As the unshakeable solidity of the world’s financial markets turns out to be a castle in the sky, we all wish someone had warned us about collateralized debt obligations (CDOs) and the dangers of securitization, before it was too late.
But wait…I did! When I was a young cub reporter covering the securitization market back in 2001, I wrote an article for Euromoney called The Hidden Risks of Synthetic CLOs. CLOs are collateralized loan obligations, whereby banks package loans such as mortgages into off-balance-sheet investment vehicles, then sell them on investors.
I warned, “if there is a stain on the ABS market’s halo, it is CLOs and synthetic CLOs…The danger is that the loans or the risk sold off will come back to haunt the banks. Says Charles Peabody, a banking analyst at Mitchell Securities in New York: “CLOs are just financial engineering that hide most of the risk that banks are taking. I call them CLOWNs – collateralized loan obligations worth nothing. US and European banks’ increased use of CLOs represent a definite danger to banks. They’re a risk that the system cannot afford to take now.”
I also said: “Another, wider, danger for investors, and indeed for the banking system at large, is the opacity and complexity of synthetic CLOs. Says Drayson: “Many investors don’t understand synthetic CLOs.” Nor do many CEOs or CFOs.”
I remember the article well, because after it was published, I was rung up by the head of CDOs and CLOs at a bank – he was American, I think the bank was Morgan Stanley, and I was subjected to a sort of verbal leg-breaking by him and his colleague, who told me I didn’t know what I was talking about and was basically a disgrace to journalism. It was bruising.
Well, I don’t want to brag, but ha! Now many commentators are saying that CLOs are a serious mess, and are going to cost banks billions of dollars.
Looks like I was right and the overpaid banker was wrong! Collateralize that, buster.
