Mark Twain once said, “History doesn’t repeat itself but it often rhymes.”

Karl Marx once said, “History repeats itself, first as tragedy, second as farce.”

Which one is right? They are both right in this case.

Those of you who watched The Big Short know that the original instrument of fraud for the 2008 crash was subprime mortgages bundled in a collateralized debt obligation (CDO).

Welcome to 2017.



Rocket-scientist financiers buy up billions of dollars of risky loans and repackage them into complex investments with multiple layers of debt. Credit rating agencies classify the top layers as triple A. Institutional investors, including pension funds and charitable organisations, flock to buy these apparently risk-free yet high-yielding investments. Tension builds. But the year is not 2006 or 2007. It is today. While the US administration talks of repealing Dodd-Frank, the reality is that regulators have been flouting that law for years and now the shadow financial markets are frothing. Almost a decade after the global financial crisis, the sequel has arrived. The central culprit this time is the collateralised loan obligation. Like its earlier esoteric cousins, a CLO bundles risky low-grade loans into attractive packages and high credit ratings. In May, there were two deals of more than $1bn each, and experts estimate that $75bn worth are coming this year. Antares Capital recently closed a $2.1bn CLO, the largest in the US since 2006 and the third-largest in history. Although most of the loans underlying these deals are of “junk” status, more than half the new debt is rated triple A. Sound familiar?

...

Because loan defaults can come in waves, mathematical models should account for “correlation risk”, the chance that defaults might occur simultaneously. But the models for CLOs assume correlations are low. When defaults occur at the same time, these supposed triple-A investments will be wiped out. CLOs are just CDOs in new wrapping.

CDO. CLO. You say "tomato". I say "institutionalized fraud".

You say "potato". I say "systemic risk".

It both rhymes AND is a farce.



Dodd-Frank was supposed to stop these credit-rating ploys. But the Securities and Exchange Commission has permitted the agencies to dodge that law. While Dodd-Frank imposed liability on the agencies for false ratings, the SEC exempted them. Likewise, Congress barred the agencies from getting inside information about issuers they rate, but the SEC permitted that, too. As CLOs grow, the cracks are spreading again...

A new Office of Credit Ratings within the SEC is supposed to provide a check on this appetite. But when I sent a Freedom of Information Act request, seeking to identify which credit rating agencies have been found to violate SEC rules, the regulators refused to divulge names. Violators remain anonymous.

I could say something here about regulatory capture, but then we would have to mention Congress.

So where is this AAA-rated subprime junk coming from? One place is the auto industry.



It’s classic subprime: hasty loans, rapid defaults, and, at times, outright fraud.

Only this isn’t the U.S. housing market circa 2007. It’s the U.S. auto industry circa 2017.

A decade after the mortgage debacle, the financial industry has embraced another type of subprime debt: auto loans. Like last time, the risks are spreading as they’re bundled into securities for investors worldwide.

...Wall Street has rewarded lax lending standards that let people get loans without verifying incomes or job histories. For instance, Santander recently vetted incomes on fewer than 1 out of every 10 loans packaged into $1 billion of bonds, according to Moody’s Investors Service. The largest portion were for Fiat Chrysler vehicles.

Some of their dealers, meantime, gamed the process so low-income borrowers could drive off in new cars, prosecutors said in court documents.

Through it all, Wall Street’s appetite for high-yield investments has kept the loans — and the bonds — coming

I really hate sequels.

Wait a sec. How is this possible? (other than regulators refusing to do their jobs)

Congress passed Dodd-Frank. Wasn't that supposed to stop this fraud?

I've got a joke about this, and the punchline is a real killer.



Back in 2010, when Congress adopted rules designed to limit the lending excesses that contributed to the 2008 financial crisis, auto dealers managed to carve out an exemption for themselves.

Oh goody.

It should be noted here that the real subprime problem isn't auto loans. It's student debt.



As the total student loan debt continues to surge, the quality of borrowers is in steep decline.

The total level of debt for so-called deep subprime borrowers totaled $8.2 billion in the first quarter of 2017, a jump of 32 percent from the same period a year ago, according to SNL Financial citing data from the Consumer Financial Protection Bureau. The category applies to borrowers with less than a 580 credit score....

Household debt overall just recently passed the peak it hit before the Great Recession. New York Federal Reserve figures show total household debt at $12.73 trillion, $50 billion above where it stood in the third quarter of 2008.

Of that total, a record $1.34 trillion is education-related, about 11 percent of which is considered seriously delinquent, or at least 90 days past due.

I should point out that $1.34T is larger than the subprime mortgage market in 2007, which had roughly the same rate of defaults.

But never fear.



Despite the seemingly grim trends, economists are not especially alarmed.

In general, they believe the subprime debt situation shows little danger of spiraling into a similar situation as the financial crisis.

Their complete failure to see the financial crisis coming aside.

Just in case you were feeling nostalgic about the old day, Wall Street has something for you too.



Brokers willing to learn the lost art of making risky mortgages are in demand again. Brandon Boyd was a high school junior during the financial crisis. Now, the former Calvin Klein salesman is teaching mortgage brokers how to make subprime loans...

Now, small and midsize independent lenders want the brokers back. Nonbank lenders that typically cater to riskier borrowers say they need brokers to fan out across the country and arrange mortgages to people with lower credit scores, or who can’t prove their income through a typical tax return.

In the first quarter, nonbank lenders accounted for about half the mortgages originated in the U.S., according to industry publication Inside Mortgage Finance.

Hurray! We've learned absolutely nothing.