- Reaction score
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Potential bad news for the US, and thus by extention the global economy. Essentially, the banking industry learned nothing from the 2008 market meltdown, and are now investing heavily in similar investment vehicles backed by low rated corporate debt instead of mortgages. What could possibly go wrong?
https://www.theatlantic.com/magazine/archive/2020/07/coronavirus-banks-collapse/612247/
The Looming Bank Collapse
The U.S. financial system could be on the cusp of calamity. This time, we might not be able to save it.
Story by Frank Partnoy
The rest of the article goes into more depth about what these are, how they work and how banks and financial institutions are resorting to many fo the same accounting tricks to put these assets "off the books" (although this didn't help anyone the last time).
So among the multiplicity of challenges that the United States will have to face in the coming decades, another banking implosion, or finding a way to unwind this potential threat and deter banks from going down this route again is going to be a high priority.
https://www.theatlantic.com/magazine/archive/2020/07/coronavirus-banks-collapse/612247/
The Looming Bank Collapse
The U.S. financial system could be on the cusp of calamity. This time, we might not be able to save it.
Story by Frank Partnoy
After months of living with the coronavirus pandemic, American citizens are well aware of the toll it has taken on the economy: broken supply chains, record unemployment, failing small businesses. All of these factors are serious and could mire the United States in a deep, prolonged recession. But there’s another threat to the economy, too. It lurks on the balance sheets of the big banks, and it could be cataclysmic. Imagine if, in addition to all the uncertainty surrounding the pandemic, you woke up one morning to find that the financial sector had collapsed.
You may think that such a crisis is unlikely, with memories of the 2008 crash still so fresh. But banks learned few lessons from that calamity, 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.
The financial crisis of 2008 was about home mortgages. Hundreds of billions of dollars in loans to home buyers were repackaged into securities called collateralized debt obligations, known as CDOs. In theory, CDOs were intended to shift risk away from banks, which lend money to home buyers. In practice, the same banks that issued home loans also bet heavily on CDOs, often using complex techniques hidden from investors and regulators. When the housing market took a hit, these banks were doubly affected. In late 2007, banks began disclosing tens of billions of dollars of subprime-CDO losses. The next year, Lehman Brothers went under, taking the economy with it.
The federal government stepped in to rescue the other big banks and forestall a panic. The intervention worked—though its success did not seem assured at the time—and the system righted itself. Of course, many Americans suffered as a result of the crash, losing homes, jobs, and wealth. An already troubling gap between America’s haves and have-nots grew wider still. Yet by March 2009, the economy was on the upswing, and the longest bull market in history had begun.
To prevent the next crisis, Congress in 2010 passed the Dodd-Frank Act. Under the new rules, banks were supposed to borrow less, make fewer long-shot bets, and be more transparent about their holdings. The Federal Reserve began conducting “stress tests” to keep the banks in line. Congress also tried to reform the credit-rating agencies, which were widely blamed for enabling the meltdown by giving high marks to dubious CDOs, many of which were larded with subprime loans given to unqualified borrowers. Over the course of the crisis, more than 13,000 CDO investments that were rated AAA—the highest possible rating—defaulted.
The reforms were well intentioned, but, as we’ll see, they haven’t kept the banks from falling back into old, bad habits. After the housing crisis, 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. There are more than $1 trillion worth of leveraged loans currently outstanding. The majority are held in CLOs.
The rest of the article goes into more depth about what these are, how they work and how banks and financial institutions are resorting to many fo the same accounting tricks to put these assets "off the books" (although this didn't help anyone the last time).
So among the multiplicity of challenges that the United States will have to face in the coming decades, another banking implosion, or finding a way to unwind this potential threat and deter banks from going down this route again is going to be a high priority.