[heifetz]

no it's not.

The subprime crisis was precipitated by a lot of people taking out mortgages with either blatantly or coerced false income information in their mortgage applications on homes that had inflated values. Once home prices stopped going up as much and interest rates started increasing, these people were no longer able to make their mortgage payments.

Leveraged loans at 7x ebitda are still less leverage than someone taking out 90% LTV mortgage (90% LTV can be thought of as 9x leverage against your equity). Companies usually also have more flexibility to increase their income, or decrease their expenses compared to an average person. And mortgages have required amortization where as most levered loans to my knowledge are interest only.

All in all, unless a significant % of companies taking out levered loans are submitting fraudulent financial filings, this is nothing like the subprime crisis.

[FireBeyond]

> The subprime crisis was precipitated by a lot of people taking out mortgages with either blatantly or coerced false income information in their mortgage applications on homes that had inflated values.

Whereas what, companies would never utilize non-standard accounting methods or falsified or exaggerated earnings reports or forecasts?

[heifetz]

Sure companies will and can do that, there has been pretty good history of really large companies committing financial fraud. However, I don't think there ever has been systematic fraud in the US, unlike with subprime mortgages

[Retric]

When you just look at companies that fail, it ends up looking a lot like systematic fraud.

Also, it was not really single family home owners that defaulted in mass. Investors, even those with prime credit ratings, were much more likely to default than non-investors when prices fell.[8][9][10] https://en.wikipedia.org/wiki/Subprime_mortgage_crisis

People talk about subrime morgages as if they meant poor people. However, largely it was people buying up large numbers of homes and then strategically defaulting that caused the real damage.

[slededit]

Fraud was cited as a major factor contributing to the S&L crises. In companies it tends to be in the form of Control Fraud where insiders fleece the corporation.

https://en.wikipedia.org/wiki/Savings_and_loan_crisis

[grey-area]

You probably mean systemic fraud, because there has been plenty of systematic fraud.

The subprime mortgage crisis is in fact an excellent example of systemic fraud which happened in the US, fraud committed by ratings agencies (AAA CDOs) and banks (autosign). The system was corrupt, and probably still is - the incentives are all wrong.

[luckydata]

Are you really sure there's no systematic fraud? The US is pretty corrupt as far as checks and balances on financial dealings goes, I wouldn't be surprised if this became another one of those "who could have known".

[notfromhere]

The bank's role is to verify that the provided information is valid.

Banks didn't care because they were going to sell off the mortgage and they didn't care about the underlying stability of the loan

[unclebucknasty]

>a lot of people taking out mortgages with either blatantly or coerced false income information

Money flowed freely b/c the mortgages didn't matter. It was the ability to bundle the mortgages and leverage them that fueled low-standards and drove much of the lending frenzy.

>The subprime crisis was precipitated by a lot of people taking out mortgages...these people were no longer able to make their mortgage payments

No. Again, mortgage debt alone was a mere fraction of the problem. Those loans were levered up many multiples through CDOs and other exotic instruments, which was the real problem.

In 2008 there was a lot of effort made to blame poor people/subprime debtors. But, it's been covered ad nauseam since then, so it's kind of surprising to hear someone still making those claims in 2019.

[sehugg]

Let's also not forget the credit rating agencies' role: https://www.theguardian.com/business/2017/jan/14/moodys-864m...

[heifetz]

The derivatives were created and rated on the assumption that the borrower's default rates were consistent with historical default rates. Of course that was not the case, and losses became multiples higher, and blew up derivatives that were highly levered. However, derivatives didn't cause the losses, borrowers defaulted!

[DeonPenny]

Derivatives did cause the loses basically for what you said above.

>derivatives were created and rated on the assumption that the borrower's default rates were consistent with historical default rates.

The historical information was wrong because the issuer of the subprime loans hid bad loans given to people with thin credit histories.

[unclebucknasty]

Well, sure, we can play the chicken-and-egg game and posit that if they'd never defaulted, the house of cards would've remained standing.

But, that's the not the predominant issue for many reasons, some of which are embedded directly in your statements. For example:

>rated on the assumption that the borrower's default rates were consistent with historical default rates

Why would they be rated as such if the viability of the underlying mortgages was not, in aggregate, consistent with those that produced the historical rates?

That alone tells the story.

The derivatives drove the outsized lending which ballooned the number of riskier subprime mortgages in the first place. Then, the many layers of leverage just exacerbated the problem.

At the end of the day, increases in subprime loan defaults could have been weathered. The derivatives were responsible for turning a containable downturn into a full-blown crisis.

[DeonPenny]

You're saying the same thing. If the underlying lone is precipitated by blatantly or coerced false income information then that was the problem. CDOs are simply derivatives that derived their value from those miss rated loans. So yes it was poor people, but it was also the people way to willing to give those people loans at rates way larger than they should of for financial instruments.

[brisance]

The people employed by the banks were complicit. It's that simple. If Jane Doe applies to buy a $1M home, and no one checks her credit and sees that she already has 3 other similar properties, whose fault is it? Passing the buck on due diligence is such a cop out. It's like a drug dealer justifying his actions; "Hey if I don't sell it to her, someone else will."

People who work in risk and compliance NEVER get promoted to the top because they are cost centers, and prevent other people in the company from getting that huge payoff.

[DeonPenny]

Thats hard because you can easily blame that on consumer credit rating agencies like Equifax. Because their number doesn't weight length of credit repayment. So if you only have had any debt for 1-3 years you can have the same score as someone who has had debt for 10-30.

It was a cop out though. I think no one in the banks thought to challenge that. Now they do but previously they didn't

[unclebucknasty]

No. I'm not saying the same thing.

[berberous]

The definition of "EBITDA" keeps getting looser each year, so the true leverage is likely somewhat higher than you'd expect by just looking at the max leverage a credit agreement permits.

Also, most leveraged loans (i.e. institutional term B loans) require de minimis principal repayment in addition to interest (1%/year).

[StudentStuff]

Any chance you have a comparison of EBITDA over the years? You've piqued my interest :P

[berberous]

Here's an article that describes the issue: https://www.reuters.com/article/us-ebitda-loans/adjusted-ebi...

This article describes some of the addbacks in more detail (scroll down to the section entitled "EBITDA add-backs and other adjustments"): https://www.hoganlovells.com/publications/the-evolving-ficti...

[XnoiVeX]

That's an eye opener for me. Thanks!

[cinquemb]

> 9x leverage against your equity

From where I'm from, physical collateral is valued more highly than paper collateral that can go to zero if such a companies earnings per share are already less than 0…

[heifetz]

most companies also have hard assets, e.g. inventory, real estate, IP, equipment, etc. If you're ok with paying 15x P/E which is the average S&P P/E, then 7x leverage isn't so bad...

Although the companies with these levered loans are a lot smaller than S&P 500 companies.

[cinquemb]

Leverage agaisnt hard assets != leverage agaisnt equity (which you were talking about), and we're talking about individual companies P/E. Everyone cannot hold an index (if everyone does so, there is no incentive to weed out bad companies), some of which are good about not including neg eps companies in the P/E caluclation [0].

[0] https://www.marketwatch.com/story/heres-the-shocking-truth-a...

[heifetz]

no it's not, and I know the two are different definitions. However, what I'm saying is that a 7x 1st lien leveraged loan against a company that is trading at 14x P/E is essential 50% the market value of the company. Of course, the hard assets of the company is probably a lot less than that.

[nickles]

> Although the companies with these levered loans are a lot smaller than S&P 500 companies.

Netflix isn't an S&P 500 company?

[jayalpha]

> no it's not.

It is easy to make fundamental predictions in finance. It is impossible to predict timings.

> Once home prices stopped going up as much and interest rates started increasing, these people were no longer able to make their mortgage payments.

When was the last time you looked at the Case–Shiller index?

[inetknght]

> Companies usually also have more flexibility to increase their income, or decrease their expenses compared to an average person.

What actions do companies have available to them which consumers do not with regards to income or expense management??

[DeonPenny]

For example, if you're GM and a lot of cars aren't selling you can shut down factories, repatriate assets, do stock buybacks, increase automation and more. If you're a person whose major asset is a house if you can't sell the house for enough to catch up on your debts or get a way better job. What can you do.

[brisance]

File for Chapter 11 bankruptcy. This gives the company some time to get things under control to pay off its creditors. Or if it's a GigaCorp like $GM, $F etc go complain to the politicians and hope they do something, although seeing how dysfunctional things are with parts of the US Government itself shut down, a good outcome is unlikely.

[gammateam]

I KNOW THIS ONE!

Public companies have the capability of selling treasury shares, and also diluting all shares and selling the newly minted shares

Public and also closely held companies also have the capability of offering new corporate loans on specific revenue streams

Finally, both public and closely held companies have a greater timeline. They issue 5-10 year loans in a good market and low interest environment, pay low amounts of interest for several years during a bad market, and then issuing new loans in a good market again.

And of course, bankruptcy not affecting the cash finances of any particular person in the company, or that individual's ability to acquire new credit. While the company entity itself takes the temporary reputational hit.

[gammateam]

> The subprime crisis was precipitated by a lot of people taking out mortgages with either blatantly or coerced false income information in their mortgage applications on homes that had inflated values.

Yes but this was exacerbated because it wasn't as many people as what you said seems to suggest.

The investment banks were so highly leveraged on the collateralized debt that it only took 7% of the mortgage holders missing payments at once to bring down the whole financial system.

This suggests that the vast majority of people lying can actually be trusted to make payments, and would prefer to not be shut out of the credit system.

[heifetz]

15 - 20% of subprime borrowers defaulted on their mortgages. That's a lot of people! Imagine, 1 in 5 of your neighbors defaulted and were foreclosed upon. This is not suppose to happen.

https://www.chicagofed.org/publications/profitwise-news-and-...

[gammateam]

Thanks, yes thats a lot. I'll double down on what I wrote as the CDOs contained a mix of all borrowers of all levels of credit worthiness. It is likely we are agreeing on our stats, but I will concede that the subprime variant therefore can't be reliably trusted to make payments, just as the models predict.