CDOs: The Ticking Time Bomb

While I'm spreading the warmth and cheer around this morning (that was sarcasm), there's a good bit over on the Naked Capitalism blog that pulls back the curtain from the spiralling morass of woe that is the CDO market.

CDOs: The Ticking Time Bomb

I for one would not try to catch that falling safe. While the higher-rated tranches of many CDOs almost certainly have some value, the problem is that these instruments were sold way beyond their natural market due to misplaced confidence in their ratings. Consider how small the market would be if the paper carried no rating.

Moreover, most fixed income investors are professional money managers subject to performance pressure. Even if one of them thought certain CDOs were cheap, he'd still hesitate to buy them out of concern that the prices would drop further before they rallied, and he'd show losses on those positions (and worse, have to explain to his boss and/or clients why he bought CDOs). Very few are going to step in until the market appears to be improving, and between now and then, we are likely to discover there is way too much CDO paper relative to who wants to own it now.

In short, while there may still be a lot of value buried somewhere in the CDO's nobody particularly wants to find out how much. And as long as nobody wants a commodity, it's price is going to be indeterminate at best, and in free fall at worst.

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