Wednesday, July 11, 2007

Mortgage-backed securities get downgraded

As troubles in the subprime lending sector are beginning to cause major problems to hedge funds that invested in mortgage-backed securities, rating agencies are now downgrading these papers.

Moody’s announced negative rating actions on 431 securities originated in 2006 with an original face value of $5.2 billion. 399 of these were downgraded and another 32 were placed on review. The rating actions were caused by loan performance deterioration which was due to a slowing home price appreciation and aggressive underwriting practices.

Standard & Poor’s (S&P) announced that it will change the way it evaluates the securities. The full impact of this will be seen in a few months, probably resulting in an increase in interest rates to subprime borrowers and losses for investors. S&P said that 612 classes of mortgage-backed securities, totaling more than $12 billion in debt, have been put on CreditWatch and most of these will be downgraded in the next few days. Ratings of Collateralized Debt Obligations, or CDOs, are also being reviewed.

According to the agency, losses on the mortgages backing these securities exceed anything that’s happened before. I guess we should assume that no one knows what a situation like this will lead to, and, most importantly, how to deal with the problem. It could result in a really big bust for the financial markets, and the dollar is already falling.

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