With the 2008 financial crisis is still fresh in the mind of many investors, it would appear that the world is setting itself up for another collapse. However, this time it could be much worse.
A seven-year high
One of the root causes of the last financial crisis, was the use and availability of collateralised loan obligations, or CLOs for short. CLOs are bundles of loans packaged together as one tradeable security, designed to help boost returns for yield-hungry investors.
Now, in theory, these CLOs are safe, if the loans used to construct them are high quality. Unfortunately, as investors are increasingly searching higher returns, lower-quality loans are being used within CLOs for their higher interest rates.
As a result, sales of CLOs have boomed during the past few months hitting a level not seen since May of 2007, just before the financial crisis took hold. Unsurprisingly, this puts banks with the biggest investment banking divisions at risk, Barclays (LSE: BARC) (NYSE: BCS.US) in particular.
The Chinese problem
Elsewhere, HSBC (LSE: HSBA) (NYSE: HSBC.US) has been trying to dispel fears of a Chinese credit crunch.
China was one of the few regions to escape the last financial crisis, and the country sailed through without much damage. Nevertheless, Chinese corporate debt has ballooned to nearly $3trn during the past few years and now Chinese authorities have decided that it is time to tighten credit conditions. This decision comes as Chinese policy makers attempt to engineer a soft landing for the world’s second largest economy.
These tighter credit conditions lead to China’s first ever corporate debt default at the beginning of March and since then a number of other companies have defaulted on their debts. Not surprisingly, City analysts have started to wonder if this wave of defaults could result in something larger, putting HSBC at risk.
Specifically, one of HSBC’s core markets is Hong Kong, where wealthy investors have been piling cash into the Chinese debt market in search of higher returns. A Chinese credit crunch would most likely reverberate throughout Asia, hitting HSBC and its smaller peer, Standard Chartered (LSE: STAN).
Actually, any Asian crisis is likely to hurt Standard Charted more than HSBC as, unlike HSBC, Standard conducts most of its business within Asia, with very little diversification outside of the region.
Mountains of debt
But these debt worries are not just limited to China, many eurozone countries remain crippled under mountains of debt. However, as investors take increasing risks in an attempt to increase returns, these debt markets are flourishing and surprisingly, it is now cheaper for Spain to borrow money than the United States.
In addition, many African nations are now tapping the financial markets for cash with Zambia and Rwanda raising billions of dollars but only paying minimal interest rates, despite the risk involved.
Foolish summary
So overall, as investors around the world lap up debt, attracted by the high interest rates, trouble is brewing. Levels of debt are rising across the world and bad debts are also growing, it’s starting to look a lot like 2007 again.
