Reuters today: A downgrade warning by Standard & Poor's on $12.0 billion U.S. subprime mortgage securities triggered a precipitous plunge in the benchmark ABX index on Tuesday, driving it to a record low: ABX plunges.
“The ABX 2007-1 “BBB-minus” index, which references risky home loans made in last year's second half, fell 6.5 points to 49 from 55.5 on Monday, traders said. It has fallen 49 percent since January.”
“A downgrade of that magnitude would trigger severe losses as investors who are prevented from holding anything other than investment grade issues would unload their holdings en masse, market participants said.”
My Comment: Some observers have been quick to discount the severity of the subprime issue. Some take assurance from the fact that Bear Stearns has so far averted an actual auction off of the remaining assets in its troubled bond funds and thereby avoided thus far the inevitable need to acknowledge losses and mark these holdings down to their deeply discounted market values.
But this way comes the rub. The rating agencies are coming under increasing criticism and scrutiny by regulators over their questionable investment ratings of sub-prime loan packets over the past couple of years. There are rumblings that a crack-down is upon them. See Moody's faces the storm in this mornings WSJ.
To show their remorse and will to change, raters will have no choice but to downgrade their ratings to reflect the reality of sub-par assets. When this happens, many present holders of these bond pools will have no choice but to sell them at steep losses since many are mandated to hold only investment grade loans. The trickle or deluge effect will be nasty.
The fact is prices can be manipulated for some time, but not forever. Sellers set the market. More on this unraveling story will come.