Junk bonds are back, which is bad news for the economy.
Companies with junk credit ratings have been increasingly issuing bonds for riskier purposes that could hinder their ability to pay back bondholders.
Demand for junk bonds has touched record levels this year as investors reach for their rich yields, a stark contrast to the meager returns available on Treasury securities and money market accounts. But the voracious demand has allowed companies to easily raise money for things that may actually end up weakening them.
Junk bonds, also called high-yield bonds, tend to offer higher yields when they pay off but carry significantly higher risk of default. The problem is not the bonds themselves, but the way they tend to be used -- to financed forced takeovers that strip value from the company taken over, to fund the collateralized-debt obligations at the center of the 2008 crash and, as they are being used now, to pay off investors without thought to what they will do to the long-term health of the company.
And companies have been using more of the proceeds for the sorts of risky projects that were common before the financial crisis and in the go-go days of the 1980s — paying dividends to private equity owners and financing mergers and leveraged buyouts.
Jo-Ann Stores and Petco, for instance, both with junk ratings of CCC, sold a combined $875 million of bonds this month, with some of the money set to quickly leave the companies through dividend payments to their private equity owners. Many analysts say that the practice can hurt the financial health of the companies by increasing their regular interest payments to bondholders without strengthening the underlying business.
Basically, the companies are adding debt without adding value, which at some point is going to come back to haunt them -- and us.