By Ed Conway, Economics Editor, in Washington DC
Investors are becoming dangerously reliant on rock-bottom interest rates, with many becoming so indebted they will face serious problems when borrowing costs rise, the International Monetary Fund (IMF) has warned.
The IMF said that the amount of cash spent on leveraged loans - the high-debt instruments with financial problems - now exceeds the level in 2007 before the crisis.
The same is the case with covenant-lite loans, which have become more lax than normal debt - they are also being created at a significantly faster rate than in 2007.
The warnings came in the IMF's Global Financial Stability Report. It said that financial markets may struggle when, eventually, the Federal Reserve, Bank of England and other central banks raise interest rates.
The report's lead author, Jose Vinals, said that many economies were reliant on these "liquidity crutches".
Referring to the market slumps last summer when the Fed signalled it was preparing to end its quantitative easing programme, the report said: "As the turbulence of last May demonstrated, the timing and management of exit is critical.
"Undue delay could lead to a further build-up of financial stability risks, and too rapid an exit could jeopardise the economic recovery and exacerbate still-elevated debt burdens in some segments of the economy."
However, it was the warning that investors are returning to the high-debt instruments that caused many problems in recent years that is likely to resonate most.
The IMF said: "The proportion of bonds with lower underwriting standards - such as covenant-lite and second-lien loans - is on the rise, as it was before the financial crisis, and this could contribute, as it did then, to higher default rates and lower recoveries as the credit cycle turns."
It warned that although share prices had risen sharply in recent years, "markets risk disappointment - especially in an environment of rising interest rates - unless equity valuations become better supported by rising earnings, capital investment, and aggregate demand".
The report also raised concerns about levels of household debt in the UK, though it added that they had fallen sharply in recent years.
The IMF said it was also concerned about the levels of debt in the emerging markets.
It added that if interest rates rose and earnings deteriorated the share of emerging market corporate debt classed as "debt at risk" of default, could rise to more than a third of the total.
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