How much of this sub-prime iceberg is still beneath the water?

At our firm we have been worried about the extreme abuse of credit/leverage this cycle.  We have been talking about it as a main issue for many months now.  Recently more main stream commentators are also voicing concern about how to fathom the depths of this issue.

As I have noted before, yes credit derivatives have spread out the credit risk, but now it is so widespread, with leverage on leverage, that it is very hard to appreciate the extent of the risk until a major shock reveals it.

Yesterday S&P said it is reviewing the “global universe” of Collateralized Debt Obligations (CDOs) that contain subprime mortgages.  They plan to change the methods they use to rate existing and new mortgage bonds to reflect the increased likelihood of mortgage defaults and losses.

S&P now estimates US property values will decline 8% on average between 2006 and 2008.

While most of the securities being reviewed by S&P have ratings of BBB+, BBB, or BBB-, some were rated as high as AA.  They now say that doubt has been cast over some of the data they used because of unprecedented levels of misrepresentation and fraud, combined with potentially shoddy initial loan data. Funny they did not notice this funny business before this.  Perhaps the record fees they were earning for rating the pools clouded their vision a little?

Late Tuesday Moody's downgraded 399 residential mortgage-backed securities ($5.2 bln) that it had recently put under review for the same reasons cited by S&P.

Humans are nothing if not predictable.  Each generation makes the same old mistakes about excess leverage in their own new way.

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