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Collateralized loan obligations

Hi Cullen,

What are your thoughts on this?

 

https://www.theatlantic.com/magazine/archive/2020/07/coronavirus-banks-collapse/612247/

 

In brief:

In 2008, households were heavily indebted, and banks disclosed tens of billions of dollars of subprime -CDOs (collateralized loan obligation) losses, leading ultimately to the GFC.

 

This time around corporate are heavily indebted and banks have huge amount of $ of dubious CLOs (collateralized loan obligation) on their balance sheet. With insolvency rate on the rise, there is a possibility that we have another banking crisis in the making, or do we?

 

Always appreciate your feedback.

 

Hi @VJ,

It all depends on how long the virus lasts and how bad things are. For now the govt is holding a lot of things together and the economy appears to be on the mend. But let's say that the govt pulls back the stimulus in Q3 and the virus flares up. Well, we're gonna be worried about a lot more than CLOs and CDOs and other three letter financial products. The whole economy is  gonna be in big trouble in that scenario.

For now, I'd argue that there's one MAJOR flaw in that article - it's not 2007 as the article claims. Right now looks a lot more like Summer of 2009. That is, the big collapse already happened and the economy is recovering. Of course, that depends on the virus though. If this thing gets way worse then all bets are off and it will start to look more like 2007 or 2008. But for now I'd argue that this environment looks more like 2009 and the bears have been way behind the curve betting on a second Great Depression.

Also, one huge difference between now and 2008 is that the Fed absolutely won't let the banking system collapse. Sure, some banks might fail in a worst case scenario but Powell has made it very clear that he won't let the banking system collapse.

I hope that helps.

"Pragmatic Capitalism is the best website on the Internet. Just trust me. Please?" - Cullen Roche

So you are saying in your opinion, they let the banking system collapse in 2008?

Or do you just mean, this time around, no one as big as lehman brothers will be allowed to fail?

Hi @ZACH-ABEL,

We didn't collapse in 2008, but we looked right into the abyss and caught ourselves before we fell in. I was in favor of bigger writedowns and letting more banks fail.

In any case I don't think they'll let us even look into the abyss this time around. The Fed is going to do whatever it takes to avoid another banking crisis. So, even if a Lehman type firm looks vulnerable the Fed will insulate it from everyone else before it becomes a big problem.

"Pragmatic Capitalism is the best website on the Internet. Just trust me. Please?" - Cullen Roche

Makes perfect sense to me, thanks Cullen for your input!