CDO History Repeating Itself: Liquidity Crunch Looms

Jul. 26, 2007 8:42 AM ET
Michael Shedlock profile picture
Michael Shedlock

Citigroup (C) is reporting: Defaults on Some 'Alt A' Loans Surpass Subprime.

Defaults on some so-called Alt A mortgages packaged into bonds last year are now outpacing those from subprime loans, according to Citigroup Inc.

The three-month constant default rate for 2006 Alt A hybrid adjustable-rate mortgages is 2.3 percent, compared with 2.2 percent for subprime ARMs, New York-based Citigroup analysts led by Rahul Parulekar wrote in a July 20 report. The figures represent the percentage of balances in a mortgage-bond pool expected to default in the next year based on 90-day trends.

[Mish comment: Here's the key phrase "expected to default in the next year based on 90-day trends". Wasn't it reliance on trends that got rating companies into hot water in the first place? Essentially Moody's, Fitch, and the S&P, all used trends to predict that housing would rise forever into the future at a slow steady rate. None of the rating companies allowed for reversion to the mean or even a flat market for that matter. I talked about this in Fitch Discloses Its Fatally Flawed Rating Model. I suspect that we are going to find 2% is a very optimistic number. If nothing else the illiquid CDO market now acts as if 2% is optimistic.]

The speed at which Alt A hybrid ARMs are being paid off due to home sales or refinancing has also fallen to about the same level as for subprime ARMs, which typically prepay more slowly, the analysts said. Slower prepayments can make the same rates of defaults more damaging by leaving more of the initial balances outstanding to eat into bond-investor protections.

The combination of challenges mean 2006 bonds backed by Alt A mortgages, a credit grade above subprime loans, may need "lower loss severities to still come out with lower

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Michael Shedlock profile picture
Mike Shedlock (Mish) is a registered investment advisor representative for SitkaPacific Capital Management ( Sitka Pacific is an asset management firm whose goal is strong performance and low volatility, regardless of market direction. Visit Sitka Pacific's Account Management Page ( to learn more about wealth management and capital preservation strategies of Sitka Pacific. I blog at Mish's Global Economic Trend Analysis ( which typically has commentary every day of the week. I am also a contributing "professor" on Minyanville (, a community site focused on economic and financial education. I do weekly podcasts every Thursday on HoweStreet ( and a brief 7 minute segment on Saturday on CKNW AM 980 ( in Vancouver. When not writing about stocks or the economy I spend a great deal of time on photography and in the garden. I have over 80 magazine and book cover credits. Some of my Wisconsin and gardening images can be seen at (

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