In recent years, certain bankers and corporate treasurers were known to gently correct people when they referred to high yield debt as "junk bonds". But these days, with the high yield market reeling, it seems no one much objects to calling these bonds junk.

High yield bond prices have fallen precipitously in recent months, while trading in the secondary markets has all but ground to a halt.

Meanwhile, companies have found that investors are unwilling to buy new junk bonds even when their coupons have risen to eye-popping levels of 13 per cent or more.

None other than William Gross, a bond guru who manages one of the largest fixed income funds in the world, recently told investors that the high yield market faces "decimation" in the new economy, and that its bonds should be avoided.

Those dire predictions should concern more than just the members of the high yield community.

The last time the market slumped in 1989 with the downfall of its modern architect, Michael Milken, and his firm, Drexel Burnham Lambert, it hastened a broader credit crunch in the US that led to the economic recession of the early 1990s.

Even if the current turmoil does not lead to such grave consequences, it is almost certain to slow economic growth as a number of small and developing companies are denied a key source of finance.

The high yield market's current travails have kicked in amid fears that the economy may be headed for a hard landing, which would prevent many riskier companies from servicing their debt.

Moody's Investors Service, the international ratings agency, noted this week that nearly three times as many high yield companies had their credit ratings lowered than those which had their credit raised during the third quarter. The agency said the deterioration of credit in the sector was the worst it had seen since 1989.

Many of the worst offenders have been telecommunications companies. In recent years, they have accounted for the lion's share of new issuance in the high yield market.

US high-yield bonds bookrunners*
Managing bank or group	Number of issues	Total ($m)	Share (%)
DLJ	28	5,766.20	14.50
Goldman Sachs	27	5,335.10	13.40
Salomon Smith Barney	38	4,546.30	11.40
Morgan Stanley Dean Witter	40	4,146.60	10.40
Merrill Lynch	61	3,676.90	9.30
Chase Manhattan	18	2,841.20	7.20
Deutsche Bank	24	2,694.20	6.80
Lehman Brothers	19	2,256.20	5.70
Credit Suisse First Boston	10	2,198.20	5.50
Bank of America	14	2,197.90	5.50
Total	286	39,728.60	Κ
Source: Thomson Financial Securities DataΚΚΚΚΚΚΚΚΚΚΚΚΚΚΚΚΚΚΚΚΚΚΚΚΚΚΚΚΚΚΚΚΚΚΚΚΚΚΚΚΚΚΚΚΚΚΚ* Jan 1 2000 to date

But with fears of a slowdown looming, and notable flops by a few of these companies, investors have dramatically pulled back from the sector.

Bonds for companies such as ICG Communications and Viatel have fallen to distressed levels. Meanwhile, shares of Morgan Stanley Dean Witter, the bank that underwrote the offerings, suffered as investors feared that it still held much of the paper in its inventory.

The hysteria reached such heights on Wall Street that Morgan Stanley was moved to issue an unusual statement, saying that its trading losses cut its earnings last quarter by just 3.5 per cent.

While the tumult in the junk market has shocked bankers in recent months, its roots stretch back at least two years to the global financial crisis that swept the world after Russia's debt default.

The ensuing crisis led investors to scramble to the security of US Treasury bonds, and riskier instruments such as junk paper were trounced. Wall Street banks that held those issues in their inventory, such as Merrill Lynch, were particularly stung by the losses.

As aresult, banks have moved en masse to reduce their exposure to junk bonds, and have committed less and less capital to making markets for them.

This reluctance has led to a dramatic loss of liquidity, making it harder for investors to sell out of issues in times of stress. The loss of liquidity has been especially brutal for smaller issues that are difficult to trade.

The mergers in the financial services industry have continued the trend. As banks such as Chase and JP Morgan or Credit Suisse and Donaldson Lufkin & Jenrette combine, traders suspect that their total exposure to the market has not equalled the sum of their parts.

Martin Fridson, chief high yield strategist at Merrill Lynch, has illustrated the effect on the market with an index that compares the interest rates for the top half of bonds by size of issue, against bonds in the bottom half.

In July 1998, rates on small bond issues were 59 basis points higher than on big issues. That spread jumped to 264 basis points after the Russian default, and has since grown to more than 450 basis points.

Despite its dire condition, a number of banks have pushed to climb the high yield league table ladders. That is because the fees are lucrative, and also because high yield has increasingly been viewed as a gateway to other financial services, such as mergers and acquisitions advice or equity offerings.

Goldman Sachs poached top bankers from Donaldson Lufkin & Jenrette earlier this year, and finished the first half as the leading underwriter in the high yield market. It marked one of the few times that DLJ has not held that spot since the break up of Drexel.

This might be just the time for other banks to push into the high yield market. With liquidity at such a premium, any group willing to commit substantial capital would be likely to gain new market share in high yield underwriting.

But given that those participating in the industry were stung after the Russian default in 1998, and now again after the recent telecom fall, they could be forgiven for hesitating just a while longer.