Did Structured Credit Fuel the LBO Boom?

Abstract

We demonstrate a link between the twin storms underlying the current financial crisis - the market for collateralized debt obligations (CDOs) and the market for leveraged loans. We show that structural changes in credit markets that led to the explosion in CDOs created an increased supply of bank loans for funding LBOs. This structured lending supported by CDOs led to cheaper credit, looser covenants, and more aggressive use of bank loans in financing LBOs. However, in sharp contrast to the LBO boom in the late 1980s, this easy credit did not lead to riskier LBO deals or deal structures. Our findings point to the effects of disintermediation of banks as they switched from an originate-and-hold to an originate-to-distribute lending model.

Keywords: structured credit, credit supply, leveraged buyout, collateralized debt obligation, loan sales, bank monitoring

JEL Classification: G31, G32, G34