The lessons of CELF

By Felix Salmon
November 26, 2010
Jesse Eisinger has the story of CELF, which has some interesting implications. Essentially, Goldman Sachs took a bunch of leveraged loans it had lying around on its balance sheet, and bundled them into a CLO called CELF which it sold in July 2008.

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Jesse Eisinger has the story of CELF, which has some interesting implications. Essentially, Goldman Sachs took a bunch of leveraged loans it had lying around on its balance sheet, and bundled them into a CLO called CELF which it sold in July 2008.

The transaction was clearly profitable for Goldman — if it wasn’t, the bank wouldn’t have done it. And like all CLOs, the reason was that there was insatiable investor demand for triple-A-rated securities. As a result, by bundling up a bunch of loans and tranching them so that a triple-A-rated security fell out the other side, Goldman could make money: demand for AAA debt was much greater than demand for leveraged loans, so turning the latter into the former was profitable.

Then, this year, Goldman unwound the deal. It bought back those AAA-rated loans — I’m hearing at about 96 cents on the dollar — and bought a bunch of the equity in the deal as well, enough to bring its equity stake to something over 50%. With control of the CLO, Goldman then decided to liquidate it entirely, breaking it up into its constituent parts and selling off those loans in the secondary market.

This deal, too, was profitable for Goldman — for exactly the opposite reason that the CLO was. Today, there’s a lot of demand for high-yielding loans, or high-yielding anything, really. Meanwhile, there’s no appetite at all for structured products carrying AAA credit ratings which no one believes. So Goldman can make money by turning out-of-favor structured product into highly-desirable loans.

Eisinger’s point here is that Goldman reckons it can do this kind of thing — making money by structuring and unstructuring complex financial products — without falling foul of the Volcker Rule: at each step along the way, it can claim to be acting in its clients’ best interest. He’s right about that, and he’s also right that if the Volcker rule can’t stop this kind of activity, it’s likely to prove pretty toothless.

But we can also draw another lesson from this story: that securitization is still pretty dead. So long as investors prefer plain-vanilla loans to collateralized loan obligations, the securitization market — which bankers and politicians both have said is crucial to the efficient functioning of the economy — will remain moribund. Let’s hope they’re wrong, and that securitization isn’t all that necessary for a vibrant economy after all. Maybe it’s mainly just good in terms of making money for investment banks.

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