2018-10-21 — nytimes.com
A financial assembly line that went haywire a decade ago and contributed to an economic crisis is gearing up again on Wall Street.
Back then, one of the products the banks churned out -- bondlike investments based on thousands of mortgages -- proved far riskier than most banks, investors and regulators had expected when many borrowers couldn't pay. The banking system froze, a financial panic ensued, and the country experienced its worst recession in decades.
This time around, a similar kind of investment, called C.L.O.s, are at the heart of the boom. And that's not the only parallel: The loans are being made to risky borrowers, lending standards are dropping fast, and regulators are easing the rules... this time, the underlying loans aren't going to high-risk homeowners. They're going to high-risk companies.
... demand for C.L.O.s has been so strong that investors aren't placing as many requirements on the loans being made to these risky borrowers... Nowadays, the vast majority of leveraged loans [are] so-called covenant lite loans [which] now account for roughly 80 percent of the new leveraged loans on the market.
And when loans are repackaged and sold, most of the money effectively comes from the investors, not the banks. And there's a tendency to be less careful when lending other people's money. This incentive problem was at the heart of the lending that led to the last financial crisis.
To fix that problem, the Dodd-Frank financial regulation law required the loan packagers to retain some of the risks of the investments they created.
But those rules have been weakened this year. A court decision exempted some of the firms that create C.L.O.s from a requirement that they hold at least 5 percent of the credit risk in such investments. The Federal Reserve and the Securities and Exchange Commission declined to appeal the decision.
... while people in the C.L.O. business point out that these assets fared pretty well during the last recession, nobody knows how the investments will perform when the next downturn comes.
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