Junk Bond Mania

The American Heritage Dictionary defines "mania" as

an excessively intense enthusiasm, interest, or desire; a craze: a mania for neatness.

In some respects, that definition seems apt when describing the emotional state of those who are currently "investing" in the junk bond market, the riskiest corner of the fixed-income universe.

Abetted by seemingly benign default rates, reports the Associated Press,

investors continue to dive into a swelling pool of the riskiest junk bonds despite receiving less return than ever before.

This has created a paradoxical and largely unprecedented scenario in which default rates continue to fall even as the high-yield bond market as a whole, as measured by ratings, is becoming increasingly risky, all while premiums have reached all-time lows.

With many predicting an economic slowdown and a rising default rate in 2007, some analysts reckon investors in the riskiest junk bonds could be in over their heads, exposing themselves to potentially big losses when the companies that issue these bonds start running into trouble.

"It bodes very bad if we have a hard landing," said Martin Fridson, publisher of the Leverage World research service. "Given today's ratings mix we could have default rates that would make even the 'Great Debacle' of 1989-1991 (when default rates reached 12.8 percent) pale by comparison." He added that even a softer landing could still produce default rates in the high single digits....

The current relationship between the default rate and the amount of highly speculative debt runs counter to both logic and history, according to Fridson.

Interestingly enough, the American Heritage Dictionary also offers another description for "mania":

Violent abnormal behavior. See Synonyms at insanity.

Given the dramatic turn of events I expect, I wonder how long it will be before those who are consumed by the former are afflicted with the latter?