The latest quarterly review from the Basel-based Bank for International Settlements (BIS) warns that an increased clamour for yield has increasingly drawn investors into high-risk instruments, resulting in conditions that are "reminiscent of the exuberance prior to the global financial crisis".
To make matters worse, there's been a surge in lending over the past year, despite the fact that aggregate public and private debt in the western economies now constitutes a higher proportion of gross domestic product than it did at the start of the crisis. The BIS points out that issuance of subordinated debt has tripled in Europe, and risen 10-fold in the US, while leveraged borrowing has outstripped its pre-crisis peak in 2007-08. The problem is exacerbated by the fact that much of this new lending offers minimal protection for creditors, while the true extent of banks' exposure is masked by widespread use of contingent convertible capital, which is designed to switch debt into equity if banks are struggling with their capital ratios. Worryingly, imbalances in debt markets have spread to emerging economies in Asia, Latin America and the Middle East, where interbank credit is at an historic peak, while the value of offshore bonds issued by private companies in these markets is now in excess of those based in the US and Europe.
All this at a time when the US Federal Reserve is to start trimming its monthly bond buying programme, draining dollar liquidity from global markets, with unpredictable results. Little wonder that global equity markets reacted favourably to speculation that current Fed vice-chairman Janet Yellen could be appointed to the top job in place of the outgoing Ben Bernanke. It's thought that Ms Yellen will be more inclined to persist with stimulus measures (if conditions dictate) than the previous frontrunner Larry Summers.
Although Mr Summers was Mr Obama's choice, many other Democrats were aghast at his proposed appointment, and the former Treasury secretary was forced to withdraw from the race. Given his support for the repeal of the Glass-Steagall Act, and his initiation of a US law that ensured that derivatives would not be regulated, it's little wonder he struggled to gain cross-party support.
