When Regulation Threatens, Bankers Predict Doom For Main Street - ProPublica

When Regulation Threatens, Bankers Predict Doom For Main Street - ProPublica

"Collateralized loan obligations, as the acronym is known, are bundles
of loans, usually made to junk-rated companies. They use the same
techniques as collateralized debt obligations, which were often made up
of subprime mortgage investments and were the rotten core of the
financial crisis. C.L.O.’s caused billions in losses for banks during
the market panic of 2008, but most recovered strongly and memories
faded. Junk-rated companies rallied, and C.L.O.’s roared back.


Under the Volcker Rule, which prevents banks from making speculative
investments or owning large pieces of hedge funds or private equity
firms, some C.L.O. holdings might be prohibited. Some C.L.O.’s own
securities or bonds, and those are considered more speculative. (In a
regulatory quirk, bonds and loans get different regulatory treatments.)
Some C.L.O.’s give certain investors the ability to remove the manager
that makes the C.L.O.’s investment decisions. That could be construed as
a form of ownership control, which would bar banks from participating
under a strict construction of the Volcker Rule.


The banking industry has been making loud noises about how the
uncertainty could have dire consequences. As with the TruPs ruckus, the
big banks have defended their interests in the name of smaller and more
sympathetic entities. According to the banking lobby and its friends in
Congress, any threat to the C.L.O. market is actually a dagger pointed
at midsize businesses, which will have trouble finding capital as a
result. In written testimony to the House subcommittee, a United States
Chamber of Commerce representative 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 up as a result of the Volcker Rule.”


Like the TruPs fight, and countless other similar Washington
showdowns, this skirmish is largely about preserving a market for the
largest banks. Just three “too big to fail” banks — JPMorgan Chase,
Citigroup and Wells Fargo — account for 71 percent of bank C.L.O.
holdings, according to Better Markets, the banking reform group. And the
large banks get fees from creating the deals.


And so banking interests have massed their forces to preserve this
business. At the House subcommittee hearing last week, four industry
representatives counterbalanced a lone professor from Georgetown Law School, Adam J. Levitin, who was tasked with defending Dodd-Frank.


Professor Levitin’s testimony made clear what the central public concern is here: The C.L.O. market hides embedded systemic risk.
When banks sponsor C.L.O.’s by creating and marketing them, they imply
that they back them without actually doing so. Investors rely on this
implied guarantee because banks have bailed out comparable affiliated
entities in the past. Ultimately, Professor Levitin argued,
taxpayer-funded deposit insurance backstops the banks making these
potentially speculative investments — exactly the thing the Volcker Rule
is supposed to end."