10-20-2013, 10:08 PM
Chapter 4: Delusions of Value: The Myths and Misconceptions of Junk Bonds in the 1980s
Chapter 4 is an in depth look at the junk bond debacle of the 1980s. It seems presented mostly as a cautionary tale and as an example of how truly irrational the market can become. I’ve never studied that particular chapter in our financial history, and this chapter is hardly exhaustive. But as I’ve noted before, it is fun to be reading about examples that predate the dot-com craze and the 2008-2009 crisis. Most interesting to me were the many similarities between the junk bond debacle as presented by Klarman and the more recent housing bubble and mortgage-backed securities nightmare.
Like the mortgage-backed securities, the junk bonds “appeared to perform a sort of financial alchemy.” Despite the newness of the product and the poor understanding of it by many (if not most), fat profits induced all of the large firms to create extensive junk bond practices. Then, of course,
Sound familiar?
Chapter 4 is an in depth look at the junk bond debacle of the 1980s. It seems presented mostly as a cautionary tale and as an example of how truly irrational the market can become. I’ve never studied that particular chapter in our financial history, and this chapter is hardly exhaustive. But as I’ve noted before, it is fun to be reading about examples that predate the dot-com craze and the 2008-2009 crisis. Most interesting to me were the many similarities between the junk bond debacle as presented by Klarman and the more recent housing bubble and mortgage-backed securities nightmare.
Like the mortgage-backed securities, the junk bonds “appeared to perform a sort of financial alchemy.” Despite the newness of the product and the poor understanding of it by many (if not most), fat profits induced all of the large firms to create extensive junk bond practices. Then, of course,
Quote:One of the last junk-bond-market innovations was the collateralized bond obligation (CBO). CBOs are diversified investment pools of junk bonds that issue their own securities with the underlying junk bonds as collateral. Several tranches of securities with different seniorities are usually created, each with risk and return characteristics that differ from those of the underlying junk bonds themselves.
What attracted underwriters as well as investors to junk- bond CBOs was that the rating agencies, in a very accommodating decision, gave the senior tranche, usually about 75 percent of the total issue, an investment-grade rating.
Sound familiar?