Subprime industry hit again

According to recent WSJ [subscription required] and Bloomberg reports, the S&P rating agency is going to possibly downgrade $12 billion of subprime mortgage-backed securities. S&P's reasoning is primarily based on their thesis that housing prices are going to fall further before recovering (8% on average between 2006 and 2008). Previously, S&P had expected less of a housing slump and a quicker recovery. As a result of this slower-than-expected housing price recovery, subprime mortgages will continue to struggle as more and more homeowners are forced into default.

The implications of this event, if it occurs, are far reaching. One important result which could occur is further negative headline exposure for the Collateralized Debt Obligations (CDO) industry. This is due to the fact that many CDO managers loaded their CDO portfolios with subprime credit when times were good. However, as the tides turned in recent months these investors have been getting killed, especially the lower quality debt/equity tranches of these portfolios. In fact, the S&P is even considering directly downgrading the CDOs with exposure to the subprime industry - an event that would likely force some insurance companies, pension funds, and other conservative investors to cut CDO exposure. In fact, I talked to one CDO trader today who said, "I need a new job asap...things are tough right now."