Felix Salmon, who authors a very good blog about finance and economics, makes the following observation about the dramatic increase in the amount of leveraged loans held by hedge funds:
[J]unk bonds are rapidly becoming a thing of the past. Today, it’s all about junk loans ñ illiquid instruments which hedge-funds hedge in the equally opaque and non-public CDS (credit default swaps) market. The good news, insofar as there is any, is that if and when a lot of these loans go sour, the impact on the banking system will be much lower than the volume of loans would imply. But the bad news is that ever-larger chunks of corporate balance sheets are now completely unregulated.
I’m not sure I follow the reasoning of Salmon’s final sentence. Privately-owned hedge funds, whose investors are wealthy folks, own a large amount of leveraged loans. That ownership has reduced the risk of loss of lending institutions, which generally do not have the profit margins to take on that sort of risk. Thus, the financing market has developed to shift the risk of these loans to those who can best afford to take the risk, which is a good thing. That large portions of corporate balance sheets are unregulated is one of the reasons that such a market developed in the first place.
Credit default swaps are hardly non-public. I work on a fixed income trading desk here in Houston and I can assure you pricing on CDS can be had from any number of dealers. These instruments are generally not made easily accessible to small investors simply because they are inappropriate for small investors. For the appropriate f speculainvestors, information on these are as easy to get as a stock quote (any individual with access to a Bloomberg terminal can easily get CDS quotes).
The financial market has developed a number of instruments that allow institutional borrowers and investors to easily hedge specific risks. In the portfolios of investors who are not exposed to these specific risks, these instruments become vehicles of speculation. That barriers exist to keep small investors from having easy access to instruments entirely inappropriate for small investors is hardly a scandal.
As far as the issuance of “junk” bonds, high yield issuances by non-investment grade borrowers are hardly becoming a thing of the past. When Milken pioneered high yield debt, he was simply creating a vehicle that allowed the market to set a price at which sub-prime borrowers could access capital markets. This is not unlike what the sub-prime mortgage market did. Investors are free to price any credit risks as they see fit. In emerging economies, the credit markets are wonderfully effective and high yield financing is incredibly strong.