I’m a movie geek. My primary genres are sci-fi and super hero movies, and sitting across the table from the right pal, I can communicate in “movie line” for practically hours.
Sometimes I even think in movie line. I’ll see a something in life, and immediately draw upon a quote from a movie to make sense of the situation in my mind.
As I reviewed the news to prepare for this week’s column, my mind couldn’t help but contemplate a quote from an average, but interesting movie I’ve watched a dozen times or so, "The Lost World Jurassic Park."
In the scene, John Hammond, the creator of the dinosaur island Jurassic Park, tries to persuade scientist, and prior dinosaur victim, Ian Malcom, to return to an island of dinosaurs for a mission. Hammond shows Ian all of the changes he’s made to the perilous environment on the island and says, “See, I’m not making the same mistakes again,” to which Malcom replies, “Nooo, no, you’re making all new ones.”
The 2008 credit crisis seemed too many to come out of nowhere, as it was sourced in a part of the financial market world, i.e. the mortgage backed security market, that was not commonly watched by typical individual investors.
With the benefit of hindsight, the credit crisis flashed warning signs as far back as 2006, but these warning signs were easy to dismiss as isolated issues, and at the time, it was difficult for even experienced investors to appreciate the full potential risk represented by some of the cracks in the housing and mortgage markets, especially when it related to the stock market as a whole.
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After this traumatic investing period, I vowed to not be caught unaware of potential warning signs, regardless of their obscurity, in financial markets. I decided I would use this column, and my practice to point out warning signs as I perceived them. Sometimes, most of the time, troublesome signals end up being non-events or isolated issues. But after 2008, I believe a deeper awareness is necessary to help manage investing risks that may exist right underneath the daily financial headlines.
This week something caught my eye that merits mentioning and watching going forward. The news was generated by what is called a leveraged loan, which in Wall Street speak is a term used to describe a loan made to company that already owes a lot of money.
The leveraged loan market is not a market that is typically accessed directly by individual investors. For small investors, if they even have exposure to these financial products, it is likely through a mutual fund or exchange traded fund (ETF), which means the exposure may not be totally apparent to the end investor. According to S&P, the leveraged loan market has ballooned to over $1.3 trillion in size, which makes it quite material to the overall economy, and because of the unique structure of the leveraged loan market it also presents some inherent potential risks that regulators such as the SEC and FINRA have been working to draw investor attention to.
The leveraged loan that drove the news was not particularly big, and wasn’t owed by a company that is particularly important or high profile. The company did not default on its loan. It did however announce it was having trouble with customers and finances. This announcement was enough to cause the price of the loan to literally collapse, almost overnight.
This price collapse demonstrates a key risk in the leveraged loan market, a risk called liquidity risk, which was also the same type of risk that drove the magnitude of the 2008 credit crisis.
Am I calling this relatively small financial incident the canary in the coal mine? No, no I’m not. But in 2019 investors are obligated to be aware. So, I’m keeping you aware and will continue to delve into this issue going forward. If we can, let’s try to avoid making all new mistakes next time around.