Saturday, February 28, 2009

CDO reality check!

The FT has more justification for the deep uncertainty surrounding how much more the markets have to fall before normalcy returns. It is also a ringing indictment of the credit rating agencies.

"From late 2005 to the middle of 2007, around $450bn of CDO (collateralized debt obligations) of ABS (asset backed securities) were issued, of which about one third were created from risky mortgage-backed bonds (known as mezzanine CDO of ABS) and much of the rest from safer tranches (high grade CDO of ABS). Out of that pile, around $305bn of the CDOs are now in a formal state of default, with the CDOs underwritten by Merrill Lynch accounting for the biggest pile of defaulted assets, followed by UBS and Citi.

The real shocker, though, is what has happened after those defaults. JPMorgan estimates that $102bn of CDOs has already been liquidated. The average recovery rate for super-senior tranches of debt – or the stuff that was supposed to be so ultra safe that it always carried a triple A tag – has been 32% for the high grade CDOs. With mezzanine CDO’s, though, recovery rates on those AAA assets have been a mere 5%... this is easily the worst outcome for any assets that have ever carried a "triple A" stamp. No wonder so many investors are now so utterly cynical about anything that bankers or rating agencies might say these days."

(HT: Paul Krugman)

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