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Here’s Why I Haven’t Been Sleeping Well Lately: A Thread on Derivatives

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Just reading this retweet from Steve Keen by a former derivatives trader . I've not seen the derivative situation mentioned on hpc for a while... 

Here’s Why I Haven’t Been Sleeping Well Lately: A Thread on Derivatives



So what’s the big deal?

Moody’s downgraded 20% of the underlying loans in the CLOs at the end of April, & put $44 billion additional on watch for further downgrade. This could end up downgrading the CLOs, which in turn could grade them as junk (40% are currently investment grade)

13 May

Looking deeper, Fitch ratings anticipates $80 billion (15% of the CLO market) to default. To compare, in 2009 they stated $78 billion would fail. 14% of these CLOs are due by the end of the year, with a total 35% due by 2021.

13 May

Let’s go back to 2007: the CDO market (re: CLO’s sister from The Great Recession) was $640 billion. Today, the CLO market is $1.4 trillion. To translate, that means *much* more room for defaults across the board.

13 May

So tying this back to why I care: Where are the CLOs created? Debt from companies with less-than-perfect credit: airlines, hotels, restaurants, and entertainment are currently the most troubled CLOs.

13 May

Here’s what could happen: Companies go bankruptLenders will be unpaid due to poorly-written covenantsLoans in the CLOs begin to downgradeCLOs get rated junkThe $1.4 trillion market becomes illiquidMarket crashes

13 May

I will be watching the CLO market in May & June, as I really believe this quarter will determine the extent of the damage. We already see a lot of companies filing for bankruptcy, it’s just a matter of how the government works to contain the damage and keep markets liquid.


13 May

It’s not as easy as saying these defaults will automatically cause a crash. CLOs have risk that is attached to the bonds which price them. Since bondholders take the default risk on these, and banks tend to be the sellers... there’s a lot of opacity to the overall market damage


13 May

I envision lots of money spent on saving the insurers of the CLOs in addition to big banks needing yet another bailout... sounds familiar, right?


Edited by Saving For a Space Ship
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