Leveraged buyout loans are the new mortgage-backed securities
Understanding the banking crisis
The real estate bubble ninjas
Share prices plummeted on Monday, September 15, 2008. The real estate bubble had burst, Lehman Brothers was bankrupt. However, this is only the abbreviated version of the story and it does not yet show why it has come so far.
It all began with banks approving loans for house construction even for customers who could not actually afford them. These included not only U.S. citizens with low incomes, but also citizens without jobs. The loans that went to borrowers without jobs were called ninja loans: no income, no job, no assets.
Until then, borrowers had been able to pay off their mortgages with new loans thanks to rising house prices. The house of cards of all the cheap money only collapsed when interest rates rose again and borrowers could no longer repay their loans.
In addition, the banks were taking ever higher risks. Trading in loans was intended to generate further profits. Mortgages with good, medium and poor credit ratings were bundled into securities. These were called mortgage-backed securities.
As if the whole thing couldn’t get any crazier, these MBS were combined in securities to form collateralized debt obligations (CDOs). The critical thing was that these were combined with other financial products or mortgages of different credit ratings. These CDOs were then sold back to investors. At some point, no one knew what was actually contained in these CDOs or who owned the receivables they contained. In some cases, even banks invested in CDOs that contained their own receivables.
Thinking it couldn’t get more speculative, the CDOs were turned into synthetic CDOs.
The iceberg that sank the Titanic
While the MBSs were the tip of the iceberg, the CDOs and the synthetic CDOs were the part of the iceberg floating underwater. The part that the passengers of the Titanic did not see.
Synthetic CDOs are a special form of asset-backed securities. In principle, it is like synthetic ETFs that do not buy the “physical” shares but mirror the value via so-called swaps. In the case of CDOs, these are credit default swaps. Depending on the risk, the profit on these products differs.
Let’s remember again that the CDOs contained loans of different credit ratings and, moreover, the banks often did not know what was included in these CDOs and from whom. In order for the securities to sell well, they were given good ratings by rating agencies. As a result, they could be sold worldwide without any problems.
When house prices began to fall, many properties were foreclosed and loan defaults occurred. As a result, banks had to make depreciations in the billions.
The banks no longer trusted each other. Consequently, no more money was lent and the 2008 financial crisis took its course.
Fast forward 2023
The same thing has now been done again. Only this time with so-called leveraged buyout loans.
Suppose a company wants to take over another company, but has too little money. Due to the cheap money of the low interest rate policy of the central banks in recent years, the banks have nevertheless financed a loan to these companies. This means the companies had to provide very little equity for the takeover.
If someone has a good idea for a name á la ninja loans for these loans — feel free to share it in the comments.
These loans, of course, have a high risk. After all, whether the acquisition makes financial sense or whether the companies are solvent is no more important than it was for home loan borrowers in 2008.
To spread the risk, packages were again put together in which the loans were collected so that they could then be sold to investors. Investors were assured of interest rate guarantees for this investment.
The parallels to 2008 are striking.
If you mix these financial products with high inflation, supply chain problems and high interest rates, you get a cocktail that can become very toxic for an economic system.
The market for leveraged buyout loans has collapsed and the products can no longer be sold. This means that no investor wants to take this risk anymore and the banks and investors are now sitting on these packages.
Current situation regarding CrediteSuisse
This has a corresponding effect on the balance sheets of the banks. The first effects of this can currently be seen in the news regarding e.g. CrediteSuisse.
As of March 20,2023, CrediteSuisse is to be bought up by UBS Bank for 3 billion euros. It is supported by the Swiss National Bank with a cash injection of 101 billion euros. In a nutshell, this means that money that does not exist is buying an overindebted bank.
Welcome to the world of leveraged buyout loans.
Let’s hope there won’t be a synthetic version of these packages full of leveraged buyout loan.
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Disclaimer: The information contained herein is for informational purposes only. Nothing herein shall be construed to be financial, legal or tax advice. The content of this text is solely the opinions of the speaker who is not a licensed financial advisor or registered investment advisor. The author does not guarantee any particular outcome.
