Most investors’ eyes are on stocks right now. And for many stock optimists the credit crunch is ancient history. Not so, says global finance insider Simon Mellon, who heading up our new Bonner and Partners Family Office project.

According to Simon, we may be looking at another serious credit blow-up in a dark corner of the credit markets known as leveraged loans. So if you think the credit crisis is over, think again. The easy part of the clean-up is probably behind us. But the real dirty work hasn’t even begun. This from an email Simon sent through to Notes HQ yesterday.

The leveraged loan market was hugely lucrative during the boom. Similar to junk bonds, leveraged loads are secured loans to high-credit-risk companies – usually leveraged buy-outs by private equity firms.

Existing issues of these leveraged loans are now trading back at “trader’s par” – above 90% of face value. This is a major turnaround, considering these loans were close to default not too long ago. But experience tells me this is yet another example of “irrational exuberance.”

I looked after a portfolio of these leveraged loans during the credit boom. And I can tell you there is some pretty hairy stuff out there. Anybody who experienced the private-equity driven corner of the credit markets first hand will tell you that leveraged buy-outs are just the ultimate flip trade – the kind of stuff that would make Gordon Gecko proud! See, the private equity houses carry next to none of the risk, and their over eager bankers carry the lion’s share.

This market looks likely to be the next big credit blow-up. According to ratings agency Standard & Poor’s, the biggest private equity groups are sitting on about $400 billion in debt. Nearly all these deals were done the same way: five-year loans with the terms getting tougher after the second year. The only reason the private equity guys agreed to these terms was because their plan was always to flip or refinance after the second year – that is sell on to the next guy and take a massive short-hold return.

The majority of these existing deals were done between 2005 and late 2006. But as we know the market has since changed utterly. Banks aren’t so eager to lend now. So the strain must be starting to show. And with everybody scrambling to pay down or refinance, I see this as being a “kill or be killed” scenario. According to Standard & Poor’s, there’s $21 billion of debt maturities in the next two years, another $50 billion in 2012, $115 billion in 2013 and $192 billion in 2014.

Most of this debt actually sits on the balance sheets of the companies that were bought out, not on the books of the private equity firms. So when these debt-ridden companies are forced to default on their debt payments, the private equity guys can just walk away. In other words, these smart suits have once again engineered it so they get all of the upside but very little of the downside.

If I’d said two years ago that $400 billion in debt is about to go bad, there would have been all sorts of outrage. Now it’s just a drop in the ocean – especially compared to the bank bailouts. But there is one important difference. Few if any of these private equity firms or the companies they financed are likely to be deemed “too big to fail”. So when this one blows it will really blow.

And just like in the asset backed finance market, the losses won’t be isolated. Thanks to a gray market for trading loan pieces, these loans are everywhere – from New York hedge funds to the balance sheets of Bavarian banks. Worse, lots of firms will have hedged (or “arb” traded) these leverage loans through credit-default swaps. So watch out for all that fresh counter-party risk. And cue the insurance company execs running for the hills.

There are ways that individual investors can get back at the Wall Street machine. Although a certain amount of discretion is always required when it comes to these kind of plays.