> But to be fair, these aren't quite the same as the repackaged Bolivia and
> Peru loans of the late 20s, are they?
Agreed, the biggest difference is that today, loans are repackaged together, so single borrower risk is diversified, and the deal sizes are smaller. Still, the repackaged emerging market loans that were sold in the form of CDOs in the mid-late 90s, mostly to Swiss Banks included sizeable exposures to Russian paper, which defaulted.
> I thought the securitization
> process considerably reduced the risk, so that while mortgagee backed
> securities are high risk high gain compared with money market funds, and
> thus shouldn't have been sold to retirees as they were during the 80s,
> they aren't in themselves considered flaming disasters that no one in
> their right mind would hold. I remember how fobbing off bonds that were
> considered too bad to sell earned you the sobriquet of Big Swinging Dick
> in Liar's Poker, but I thought those sales were to large and usually
> institutional investors. Wasn't the sale that earned the author that
> nickname a French institutional investor?
True, CMO's were tranched or sliced into different risk buckets that were sold individually, mostly to institutional investors - like asset management companies, some insurance companies, and banks. The French and British institutions were probably most active in purchasing mortgage and asset backed products in Europe, and the asset managment firms and banks in the US. In my own experience, the biggest buyer of CMOs in Europe was Abbey National - the bank.
The tradition of fobbing off toxic bonds continues. As does the tradition of 'no bid back' for toxic bonds once they are sold.
The 90's CDOs or collateralized corporate debt packages are far more risky than CMOs even though the financial engineering is similar. First, usually the number of bonds or loans or credit derivatives backing them are fewer. Typically you can do a deal with 100 names. The equity of these CDOs, or the most risky tranche, was sold primarily to insurance companies (who were supposedly better equipped to understand the inherent credit risk), but also to banks with retail customers. One of the Hawaiian banks, for example, sued Bear Stearns for selling them CDO equity that tanked.
Second, CDOs are sold on the basis of expected default rates. But, they're constructed and marketed to investors at lower than realistic default rates, like on a 2% default rate expectancy - for HIGH YIELD names. All outstanding CDOs, which together hold more than 1/3 of the high yield bonds and loans that were issued since the mid-late 90s, are performing abysmally. And, no investment bank or bank that created them will buy them back. When I was at Bear in Europe, we sold these US bond CDOs to commercial banks, like Kredietbank in Belgium who sold them to retail investors in conjunction with high return savings accounts. Additionally, they were sold to huge insurance companies like Axa in France and INA in Italy, to up their returns in order to make payouts on pension funds that declining government bond rates and returns could no longer cover - this between 97-99 mostly. CDOs also consisted of bank loans that banks wanted off their balance sheets. For example, one of the first big corporate loan CDOs was constructed by JPM, it was called Bistro, and it was sold out of their British subsidiary to non-US investors to avoid US regulatory treatment. The first CDOs in general, started in 1995, and included bad Emerging market bonds and loans.
>
> >issuance and deposit / loan business was split up.
>
> Right, that part I understand. But I thought there was also another
> clause that said banks couldn't invest in stocks the way they can say in
> bonds, specically to protect their capital from plunging if there were
> another crash. Is that just my imagination? I seem to remember people
> saying during the early 90s that those Japanese banks, they were in big
> trouble because they owned lots of stock, but our American banks didn't
> have that problem.
>
No, I think you're right. I have to go back and look up the clause. Still, bank holding companies can definitely invest in stock. I think the Bank Holding Act of 1956 just capped at 5% their exposure to individual stocks of non-financial companies. The Bank Holding Act of 1984 (kind of a deregulated one) allowed for Financial Holding Companies to acquire or control shares, assets, etc. so long as they can show its a bona fide merchant or investment banking activity. Here's a fun link to all you ever wanted to know about the Bank Holding Company Act.
<A HREF="http://www.fdic.gov/regulations/laws/rules/6000-1100.html">http://www.fdic.gov/regulations/laws/rules/6000-1100.html</A>
>
> >Also now, banks can own stocks as assets, but at the holding company
> >level.
>
> Right, but aren't loans still made at the bank level, beneath the holding
> company level? So wouldn't this still stop a loan from being
> collateralized by stock?
Yes. Loans are made at the company or bank level. But, loans to corporate executives, partnerships and special purpose entities can be directly backed by stock - this is now a problem for Bank of America in particular who issued stock backed loans to (among others) Bernie Ebbers at WorldCom, Adelphia's Rigas family and ImClone's Sam Waksal - who actually didn't even own the stock he pledged against the loan.
Loans made to corporations backed by stock are a little less obvious today than before Glass Steagall. Enron for example was loaned over $5 billion by JPM Chase in a series of off-shore deals booked through JPM's Mahonia subsidiary in the tax-exempt Channel Islands. These deals were backed by assets backed by stock. Many of Fastow's special purpose vehicles were the same.
CSFB and DLJ loaned to other energy companies, like El Paso and Williams, indirectly feeding money into special purpose entities, backed by stock and assets. So, though, the link is not direct, it doesn't stop banks lending money to corporate special purpose vehicles backed by stock. For energy companies, the collateral usually included other assets as well. From a risk perspective, though, it's the same thing. From a transparency perspective it isn't. I'm not entirely sure about this, but I don't believe corporations include the debt owed by their special purpose vehicles on their main balance sheets, part of the general fuzzy numbers problem. Nor, is there a limit on banks as to which entities they lend to, beyond their own due diligence of the credit risk.
Nomi
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