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Bond Outlook July 11th

The sub-prime/CDO crisis is not just about “knock-on effects” as risk aversion grows, but is a sign of systemic failure by the US financial system. Expect serious pressure to reform.

Bond Outlook [by bridport & cie, July 11th 2007]

No sooner do we write of “a widespread refusal to face the CDO problem head on” (Weekly of 4th July), then one party is breaking the silence, viz. S & P with its threat to downgrade USD 12 billion of CDOs. Moody’s may have made the same threat even earlier, but they only whispered it. S & P were so loud that even stock market investors noticed! Indeed, the contradictory nature of bond and stock market responses to the sub-prime/CDO problem (bond markets concerned, stock markets dismissive) has, temporarily at least, ceased. Both are now showing signs of worry.

Maybe it should be the rating agencies that should be worrying. Criticism does not stop at their doing too little too late in downgrading selected CDOs. More serious is the role they played in the “sleight of hand” that converted sub-prime mortgages into AAA securities using the same grading language as for top class corporate bonds. The least that can happen is that their credibility declines, but it is quite conceivable that they be accused of dereliction of duty.

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