unleashed in the course of the presidential election in the run up to what will be much more significant parliamentary election, which have to take place within the next 12 months. The interesting question for me about Slovakia has always been how does it want to orient itself? Is it a country that sees itself at the heart of Europe and at the heart of NATO? Does it keep an eye on Russia? Does it want to follow Viktor Orban down the illiberal path? The destiny of Slovakia remains very much alive.

Thanks, Tom.

Thanks a lot.

That's all for this episode of the Intelligence. You can subscribe to the economist@exterator.com radio offer 12 issues for $12 or 12 pounds. See you back here tomorrow. Sam.