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Tuesday, October 13, 1998 Published at 15:15 GMT 16:15 UK

Business: The Economy

Corporate bonds bomb

Investment in US companies is mainly financed by bonds

The collapse of the US corporate bond market is putting fresh pressure on companies to cut back on investment.

It is yet another sign of how the global financial crisis is having an impact on the real economy.

Large companies, especially in the US, finance much of their borrowing through corporate bond issues rather than through bank lending.

But now the 'spread', or difference in interest rates over base rates, has widened dramatically - making it much more expensive for companies to borrow money.

In the last two months, the spread has widened for all corporate bonds from 0.7% to 1.4% - meaning that big companies like General Motors or GE have to pay nearly 1% more to borrow money.

And for low-rated corporate bonds, spreads have widened even more: by 3% for B rated bonds, and by 6% more for C or "junk bonds", where companies now are paying 17% more than long bond yields.

The increased cost of borrowing has meant that companies have not received much benefit from the recent cuts in interest rates by central banks.

It is the worst crisis in the bond market since Drexel Burnham Lambert collapsed in 1989. The bank had specialised in high yield bonds, and by the early 1990s many of these were in default.

Credit crunch

Now default rates are much lower, running at around 3%. But the higher interest rates demanded are a sign of how risk averse investors have become.

Last week, investors fled even the safest of all bond investments, the US treasury long bond, in a flight to cash.

Many US companies will not be able to pay the high interest rates demanded, which will cut into profits and reduce investment.

But bank credits are also scarce, and unlikely to serve as a replacement for the $450bn high quality corporate bond market.

And banks are also drawing in their credit lines to companies in Europe, where fewer companies use bond markets.

"Loans are getting shorter in maturity and much more expensive in Europe right now," said Karl Bergqwist of HSBC Markets.

Many banks now want to refinance such loans on the bond market - putting on effective block on such lending.

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