High-yield debt

As indicated by their lower credit ratings, high-yield debt entails more risk to the investor compared to investment grade bonds.

[1] In the case of high-yield bonds, the risk is largely that of default: the possibility that the issuer will be unable to make scheduled interest and principal payments in a timely manner.

[3][2]:209 A recession and accompanying weakening of business conditions tends to increase the possibility of default in the high-yield bond sector.

Other investors focus on the lowest quality debt rated CCC or distressed securities, commonly defined as those yielding 1,000 basis points over equivalent government bonds.

In the mid-1980s, Milken and other investment bankers at Drexel Burnham Lambert created a new type of high-yield debt: bonds that were speculative grade from the start, and were used as a financing tool in leveraged buyouts (LBOs) and hostile takeovers.

[11] In emerging markets, such as China and Vietnam, bonds have become increasingly important as short term financing options, since access to traditional bank credits has always been proved to be limited, especially if borrowers are non-state corporates.

When such CDOs are backed by assets of dubious value, such as subprime mortgage loans, and lose market liquidity, the bonds and their derivatives become what is referred to as "toxic debt".

Holding such "toxic" assets led to the demise of several investment banks such as Lehman Brothers and other financial institutions during the subprime mortgage crisis of 2007–09 and led the US Treasury to seek congressional appropriations to buy those assets in September 2008 to prevent a systemic crisis of the banks.

[15] Alternatively, potentially insolvent banks with toxic assets sought out very risky speculative loans to shift risk onto their depositors and other creditors.

[16] On 23 March 2009, U.S. Treasury Secretary Timothy Geithner announced a Public-Private Investment Partnership (PPIP) to buy toxic assets from banks' balance sheets.

[18] Nobel Prize–winning economist Paul Krugman has been very critical of this program arguing the non-recourse loans lead to a hidden subsidy that will be split by asset managers, banks' shareholders and creditors.

[23] On 5 July 2011, Portugal's rating was decreased to "junk" status by Moody's (by four notches from Baa1 to Ba2) saying there was a growing risk the country would need a second bail-out before it was ready to borrow money from financial markets again, and private lenders might have to contribute.