Saturday, July 21, 2007


An excellent read on CDOs and how the problem is a lot worse than Wall Street is letting on.

A typical mezzanine asset-backed CDO is divided into layers. At the bottom is the riskiest and most lucrative piece, the equity tranche. It takes the first hit when the underlying collateral gets into trouble as homeowners fall short on their mortgage payments. At a 5 percent default rate on the underlying assets, the owners of the CDO equity slice lose all their money.

Next up is the BBB rated portion. It gets bashed when defaults climb to more than 5 percent, and wiped out should they reach 10 percent. The A rated piece goes boom at 14 percent, and the AA tranche becomes worthless at a 23 percent default rate.

And more from the same article

Daniel Taylor, a Philadelphia-based fund manager at Aberdeen Asset Management, reckons it will only take a 1 percent decline in national U.S. house prices for collateral losses to surge to more than 40 percent -- at which point your top-rated security is in the same sinking boat as the lower-rated securities.

This is some scary stuff. The subprime/CDO issue is the real deal.

1 comment:

JJ2000426 said...
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