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The Bomb That Blew Up in 2008? We’re Planting Another One (Op-Ed)
(pepe recommends anything written by 'Das-as he is known. He knows what he is talking about and has for many year's)
Collateralized loan obligations may look safe but they pose risks that are poorly appreciated
Financial markets have short memories. Of late, they’ve convinced themselves that collateralized loan obligations (CLOs) are much safer instruments than the collateralized debt obligations, or CDOs, on which they’re based and which helped precipitate the 2008 crisis. They’re wrong – and dangerously so.
Current CLOs outstanding globally total around $700 billion, with annual new issues of over $100 billion. That’s broadly comparable to subprime CDO volumes in 2008. Both Bank of England Governor Mark Carney and former Fed Chair Janet Yellen have warned about potential risks; regulators in Japan, where banks have been big CLO buyers, are particularly concerned.
The structure of CLOs is economically similar to CDOs. Each pools multiple loans to create synthetic, bond-like investments. Investors buy a slice (or tranche) of the underlying interest and principal cash flows of the portfolio. A defined order of which investors get repaid first and which bear the most losses allocates risk differentially.
High-risk CLO equity pieces, which are unrated, are first in line for losses and last for repayment. Less-risky subordinated or mezzanine pieces, typically rated anywhere between BBB and B, rank ahead of equity. Low-risk senior pieces, typically rated A or better, rank first for payments and only bear losses if the equity and subordinated pieces are completely wiped out.
CLOs, like CDOs, are designed to increase the leverage on a portfolio of debt. In other ways, CLOs are indeed set up to be safer. Rather than mortgages, subprime or otherwise, they repackage corporate loans, primarily leveraged loans, as well as consumer credit such as automobile loans. Investors in better-rated tranches have greater protection than they would have in CDOs, as higher levels of losses are required before they lose money.
https://www.bloomberg.com/opinion/articles/2019-03-03/collateralized-loan-obligations-are-riskier-than-most-realize
This is not a new issue.
Why a U.S. Subprime Mortgage Crisis Is Felt Around the World (from 2007)
https://www.nytimes.com/2007/08/31/business/worldbusiness/31derivatives.html
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