Regular readers of this blog know that on Wall Street, greed is considered good. Big banks keep on repeating the mistakes of yesterday. Never mind the often, disastrous consequences that follow.
In fact, one of the biggest mistakes, high-risk collateralized debt obligations, CDOs, is once again on the rise after years of decline following the 2008 financial crisis.
Investment banks create CDOs by pooling together assets that generate a cash flow. The bankers then cut up the pool into tranches, or slices, and sell it to investors. According to website Investopedia, a CDO is so-called because the pooled assets – such as mortgages, bonds and loans – are essentially debt obligations that serve as collateral for the CDO.
“In a Blast From a Financial Crisis Past, Synthetic CDOs Are Back” was the alarming headline of an article at the end of August in the Wall Street Journal.
“The synthetic CDO, a villain of the global financial crisis, is back,” the Journal reported. “A decade ago, investors’ bad bets on collateralized debt obligations helped fuel the crisis. Billed as safe, they turned out to be anything but. Now, more investors are returning to CDOs—and so are concerns that excess is seeping into the aging bull market.”
Remember, the federal government spent hundreds of billions of dollars bailing out Wall Street banks after the mortgage bubble burst and the CDO market collapsed. Remember “Too Big to Fail”? CDOs were at the center of that story.
During the financial crisis, synthetic CDOs became a symbol of the financial excesses of the era, according to the Journal. Labeled an “atomic bomb” in the movie “The Big Short,” they ultimately were the vehicle that spread the risks from the mortgage market throughout the financial system.
In the U.S., the CDO market sank steadily in the years after the financial crisis and has remained fairly flat since 2014, the Journal reported.
The concern is offshore. In Europe, the total size of the market is rising again—up 5.6% annually in the first quarter of the year and 14% in the last quarter of 2016, according to the Securities Industry and Financial Markets Association. Investors chasing yield or large institutions like pension funds and hedge funds are clamoring for CDO investments. Big banks, Goldman Sachs, J.P. Morgan and Citigroup are leading the charge in selling these highly risky investments.
“Perhaps the most surprising twist is Citigroup itself,” according to a Bloomberg report about the burgeoning market for CDOs from the end of September. “Less than a decade ago, the bank was forced into a taxpayer bailout after suffering huge losses on similar types of securities tied to mortgages. Now, many in the industry say Citigroup is responsible for over half the deals that come to market, though precise numbers are hard to come by.”
“And other Wall Street banks, which shunned the market since the crisis or struggled to establish a foothold, are angling for a bigger slice of the action,” Bloomberg concluded.
The Trump administration is working feverishly to roll back financial regulations put in place after the financial crisis, particularly constraints on risk-taking and borrowing. If another financial crisis hits, it is likely investors will face it without consumer protections President Obama and the Democrats in Congress created in 2009 and 2010.
If it feels like we’ve seen this disaster flick, it’s because we have. Unfortunately, Wall Street seems to learn nothing from history.
Zamansky LLC are investment and stock fraud attorneys representing investors in federal and state litigation and arbitration against financial institutions.