The Wall Street Journal, Greenspan, Milken, and the Next Bubble

Today’s Wall Street Journal has a good article regarding Collateralized Loan Obligations, which are bundles of loans which are then divided up according to the degree of risk. The CLOs allow companies taken over by private equity operators to float the enormous debt that makes the deals work.

The most risky parts of the securities pay very high interest rates, which make them appealing to pension funds that want to register high rates of return — the problem is they’re very risky. My own pension fund, California’s Public Employee Retirement System, which has a very good record, is putting money into these very risky investments. I assume it is not a major portion, but it lost a bundle on Enron.

The article cites two authorities supporting the CLOs:

“CLOs have been lauded by former Federal Reserve chairman Alan Greenspan and others for dispersing risk. Michael Milken, whose underwriting of junk bonds at Drexel Burnham Lambert Inc. during the 1980s ignited that decade’s buyout boom, has said that CLOs are among the most important financial innovations of the past quarter century.”

Milken, of course, went to jail for his shenanigans, but remained a billionaire. Greenspan for all his supposed genius earned $40,000 for writing a letter in support of Charles Keating’s Lincoln Savings and Loan. He also recommended variable-rate mortgages as beneficial for consumers — some of which no doubt have lost their homes.

So, perhaps we should take Journal’s warning to heart, and be leery of the impending consequences are bursting bubble.

Ng, Serena and Henny Sender. 2007. “CLOs Spark Worries of Volatility and Risk; Loan Standards Loosen.” Wall Street Journal (26 June): p. A. 1

6 comments so far

  1. brian ranson on

    This is a diatribe without the benefit of facts or analysis. Does Greenspan’s letter mean that his statement on variable rate mortgages is incorrect? Of course not, but that is the implication. Does the fact that there are defaults on variable rate mortgages mean that the instrument itself is wrong or inappopriate? Again of course not.
    Similar considerations apply to Michael Milken. Does the fact that he stayed a “billionaire” (probably not true) mean that his comments on CLOs are wrong? If you want to comment on economics it might be best to use facts rather than innuendo.

  2. mperelman on

    Brian, there is a place for variable rate mortgages. suppose you are about to graduate with a Harvard MBA. You don’t have much money now, but soon you will be rolling in cash. Variable rates would make sense.

    If you are financially unsophisticated — as many of the purchasers probably were — and you don’t know about the risks, then the answer is different.

    If an industry preys upon the latter type of person, one cannot applaud it.

  3. xztheericzx on

    i’m eric. joining a couple boards and looking
    forward to participating. hehe unless i get
    too distracted!

    eric

  4. oOgerryOo on

    Hello,
    I’m Gerry.

    Just saying hello – I’m new.

  5. RaiulBaztepo on

    Hello!
    Very Interesting post! Thank you for such interesting resource!
    PS: Sorry for my bad english, I’v just started to learn this language😉
    See you!
    Your, Raiul Baztepo

  6. PiterKokoniz on

    Hi !!!!😉
    I am Piter Kokoniz. Just want to tell, that I like your blog very much!
    And want to ask you: what was the reasson for you to start this blog?
    Sorry for my bad english:)
    Thank you:)
    Your Piter


Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

%d bloggers like this: