Collateralized Loan Obligation - CLO

Financial securitization and risk maximization reached peak bananas during the 2008 financial crisis, thanks to the creation of collateralized mortgage obligations (CMOS). Securitization has been a dirty word for a decade, but Wall Street is still finding ways to bundle loans and create more products for income-starved investors due to the Fed’s Zero Interest Rate Policy (ZIRP).

Collateralized loan obligations are similar to (CMOs), but consist of different types of loans, and originate from other sources. In this case, CLOs usually take company and banking loans and put them into bonds that provide different risks and rewards. Designers and sellers of CLOs tell wealthy investors that they can obtain double-digit incomes, that these instruments perform well even when interest rates rise, and that they originate from companies that have low default rates.

Of course, that was the same pitch for CMOs, until people started building products that were constructed with crappy loans and higher default likelihoods. So, once managers run out of loans of higher-rated business loans to collateralize, they could start tapping into loans with higher default risks and higher likelihood of losses. It’s probably already happening.

In 2018, a Federal judge lifted a “skin in the game” rule that forced financial firms to own a share of their risk. A Dodd-Frank rule had made CLO assembly more expensive and forced banks to own a stake in the bonds they created to prevent them from bundling risky loans.

No such rule now exists.

So, if there are more risky loans bundled and a corporate bond crisis ensued, a lot of these things would then...implode. If there’s one thing we know about Wall Street, it’s that greed has no memory.

Now, run. Tell no one. Start burying money in the walls.