House Republicans Set Up Next Financial Bust?

CLO cards Financialists score on H.R. 37. When at first you don’t succeed – keep voting – and pass the Eleven Bill Wall Street Wish List on January 14, 2015. [rc37]  This amalgamation of pro-Financialist bills is guaranteed to warm the cockles of the Wall Street denizens, even if it has some very real potential dangers for Main Street and Elm Street.   There is at least one reason to sound the alarm.

Collateralized Loan Obligations

One of the items on the Wall Street Wish List was more time for the banks to deal with Collateralized Loan Obligations.  Let’s break this down into some easy-to-understand parts, beginning with the CLO.

“A security backed by a pool of debt, often low-rated corporate loans. Collateralized loan obligations (CLOs) are similar to collateralized mortgage obligations, except for the different type of underlying loan.”

And, what’s a security?

“A financial instrument that represents: an ownership position in a publicly-traded corporation (stock), a creditor relationship with governmental body or a corporation (bond), or rights to ownership as represented by an option. A security is a fungible, negotiable financial instrument that represents some type of financial value. The company or entity that issues the security is known as the issuer.”

So, what we have in the CLOs  are financial instruments (fungible, and negotiable) issued by a corporation (financial institution). These bits of paper are made up from pools of corporate debt, usually of the low rated variety, sliced diced tranched etc. for Wall Street’s trading pleasure.

If this is sounding familiar, it should because those sliced diced tranched mortgage based pools were precisely what got Wall Street in big trouble in 2007-2008.  The only thing that’s different now is that the pools in question are made up of questionable corporate debt instead of questionable mortgages.  Let’s drill down more closely to see what’s so attractive to Wall Street about putting off the deadline for bankers to comply with the Volcker Rule on CLOs.

Collateralized loan obligations are investment funds which are primarily made up of leveraged loans, associated with large corporate loans with low to very low credit ratings; these loans can be swapped in and out by the fund manager throughout the life of the fund. Watch closely now – because the next point is important.

CLOs are NOT backed by loans to small business or individuals, but rather are typically composed of the debt that companies incur after being taken over by a private equity firm. [BetterMarkets]   Right! We are not speaking of loans to small business firms on Main Street, no matter how much obfuscatory palaver is applied by the Republican allies of the Wall Street Casino Major Players – this is about allowing banks to play with debt incurred during when private equity firms take over a company.

This isn’t about your neighborhood bank either.  Only four banks (Wells Fargo CLO Holdings, Citigroup CLO Holdings, State Street CLO Holdings) have 69% of all CLOs.  Nor is this a minor item, because the total U.S. bank CLOs add up to about $85 billion. [BetterMarkets]  Many crocodile tears have hit the floor from the faces of the Financialist collaborators in Congress about those “poor little neighborhood banks, distressed by government regulations,” to which we might say, “Horse Pucky.”  Why don’t the CLO Holdings want to comply with the Volcker Rule?

“The Volcker Rule prohibits proprietary trading and limits bank ownership of hedge funds. Bank investments in CLOs have the potential to be both a proprietary position and an investment in hedge funds because investing in a CLO is functionally identical to owning part of a hedge fund that invests in leveraged loans. Importantly, the Volcker Rule already provides both ample time to divest these sought-after instruments, and a variety of ways to bring existing CLOs into compliance with the rule. Specifically, CLOs backed entirely by loans are excluded from the Volcker Rule and many CLO holdings are not considered “ownership interest” under the Volcker Rule.” [BetterMarkets] (emphasis added)

In short, when a bank is trading in CLOs for its own direct gain, and not on behalf of any customer, and when it’s trading in funds which are composed of some loans, and a basket-load of other Stuff – sovereign debt, junk bonds, structured derivatives, credit default swaps – it would have to sell off the CLOs if they involve “high risk activity.”  “High Risk Activity” is pretty-speak for junk.  Also, when we hear bankers lament that they’d have to sell off their not-so-pretty CLOs at “fire sale prices” if they had to comply with the Volcker Rule sooner rather than later, we should not waste a whole box of tissues immediately.

Wall Street CLO funds which are not in compliance will be almost gone by 2019 – having been either matured or redeemed – so why worry? [LeveragedLoan] First, there’s that “almost” part. The idea behind the Volcker Rule was that banks should not be allowed to play with depositors’ money in the Wall Street Casino. Period. So the notion that having just a few “non-compliant” CLOs (those made up with pounds of junk included) isn’t acceptable. Period.

Secondly, it’s not like the leveraged loan business is slacking.  U.S. CLO issues hit $124 billion in new issues from 234 deals in 2014, up from $83 billion in 2013, and “blowing through” the previous $97 billion high in 2006. [LeveragedLoan]  Could someone be counting on another four years to do some back-door proprietary trading while waiting for the front door (Volcker Rule) to close?  Might a few of the Wall Street Bankers be counting on the fading memories of Main Street and Elm Street, so that as the memory of the Banking Debacle of 2007-2008 wafts off to the horizon they can go back to their Casino Business As Usual? [BetterMarkets]

It’s important to remember at this point that the CLOs based solely on loans and therefore  excluded from the Volcker Rule aren’t the beneficiaries of the services of the House of Representatives in voting for H.R. 37.  That would be the Junque Boutique CLOs padded with credit default swaps, structured derivatives, sovereign debt, and good old fashioned junk bonds that are the primary beneficiaries of Congressional largess, or exactly the financial products that got Wall Street in trouble the last time.

So, who from our Silver State voted to coddle the non-compliant CLO Holdings, to protect the managers of highly questionable funds with highly questionable holdings? And, to put the taxpayers on the hook for any fall out when this latest house of cards collapses?   The Big Banker Roundtable of High Flying Traders – with other peoples’ money – will want to thank: Representative Joe Heck (R-NV3), Representative Mark Amodei (R-NV2), and Representative Cresent {Does He Really Even Understand This Stuff?} Hardy (R-NV-Bundy Ranch).  Representative Dina Titus (D-NV1) had the good sense to stand with Main Street and Elm Street on this one.

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