Understanding Credit's Alphabet Soup

Monday, August 06, 2007 | 11:06 AM

There were a couple of great graphics in the New York Times recently, explaining in some degree of detail, the machinations of the RMBS, CDO and CLO markets.

These are the packaged (and repackaged) holdings that are based upon the sub-prime mortgages that have been defaulting in such large numbers, and have been leading to hedge fund blow ups.

First up: todays front page article by Gretchen Morgenson: Mortgage Maze May Increase Foreclosures.



Graphic courtesy of NYTimes


Next up, the accompanying graphics to Floyd Norris' The Loan Comes Due:







Graphic courtesy of NY Times


The Loan Comes Due
NYTimes, August 5, 2007

Mortgage Maze May Increase Foreclosures
NYT, August 6, 2007

Monday, August 06, 2007 | 11:06 AM | Permalink | Comments (14) | TrackBack (1)
de.li.cious add to de.li.cious | digg digg this! | technorati add to technorati | email email this post



TrackBack URL for this entry:

Listed below are links to weblogs that reference Understanding Credit's Alphabet Soup:

» Financials: Worse than they look from The Big Picture
On Tuesday, we wondered aloud what the SP500 might have looked like had the true nature of the Financial sector's true risk-adjusted earnings been known (SP500 ex-Risk ?). We questioned how the Financials looked historically, now that they wiped out so... [Read More]

Tracked on Nov 8, 2007 6:51:22 AM


Here’s my understanding of the subprime issue. Your blog helped me piece things together:

Rising default rates on sub-prime and alt-A mortgages have made mortgage-backed bonds and collateralized debt obligations (CDOs) less attractive, and investors are demanding a higher risk premium for these securities. Uncertainty in the secondary mortgage markets has raised interest rates for all homebuyers.

In order to compensate for the risk premium that buyers of CDOs are demanding, banks have raised interest rates and credit standards. Wells Fargo is charging 8% for a prime jumbo 30-year fixed-rate loan that was 6 7/8% late last week:

Higher rates for conventional mortgages will place additional pressure on the housing industry and housing prices. (Ms. Studio54 sells real estate downtown, and she’s more concerned with changing demographics than with higher interest rates. She called last month and complained, “I can’t handle the Village anymore. Lesbians and straight people have taken the whole place down…There’s no fashion!…I sold an apartment and they wanted to build a bookcase…”)

Understanding how CDOs were created provides insight as to why foreclosures on subprime mortgages have affected rates for conventional mortgages. (Doug Kass, Gary Schilling, and Barry Ritholz have been sounding the alarm for several months.) Mortgages were packaged into mortgage-backed bonds, and mortgaged-backed bonds were packaged into CDOs. In 2006, only about 15% of U.S mortgages were subprime, but they were packaged into half of all CDOs.
(sources for figures:

CDOs were considered safe investments because the packages of underlying mortgages were thought to be sufficiently diversified to reduce risk. However, default rates rose beyond projections and valuations of highly rated CDOs were hit. A letter from Bear Stearns to clients of two of its hedge funds confirmed that the steep losses were due in part to "unprecedented declines in the valuations of a number of highly-rated [double-A and triple-A] securities.":

Sam Molinaro, CFO of Bear Stearns, remarked that this fixed-income market is about as bad as he has seen in 20 years. He also indicated that the company is not ready to buy back stock, which didn’t give investors a comfortable feeling.

There’s also concern that subprime woes will spread to high-grade debt, leading to higher borrowing costs for companies and reducing their earnings:

“The impact of tighter credit is already apparent in the market for high-grade debt. Yesterday, for example, Tyco Electronics, Ltd. pulled a $1.5 billion bond deal "due to unfavorable conditions in the debt markets," the company said. Selling bonds for a company like Tyco, which has put its past scandals behind it, is normally a routine affair.”

I’m not a veteran Fed watcher, but it seems appropriate that they should state the degree to which they believe that higher borrowing costs for consumers and businesses will affect the economy. They might believe that risk is being repriced to normal levels, but the repricing comes at a cost. Goldman is looking for the Fed to move to a "neutral" stance, in which risks to growth are on par with risks of higher inflation.

Posted by: Guy | Aug 6, 2007 11:23:32 AM

The comments to this entry are closed.

Recent Posts

December 2008
Sun Mon Tue Wed Thu Fri Sat
  1 2 3 4 5 6
7 8 9 10 11 12 13
14 15 16 17 18 19 20
21 22 23 24 25 26 27
28 29 30 31      


Complete Archives List



Category Cloud

On the Nightstand

On the Nightstand

 Subscribe in a reader

Get The Big Picture!
Enter your email address:

Read our privacy policy

Essays & Effluvia

The Apprenticed Investor

Apprenticed Investor

About Me

About Me
email me

Favorite Posts

Tools and Feeds

AddThis Social Bookmark Button

Add to Google Reader or Homepage

Subscribe to The Big Picture

Powered by FeedBurner

Add to Technorati Favorites


My Wishlist

Worth Perusing

Worth Perusing

mp3s Spinning

MP3s Spinning

My Photo



Odds & Ends

Site by Moxie Design Studios™