THE ECONOMICS OF THE PRIVATE MARKET
The Recent Credit Crunch in the Private Placement Market
Since the middle of 1990, issuers of belowinvestment-grade securities have encountered a sharp contraction in the availability of credit in the private placement market. A sharp rise in interest rate spreads on these securities indicates that the reduction in supply has been larger than any decline in credit demand associated with the weak economy. This credit crunch has resulted mainly from a greater reluctance of life insurance companies to assume below-investment-grade credit risk. This reluctance is due mostly to concerns that high balance sheet proportions of such investments could lead to a runoff (or even a run) of liabilities and threaten the profitability and, perhaps, even the survival of insurance companies. Asset quality problems at many life insurance companies, regulatory changes, and runs at a few insurance companies have contributed to the reluctance of insurance companies to buy below-investmentgrade private placements.
The reduced availability of credit from life insurance companies has likely adversely affected the ability of below-investment-grade companies to obtain financing. Few alternative lenders have entered or expanded their presence in the belowinvestment-grade sector of the private market to fill the void. The reason appears to center on the high start-up costs that potential lenders must incur to enter the private market. Also, the number of alternatives to private placements is limited. Although they may be the main practical alternative, bank loans are far from perfect substitutes, and some firms shut out of the private market may have found banks to be reluctant lenders.