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the current economic shock has taught us anything it is that despite all the new controls rules regulations put in by Congress after the financial crisis Wall Street has shall we say a way of finding new and inventive ways of creating things to sell like the hundreds of billions of dollars in subprime mortgage-backed securities that basically broke bank balance sheets more than ten years ago a similar but simpler Wall Street product needs to be on your radar if it's not already you've probably heard about them they're called cielos collateralized loan obligations no not CDOs those are collateralized debt obligations which of course just you know help destroy the banking system in 2008 cielos our bundles of business loans generally made to smaller or mid-sized companies some of whom have maybe trouble balance sheets or maxed out their own borrowing can't sell bonds directly to investors or do not qualify for traditional bank loans there are some key differences than CDOs the biggest of which and they're important is that there are no mortgages in them and there are none of the dangerous credit default swaps remember those built into those products now the market for these cielos they have boomed in the past decade the loan market is now valued at more than 750 billion dollars at the end of 2018 with some estimates pegging the number of CLO markets because there are leveraged used at 1.2 trillion most priced in u.s. dollars but while this market may have survived relatively unscathed the pre-pandemic the current crisis has exposed its weak points and according to our next guest could lead to a crisis bigger and more serious than what we saw in 2008 how's that for an introduction joining us now is UC Berkeley School of Law Professor Frank Partnoy who detailed this new major risk the current issue of the Atlantic the looming Bank collapse it has been one of their most read stories for about a week and it should be by the way one of the top five business books of ever read was written by that gentleman called the Match King Frank it's a pleasure to get you back on nice and early from California thank you it's an important topic how much great to see it or more risky RCL OS how much more or more less risky or cielos than CD well it really depends on the time so back in 2007-2008 cielos weren't risky at all we weren't worried about these businesses all defaulting simultaneously we were worried about subprime mortgages defaulted simultaneously right now in the pandemic we have a lot of businesses that are troubled that are very likely to default and so today cielos are the more dangerous how much and your article noted as of annual filings or quarterly filings Wells Fargo JPMorgan and Citibank had if my numbers are right about 70 to 80 billion on their balance sheets AIG had a few billion more how much do you think is out there ultimately across the bank balance sheet spectrum I think your numbers are about right in aggregate and we know that there are certainly more than 100 billion of cielos at banks and the Fed has done a study that essentially said that we also know that there are about a hundred billion or so of cielos that are unaccounted for what we can't find them and we're getting lots of surprises on cielos so JPMorgan announced that it had lost two billion dollars and unrealized loss on cielos basically nobody even noticed that it happened and Wells Fargo recently announced that it had seven point seven billion dollars that would have called loan form CLO s that were a surprise to many people so these are big numbers we're talking about those three banks we're talking about significant numbers and it's not they're not the kind of numbers that will bring the bank down on their own but they are numbers that should cause us concern when coupled with other kinds of losses that makes inevitably are going to have in the next quarter and beyond this year you lose your phone you hit a button it starts beeping I don't know how a hundred billion dollars in a Wall Street product just goes missing maybe we need to find my CLO thing either way Frank let's move on okay here is the problem with 2007 we're gonna get a history lesson as we know everything was sort of stacked together triple a single a double B BC like a Jenga game of course famous for the movie the big short and the bottom went bad and so the whole thing collapsed our CL OS the ones at least that you have seen are they structured the same way as the rich still in that sort of you know small percentage at the bottom but kind of holding everything up yes the basic idea is the same so you have underlying credits the loans themselves that are rated single B or triple C 15 percent of them are Triple C about two thirds or single B's so those underlying loans are risky loans but the idea is that when you package them that the top part of the CLO should be low risk in the same way the top part of the CDO was thought to be low risk in 2007 now the problem is if a lot of these loans all default at the same time the way subprime mortgages I'll default it at the same time then even those top layers the layers that are rated triple-a or double-a can become at risk so in late March we know that the triple-a layers were seriously at risk and there were major concerns about the pricing of those triple-a layers the Fed has intervened and so we add support psychologically in the market but many people are worried that the losses that are increasing in the future will start to eat into those triple-a and double-a layers and that's a critically important distinction because we're not here to terrify people at 5:50 in the morning to 50-year time Frank the problem with 2007 is 8 as we now know looking in hindsight was that nobody not many people anyway saw it coming and they didn't act in time to save those mortgages that went bad thus crashing everything down all these Fed programs are really hard to keep track of even for people who track them for a living do you think the Fed has gotten out enough ahead of this because of what we learned 12 years ago certainly the Fed has been very quick and they've learned that it's important to really impact the psychology of markets so that's what they did in response to late March and that's what they're doing now that's what they did yesterday with a new program that was announced for secondary lending also it's interesting to know that the Fed said after all the bad news last week that it's going to start examining banks more it had said it wouldn't be doing that so this obviously is concerned and they're getting ahead they're being quick and it's a lot of money but one of the other important things to recognize is that the Fed isn't buying everything the Fed can't buy every piece of debt that's out there and dodd-frank the legislation after the last financial crisis restricted the venn so if that isn't able to buy investments in insolvent institutions it's not supposed to prop up banks so it has restrictions and it's not supposed to rely on credit ratings but if you look at the turn sheets that the Fed is putting out now very very frequently including yesterday they are relying on credit ratings and so there's a lot of uncertainty about these fed programs will hear from the chair today and tomorrow and you very well may be addressing some of this uncertainty about these grounds you think the credit rating agencies are gonna get it right this time we screwed it up last time make tonight and you were very prescient in that and criticizing the credit rating agencies and unfortunately some of the same kinds of models that were used that are being used now today so the same kinds of concerns today with respect to what supposedly is a triple-a rating you you