By Heidi N. Moore, contributor
Can a bubble be a force for good? It can, if you consider the miraculous story of redemption of high-yield bonds.
Junk bonds are supposed to be risky -- in fact, they're the riskiest kind of corporate debt you can buy, because the companies that issue them have a greater chance of not being able to pay their debt and falling into bankruptcy. At least, that is true in normal years. In 2010, companies that issue high-yield bonds are defaulting on that debt at a rate of only around 1%, compared with more like 14% in 2009, according to a new report from Fitch Ratings credit analyst Mariarosa Verde. Verde notes that there are both fewer and smaller companies defaulting on their high-yield debt in 2010. For a bit of context, the current default rate on junk bonds compares to a historical default rate between 4% and 68%, depending on the junk bond's rating. Now junk bond defaults are so low that they are half the historical default rate for highly rated -- or investment-grade -- corporate debt, a which historically maintained a 2% default rate. Municipal bonds issued by the most financially sound cities and states historically default by 0.7%. So right now, junk bonds are about as likely to default as highly rated munis.
If you feel like you just fell through the looking glass, you're not alone. Junk bonds are, to say the least, unlikely heroes. Former Treasury Secretary Hank Paulson has said that he was blindsided by the fall of AIG (AIG) because he and his staff were expecting private equity-owned companies, which are the ones more likely to be loaded with junk debt, to be victims of the next debt crisis. In a recent interview with Charlie Rose, private equity investor Jonathan Nelson of Providence also conceded that the private equity industry was surprised it was able to dodge the debt bullet. Between 2005 and 2007, there were $1.7 trillion of leveraged buyouts, all, of course, fueled by junk bonds. The problem even earned a book, reporter Josh Kosman's The Buyout of America: How Private Equity Will Cause the Next Great Credit Crisis. More
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