Greetings Traders:
I hope the fathers among you are enjoying a great Father's Day. I especially hope those doing dad duty without the title are enjoying the day... yours is heroic effort.
I'd leaned back from writing this Sunday email for the last few weeks... - I got busy as I stepped in to help run a non-profit I've been working with for a few years...
- 'rona turned me into an unwitting [terrible] educator... if you never hear it again, you heard it here... teachers don't make nearly enough money
- And I've had mixed feelings about all of the inequality protests and marches... and by that I mean #defundthepolice? That may just be a tagline, but it's irresponsible and short sighted in my view... but that's just me
- It's a lot of work putting together a big email on Sunday...
At any rate, the message in this email is important and I wanted to get it to you guys, so here we are. What follows is a summary of sorts... You can find the link to the referenced article below.
A little over a decade ago, millions of Americans suffered long-term financial pain because of the Great Recession and the crash of September 2008. Maybe even some of you… Now, the coronavirus pandemic is inflicting additional pain on millions of Americans, and a UC Berkeley law professor Frank Partnoy warns that another banking crisis is a strong possibility.
After months of living with the coronavirus pandemic, we’re all well aware of the toll it’s taken on the economy:
- broken supply chains,
- record unemployment, and
- failing small businesses
All of these factors are serious...devastating even... and could mire the United States in a deep, prolonged recession. But, according to Partnoy, there's another threat to the economy lurking on the balance sheets of the big banks. Imagine if, in addition to all the uncertainty surrounding the pandemic, you woke up one morning to find that the financial sector had collapsed.
Partnoy goes on to explain why he fears that possibility. Banks, according to Partnoy "learned few lessons from" the "calamity" of the "2008 crash" — and "new laws intended to keep them from taking on too much risk have failed to do so. As a result, we could be on the precipice of another crash, one different from 2008 less in kind than in degree. This one could be worse."
In 2010, Partnoy notes, Congress passed the Dodd-Frank Act "to prevent the next crisis." But one financial instrument that, according to Partnoy, has become problematic is what is known as a CLO or "collateralized loan obligation" — not to be confused with a CDO or collateralized debt obligation.
"After the housing crisis," Partnoy notes, "subprime CDOs naturally fell out of favor. Demand shifted to a similar — and similarly risky — instrument, one that even has a similar name: the CLO or collateralized loan obligation.”
A CLO walks and talks like a CDO, but in place of loans made to home buyers are loans made to businesses — specifically, troubled businesses. CLOs bundle together so-called leveraged loans, the subprime mortgages of the corporate world. These are loans made to companies that have maxed out their borrowing and can no longer sell bonds directly to investors or qualify for a traditional bank loan.
Got that? These are loans to businesses to whom no one wants to lend money...
In December 2019, the Financial Stability Board estimated that, for the 30 “global systemically important banks,” the average exposure to leveraged loans and CLOs was roughly 60 percent of capital?
Partnoy observes that CLOs have been "praised by Federal Reserve Chair Jerome Powell and Treasury Secretary Steven Mnuchin for moving the risk of leveraged loans outside the banking system." But according to Partnoy, that doesn't mean that they aren't risky.
Partnoy wraps up his Atlantic article on a troubling note, warning that the financial problems resulting from the coronavirus pandemic could become even worse if large banks are allowed to take dangerous risks.
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