This Time Is Different, but It Will End the Same Way:
Unrecognized Secular Changes in the Bond Market since the 2008 Crisis That May Precipitate the Next Crisis

Daniel Zwirn, Jim Kyung-Soo Liew and Ahmad Ajakh | Published in The Journal of Fixed Income, Fall 2019

  1. Lack of market-making and other regulatory changes that will impede price discovery in the next downturn
  2. Masking of the deterioration of underlying collateral and rearview mirror analysis
  3. New versions of the old games played by the rating agencies
  4. Explosion in asset-liability mismatched structures
  5. Regulatory changes in compliance of financial institutions


The US bond market had over $42.39 trillion of outstanding debt at the end of the third quarter of 2018, eclipsing the US stock market’s approximately $30 trillion in market capitalization. The sheer size of the bond market provides ample opportunities, as well as risks, for institutional investors. Some of these risks escape investors’ radar because of the nature of fixed income securities: low transparency, illiquidity, and over-the-counter (OTC) trading. In this article, the authors present our concerns regarding five secular changes wrought by the over-regulation of the marketplace after the financial crisis of 2008 and investors’ persistent thirst for yield. Further, although painful lessons were gleaned after the punishing 2008 financial crisis, the authors present empirical evidence that suggests that many sectors, such as auto loans and collateralized loan obligations, that were largely unscathed by this crisis may be at risk in the next downturn. This article is based on original data sources and academic research. The authors are in continuing dialogue with other experts that may further the research, and welcome interested parties to get in contact.


The US bond market had over $42.39 trillion of outstanding debt at the end of the third quarter of 2018, eclipsing the US stock market’s approximately $30 trillion in market capitalization. When we compare the outstanding debt at the end of 2008 with that at the end of 2018Q3, we find that the mortgage market has remained relatively unchanged, with $9.5 trillion outstanding in 2008 versus $9.7 trillion in 2018Q3. It is interesting, however, that corporate debt outstanding has grown more than 1.66X from $5.5 trillion in 2008 to over $9.2 trillion in 2018Q3.1 Given this rapid growth in the corporate credit market, there is urgency in understanding the current market dynamics and identifying possible hidden risks therein. Some themes in our examination of the corporate markets will, unsurprisingly, echo the past crisis in the mortgage markets. Although corporate credit is one of the areas most susceptible given these changes, most of the tradeable fixed income universe (as well as those privately negotiated sectors priced as a spread to that universe) is exposed to these risks.

The five secular changes we highlight are as follows:

  1. Lack of market-making and other regulatory changes that will impede price discovery in the next downturn,
  2. Masking of the deterioration of underlying collateral and rearview mirror analysis,
  3. New versions of the old games played by the rating agencies,
  4. Explosion in Asset-Liability mismatched structures, and
  5. Regulatory changes in compliance of financial institutions.

Note that some areas have significant overlap in terms of their manifestations in the marketplace. For example, corporate bond ETFs and open-ended mutual funds have been created to appease the demand from retail investors for access and exposure to corporate bonds and loans. These products are attractive to retail investors (and those that have sold products to them) because they believe that ETFs and mutual funds have daily liquidity. What retail investors may not have considered, however, is that this perception of daily liquidity is not entirely accurate: these products are based on OTC-traded securities, which are riddled with hidden risks in down-market cycles. To fully understand trading dynamics, one must understand asymmetric market-making risks, whereby in up markets these underlying OTC securities trade relatively efficiently, but in down markets their liquidity (and the market-makers that supply it) completely disappear. In down markets, redemption suspensions will catch corporate bond ETFs and mutual fund investors by surprise and result in tremendous confusion and possible retail investor panic as this asset-liability mismatch becomes evident. The investors in the assets—ETFs and mutual funds—will be shocked to find that they cannot quickly redeem because the underlying OTC securities will have no bids and, thus, no exits.

In 2008, the US real estate markets had too much easy credit available for those who sought to purchase homes beyond their financial means, eventually resulting in the implosion of the housing market and a staggering economic downturn. Have we subsequently learned the lessons of being overlevered? The answer is a resounding no, as evidenced by the current state of the auto loan market. Because auto loans appeared relatively resistant in the financial crisis of 2008, lenders concluded that the auto loan sector is resistant in general to financial crises, relying on the prior track record, as observed through the lens of their rearview mirror. But this reasoning is flawed: the factors that gave rise to the mortgage crisis of 2008 are increasingly present in the auto loan market, and there is no basis for finding that the auto loan market is immune to market collapse.

As investors pour more capital into the auto loan market, auto loan originators, whose primary responsibility is to screen auto loan candidates by their credit worthiness, will be inclined to lower their standards to distribute this increased capital in the form of auto loans. As credit standards weaken, the number of auto loan borrowers will increase as those who were previously unqualified for an auto loan become able to secure a loan. Furthermore, the originators (who are paid a significant premium to their basis soon after origination by the indirect auto lenders) are financially incentivized to issue as many loans as possible, which shows the scale of the train wreck to come in this sector. Why do the investors and originators take on such massive risk to reap outsized profits? Are there no systemic restraints or consequences for these parties? Surprisingly, no, there are none, due to the principle of moral hazard. After the 2008 financial crisis, the federal government bailed out the entire subprime mortgage industry and stuck the taxpayers with the bill. If, within a sector, there is massive upside to taking on massive risk, but very limited downside, a crisis is all but inevitable.

At this juncture, we do not see pre-2008 leverage levels building up in the residential real estate market, but we do see signs that debt levels are rising beyond the high point in 2008. We document evidence of overly levered leveraged loan and corporate bond markets providing early warning signs that we are nearing the limits of our credit markets. The pain of the 2008 mortgage downturn seems to be fading from our collective memories because many similar stories are building in overly levered components of the financial markets, and market participants buying these securities are behaving as if unaware of the true dangers and risks.

The urgency with which we examine and present these five areas of secular changes is due to the present critical stage in the markets. An important and support able assumption made in this article is that, because eco nomic cycles exist and there have been secular changes in the credit markets, the question of the next financial crisis is a matter of when rather than if.

In this article, we examine the secular changes in the bond and loan markets since the 2008 financial crisis. The theme we highlight throughout this article is that downturns in the economy are inevitable. Although the timing of downturns is beyond the scope of this discussion, we cite some of the widely accepted indicators of economic slowdown to frame our discussion.


1 Data sourced directly from SIFMA which is the leading trade association consisting of broker-dealers, investment banks, and asset managers within the US (SIFMA 2019).