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March 11, 2014

A recent headline in The American Banker, a trade publication, stated the industry’s view of CLOs when it set forth: “HOW DODD-FRANK MIGHT KILL THE C.L.O. MARKET.” The Republican House, ever obedient to bankers with lots of money for campaign contributions, held a hearing recently to discuss this serious issue, apparently more serious than the Ukraine standoff and economy-killing wage inequality, both of which are nothing compared to a potential loss of banking profits, one must understand. So should ordinary citizens don mourning garb if it dies? Freed of risk, I would applaud at the funeral.
At the Republican House subcommittee meeting recently called to examine this serious invasion of private enterprise by those “socialist” regulators, testimony was heard from four of the big banks’ lobbyists and one lone defender of Dodd-Frank. The banks’ lobbyists, recognizing that big banks are not popular these days because of such things as bribing Chinese officials and laundering Mexican drug gangs’ money, told the friendly subcommittee that any threat to the C.L.O. market is actually a dagger pointed at midsize businesses, which would have trouble in finding capital as a result. The U.S. Chamber of Commerce provided written testimony to the subcommittee which expressed “serious concerns that the regulators had failed to take into account the impact of the Volcker Rule upon the capital formation of Main Street businesses,” adding ominously that “it may only be the first wave of capital formation problems that may crop us as a result of the Volcker Rule.”
This pretended concern for Main Street and capital formation is, of course, a cover for the big Wall Street banks to continue playing the CLO game, a game which HIDES EMBEDDED SYSTEMIC RISK to you and me, the same game (along with other such games) that nearly brought the world down in 2007-2008. The lobbyists’ testimony in truth had nothing to do with mid-size capital formation etc.; it had to do with preserving the CLO market for the big banks. What the lobbyists did not testify to is the fact that only three of several of the banks that are “too big to fail” control 71 percent of bank C.L.O. holdings – JP Morgan Chase, Citigroup and Wells Fargo, who not only make money from participation in such business but are paid fees and commissions to put them together in the first instance and run them.
The sole individual testifying before the subcommittee in favor of Dodd-Frank as applied to CLOs was a Georgetown professor, Adam Levitin. He correctly noted that the C.L.O. market hides embedded systemic risk for all of us and that when banks create and market such paper, there is an implication that the banks are backing them, but they do not. Investors who rely upon such an implied guarantee because banks have on occasion bailed out affiliated entities in the past would be bankrupted if we have another 2007-2008 experience. He also said that ultimately taxpayer-funded deposit insurance would bail out the banks making these purely speculative investments – the very situation the Volcker Rule was designed to end. You and I would again be subject to bailing out the big banks though it would be the banks that take the risk while we once again play passive stakeholders. The banks would once again have privatized the profit and socialized the risk. They win; we lose.
So will the Volcker Rule ruin the C.L.O. market and bring on meltdown of capital formation for middle-sized American businesses – as asserted by the big banks’ hacks? Propaganda. As with other asset-backed securities markets (such as the one for bundles of credit card loans recently altered by international regulations which have made them safer), all the big banks have to do is alter their contracts so that their CLOs conform to the Volcker Rule. Big deal! We win; they’re regulated. GERALD E


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