Managing business finance Essay Example | Topics and Well Written Essays - 1750 words - 2

Managing business finance - Essay Example There is a flow of loan repayment similar to a waterfall from the top down with each cash proceeds from these loans goes to fees and tranches of debt. The CLO arrangement permits attaining surplus cash to run from the loans to liabilities like CLO Bonds. The junior investors obtain the surplus cash flow after paying the higher-risk tranches. Therefore, as long as the costs in issuing debt remain lower than the loan portfolio, the CLO equity tranche will receive the excess cash. Nevertheless, the checks and balances structure may assist in preventing losses to the bondholders. During the 2007/8, financial crisis, the CLOs played a big role in the U. S Subprime crisis, and this was the first financial crisis in history after the Great Depression. Bank credits contribute in households accumulating debt relative to net worth with firms increasing their projects hence over-speculation and over-investment. The Community Reinvestment Act 1977 gave incentives to investors to extend loans to low-income earners. Therefore, instead of the banks applying more prudent and credit evaluations, they became flexible in their loaning through CLOs. This act saw an increased demand of loans with very many defaulters. These loans to people with poor borrowing credit history or the subprime caused a plunging of property prices that slowed down the U. S economy, and the banks losses amounting to $223 billion. These losses were due to the changed lending basis by the banks in mortgage that exposed the massive defaulters. Between 2002 and 2004, the U. S interest rates were low, and so the people speculated the low rates would remain low hence they did a lot of borrowings (Kolb 2010 p. 28). The banks introduced the CLOs selling loans to investors especially in the housing sector. Unfortunately, the government increased the interest rates in 2004, and the house owners would default the payments. This