Former Fed Chair Yellen says excessive corporate debt could prolong a downturn

Key Points
  • Former Federal Reserve Chair Janet Yellen said Monday that she's concerned with ballooning levels of corporate debt.
  • In an interview with economist Paul Krugman, Yellen said much of the underwriting for the $9.1 trillion in corporate debt looks "weak."
  • The former Fed leader also noted that the current holders of corporate debt do not appear to be levered to excess, mitigating the risk of any credit ripple effects.
Federal Reserve Chairman Janet Yellen speaks during a news conference after a two-day Federal Open Markets Committee (FOMC) policy meeting in Washington, September 20, 2017.
Joshua Roberts | Reuters

Former Federal Reserve Chair Janet Yellen is worried about excessive leveraged lending and the level of corporate debt across Wall Street.

"Corporate indebtedness is now quite high and I think it's a danger that if there's something else that causes a downturn, that high levels of corporate leverage could prolong the downturn and lead to lots of bankruptcies in the non-financial corporate sector," Yellen told economist and New York Times columnist Paul Krugman at the City University of New York on Monday.

"I think a lot of the underwriting of that debt is weak. I think investors hold it in packages like the subprime packages ... the same thing has happened. It's called CLOs, or collateralized loan obligations," she added.

The comparison to the infamous practice of securitizing large amounts of subprime mortgage loans into bundles may spook some investors who recall the consequences of the housing crisis between 2007 and 2010. Corporate indebtedness has ballooned in recent years, with companies now carrying a $9.1 trillion debt load compared to just $4.9 trillion in 2007.

Such a large tab could become a financial headache should interest rates continue their 2018 trek higher and effectively boost the cost of borrowing. Some market participants have also voiced concern over companies on the edge of the investment-grade universe losing their standing and turning into high-yield or junk. That, in turn, could usher rates significantly higher.

Though many have recognized the growing malcontent surrounding the high levels of corporate indebtedness, Yellen and others are quick to point out that interest rates have remained historically low in recent years despite recent increases to the overnight lending rate. The former Fed leader also noted that the current holders of corporate debt do not appear to be overleveraged, mitigating the risk of any credit ripple effects.

"I don't see a shock in the offing that's likely to cause that kind of financial crisis," Yellen added, referring to the downturn a decade ago. "There's much less leverage in the financial sector now as far as I can see relative to before the crisis. I think that most of those risky loans are owned by investors that are not leveraged. So they may suffer losses, but they're unlikely to turn around and start selling other assets that can lead to fire sale contagion."

Yellen was replaced as Fed chair in February by President Donald Trump's nominee, Jerome Powell. The new Fed chair has overseen three increases to the federal funds rate since joining the central bank, which is expected to hike rates again later this month.

— CNBC's Jeff Cox contributed reporting.