Today’s financial markets look a lot like they were a decade ago. And that can only mean one scary thing: The problems are imminent.

Just as they did for much of 2007 and 2008, before the markets exploded into a crisis of epic proportions, investors in the debt market, which is even larger than the stock market, feverishly seek higher yields and eagerly buy the risky market too much. securities that will provide these returns without charging the appropriate premium for the risks taken. Ten years ago, the high-yield investing of the day pushed by Wall Street was securities backed by mortgages – real estate mortgages packaged and sold as “safe” investments all over the world. Nowadays, bankers and traders are pushing another form of so-called “safe” investment, the “Secured Loan Obligation” or CLO.

CLOs are nothing more than a set of risky business loans made to businesses with less credit. The big Wall Street banks are making these loans to their corporate clients and then looking to take them off their balance sheets as quickly as possible, much like they did a decade ago when they were packing and unloading risky mortgage securities. Much like mortgage-backed securities, to move the lending, banks have relied on the almost insatiable demand for higher returns – the combination of the price paid for a bond and the interest received – from investors who represent the risky loans. Will give them back more than they could get by, say, by investing in safer Treasuries. (A few percentage points difference in return adds up to real money.)

It is not a tiny part of the market. Of the trillions of dollars in outstanding business loans in the United States, approximately $ 1.2 trillion is considered “leveraged loans” or loans to businesses considered greater credit risk. Some of these companies will not be able to cope with the high level of debt they have taken on, and when they reach the breaking point, company bankruptcies will start to rise again.

And these failures could be a serious concern, according to smart people like Jerome Powell, Chairman of the Federal Reserve. In a speech to the Economic Club of New York in NovemberMr Powell said he believed investors in CLOs would bear the brunt of rising corporate bankruptcies, rather than the big Wall Street banks. These investors include Japanese banks as well as investors in hedge funds, mutual funds, and pension funds (in other words, you and me).

Janet Yellen, predecessor of Mr. Powell, broadcast the same concern in December, in a conversation with Times columnist Paul Krugman. Ms Yellen said she feared corporate debt was “quite high”: it now exceeds $ 9 trillion, up from $ 4.9 trillion, in 2006, according to the Securities Industry and Financial Markets Association. “I think a lot of the underwriting of this debt is low,” she said. “I think investors are holding it in packages like subprime packages,” which became so popular before the 2008 crisis. “The same thing happened. This is called CLOs, or secured loan obligations. ”

Randal Quarles, who oversees the supervision and regulation of Wall Street at the Federal Reserve, also underlined the imminent systemic risk to the financial system if and when CLOs start to be hit with defaults. On the one hand, he told the Council on Foreign Relations in DecemberHe takes comfort in the fact that Wall Street banks are offloading risky loans to investors – when they do, it takes that risk away from the heart of the financial system. But there could be a risk of “back door” exposure for banks, he said. This is “something we need to be vigilant about,” he added, and it is something the Fed continues to analyze.

A backdoor risk is exacerbated by a tactic of some overly smart hedge fund managers. They buy some of the risky corporate debt at a discount, then buy more insurance on that debt – known as “credit default swaps” – to theoretically cover their risk. These wise men then do all they can to force the company to file for bankruptcy, which contractually triggers the repayment of the debt by the insurance. Since the insurance payment far exceeds the overall cost of discounted debt, the hedge fund benefits tremendously.

The problem, of course, is that filing for bankruptcy can send the company and its creditors, including investors in CLOs, into a downward spiral, hurting everyone but the architect of the scheme. This is what happened to Windstream, an Arkansas-based telecommunications company that was placed under bankruptcy protection in February. These “empty creditors,As Henry Hu, a University of Texas law professor has dubbed them, they are being rewarded for pushing companies into otherwise unnecessary bankruptcy. This is not the way markets are supposed to work.

After a brief moment of reason in December, the looping demand for high-risk debt has warmed again. Over $ 13 billion in leveraged loans were sold in February, and they will soon find their way into financial markets as a CLO.The existential question remains: why do investors fail to pull the hard lessons of risk, even if the consequences remain so fresh?

William D. Cohan is a Vanity Fair Special Envoy and the author of the upcoming “Four Friends” book.

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