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Replies to post #468068 on Fannie Mae (FNMA)
Bill—I did. I’ve found Steve to be an astute observer of our financial scene, and I always read his columns when I see one of them.
Today’s column (“The Junk Debt That Tanked the Economy? It’s Back in a Big Way”) addressed what he believes is an emerging bubble in “leveraged loans,” which are loans made by banks to companies with lots of debt, and which then are sold to investors through “collateralized loan obligations,” the generic equivalent of the collateralized debt obligations (CDOs) that fueled the mortgage bubble and in my view (and that of many others) caused the financial crisis.
I thought Pearlstein had two convincing observations. His first was that even though the credit quality of leveraged loan packages has deteriorated significantly in the last couple of years, money continues to pour into them because hedge funds and private equity firms—who earn 20 percent of investors’ profits when things go well and give back nothing when they don’t—are putting unsophisticated retail investors into them. That will not end well.
I knew this first fact, but the second key point in Pearlstein’s article was new to me. That was the decision by three judges in the D.C. Court of Appeals (which included Supreme Court nominee Brett Kavanaugh) that collateralized loan obligations could be exempted from the requirement in Dodd-Frank that they retain a 5 percent interest in the securities they issue. According to Pearlstein, the argument that won the day for the CLOs was that because CLO managers can earn bonuses if their investments perform well, they don’t need to retain an interest in them to guard against their losing money. I found that to be astounding: the judges essentially said that being able to make a large amount of money in good scenarios while still making some money in disastrous ones is sufficient discipline against taking excessive risk that real “skin in the game” isn’t necessary. That doesn’t pass the laugh test. Pearlstein pointed out that all three judges in this case—none of whom have any background in the subject matter—have a long association with the Federalist Society. Wait; where have we seen that before? Oh, yes, the decision in the Perry Capital appeal. Rather than rule objectively on the facts of the case, better to check in with your ideological buddies and ask, “What’s the right answer to this one?” and go that way. Oddly enough, it’s not much comfort to learn that Perry isn’t the only recent decision that uses fun-house mirrors to produce a result that gives the Financial Establishment what it asked for.
