High-Yield Debt: Fallen Angels, CDO Tranches and Greece Downgraded to Junk

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Junk bonds, or high-yield debt, are bonds rated below investment grade by agencies such as Moody's and Standard and Poor's, paying higher yields to compensate for higher default risk. The U.S. average default rate is about 5 percent, rising to between 5.6 and 7 percent in the 1989 to 1990 liquidity crisis and to just under 9 percent during COVID-19. As of early 2022, U.S. high-yield bonds outstanding totaled about $1.8 trillion, 16 percent of the $10.7 trillion corporate bond market, with $435 billion issued in 2020 alone. Pension funds, insurers and mutual funds dominate the market, though many are barred by their own rules from holding bonds below a set rating.

Junk bonds began as fallen angels, investment grade bonds downgraded when their issuers stumbled. In the 1980s Michael Milken and Drexel Burnham Lambert saw they were undervalued and began issuing speculative grade debt directly to finance leveraged buyouts and hostile takeovers, with debt-to-equity ratios as high as 6 to 1. Wall Street later repackaged risky consumer debt, including subprime mortgages, into collateralized debt obligations whose top tranches won AAA ratings until the housing market stalled. On March 23, 2009, Treasury Secretary Timothy Geithner announced a $500 billion Public-Private Investment Partnership to buy toxic assets, and on April 27, 2010, S&P downgraded Greece's government debt to junk.

• By 2005 over 80 percent of high-yield debt was used for general corporate purposes rather than buyouts.
• Zombie banks either stopped lending under debt overhang or gambled on ultra risky loans.
• Paul Krugman called the bailout's non-recourse loans a hidden subsidy, while Meredith Whitney argued banks would refuse to sell at fair value.
• Moody's cut Portugal four notches to junk in July 2011 and cut Italy to Baa2 in July 2012, one notch above junk.
• Even during Europe's 2012 crisis, companies issued 50 billion euros in high-yield bonds, and the debt remains key in China and Vietnam.