WHAT ARE CLOs ? A must know in 2020.

# WHAT ARE CLOs ? A must know in 2020. ## TL;DR :eyes: CLOs are Collateralized Loan Obligations. Sound familiar? That’s because they sound like CDOs from 2008. CLOs are securities backed by loans, each with varying tranches and each trance with varying quality denomination. Once the loans are packaged, the CLOs get another rating, artificially higher due to the repackaging. In other words, it’s harder to see the crap that resides inside. ## Background/Context :earth_americas: Sounds a bit like CDOs or CDSs, the bad guys of the 08 crisis. Yet in 08, not a lot of CLOs were traded and those who were were quite highly ranked. Ok so why are we talking about all this? 🥶 Well, in April 2020, Moody’s (the American credit rating company) downgraded 20% of the underlying loans in the CLOs. They anticipate close to 15% of the CLOs to default. Are CLOs a big chunk of the economy now? :bar_chart: As an example the CDO’s market in 2007 was $640 billion , today’s CLOs market is close to $1.4 Trillion. In other words, there is much more room to default. Now add a pandemic to the fire and debt from companies with less-than-perfect credit: airlines, hotels, restaurants, and entertainment are currently the most troubled CLOs. ## The Bad Scenario So here’s the bad scenario: :smiling_imp: 1. Companies go bankrupt 2. Lenders will be unpaid due to poorly-written covenants 3. Loans in the CLOs begin to downgrade 4. CLOs get rated junk 5. The $1.4 trillion market becomes illiquid 6. Market crashes :bomb: ## No clear alternative To understant how to get out of this mess, we first need to answer one crucial question: Who buys those CLOs? —> Firms that need securities: banks, hedge funds…. To prevent such crash, an alternative would to print lot of money to save the insurers of the CLOs: another bailout for the banks in other words… Because this is the derivative market, it is quite hard to see such an apocalyptic scenario unfold, it’s very opaque :eyes: . Remember the Big Short 🎥 ? The guy had to actually go through each mortgage package and check their individual rating, and he had access to that data in the first place! ## CLOs in the press: [#1](https://www.google.com/url?sa=t&rct=j&q=&esrc=s&source=newssearch&cd=&ved=0ahUKEwio44Llm__rAhWSCWMBHcvkBFMQxfQBCC8wAA&url=https%3A%2F%2Fwww.ft.com%2Fcontent%2Ff10eaaac-0f4e-46bc-8f78-0754028da46a&usg=AOvVaw2kX1QHszBGqGKEpg09zSed) [#2](https://www.google.com/url?sa=t&rct=j&q=&esrc=s&source=newssearch&cd=&ved=0ahUKEwi7hLG4nP_rAhWQHxQKHZxIAiAQxfQBCFcwBQ&url=https%3A%2F%2Fwww.bloomberg.com%2Fnews%2Farticles%2F2020-04-22%2Fhow-a-deluge-of-downgrades-could-sink-the-clo-market-quicktake&usg=AOvVaw3BaWWpHblYYOkO8NKA-4Xd) [#3](https://www.google.com/url?sa=t&rct=j&q=&esrc=s&source=newssearch&cd=&ved=0ahUKEwik_eDNnP_rAhWNAWMBHfAbCGEQxfQBCC8wAA&url=https%3A%2F%2Fwww.economist.com%2Ffinance-and-economics%2F2020%2F05%2F07%2Fcredit-rating-agencies-are-back-under-the-spotlight&usg=AOvVaw0NybVmISLCdOACPe2pJtig) [#4](https://www.google.com/url?sa=t&rct=j&q=&esrc=s&source=newssearch&cd=&ved=0ahUKEwik_eDNnP_rAhWNAWMBHfAbCGEQxfQBCEUwAw&url=https%3A%2F%2Fwww.theatlantic.com%2Fmagazine%2Farchive%2F2020%2F07%2Fcoronavirus-banks-collapse%2F612247%2F&usg=AOvVaw0kkwQqdUhmkaLnTBETeg1f)