No problem. What happens is that credit hedge funds and Wall Street trading desk hit a computer key, open a new spreadsheet window, wrap it in legal boilerplate, provide this newly minted CLO with a credit line and then start bidding for available LBO paper in the junk loan market. When they have accumulated enough offers, they slice and dice the resulting portfolio of LBO loans, and issue multiple tiers of debt– with these new slices being rated from AAA to junk against the loans listed on the spreadsheet.
So we now have a spreadsheet, a part-time “portfolio manager” and hundreds of millions of the latest CLO toxic waste. For 95 weeks running, there was no want of buyers for this CLO issued paper. In its infinite wisdom, the Fed drove interest rates on CDs and high quality paper to nearly zero—–so the scramble for “yield” was on. Soon Grandpa was being forced to buy a high yield mutual fund in order to pay the light bills.
But now LBO risks are soaring due to recklessly escalating deal prices and also because the LBO kings are stepping-up their patented late cycle cash strip-mining operations in the form of “leveraged recaps” funded with new “cov lite” debt. So even yield starved retail investors have begun to turn tail and run. During the last two weeks there were actually outflows from high yield mutual funds.
That leaves a big gap in the market, however. The CLO jockeys are still banging out new spreadsheets, but buyers for the sliced and diced CLO paper are suddenly getting scarcer. Still, no problem!
Here’s why. Wall Street is back in the business of lending money at the Fed’s gifted rate of zero plus a modest 80 basis point spread—so that the fast money can buy CLO paper on 9 to 1 leverage. There is your triple shuffle.
It didn’t work out last time, but that doesn’t matter because the game is obvious. After enough buying on Wall Street’s triple leverage, junk loan prices might temporarily rebound. Then the brokers will put out the call to retail: The junk loan asset class is rebounding—its time to come back. For the final shearing, that is!
Today’s Wall Street Journal article explains exactly how its being done. Needlessly to say, every one of the big banks back in the business got bailed out last time by TARP and the Fed. They seem to learn something—even if our policy makers never do.