Tuesday, January 15, 2008

The Race to Downgrade

Earlier summaries at HingeFire outlined the “race to downgrade” as one of the risk factors adversely impacting the economy. The continually downgrade cycle has become so prevalent that the financial press has now derived a name for it - the “Friday CDO downgrade bonanza”. It appears that Standard & Poors each Friday cuts the credit rating of another large group of CDO tranches.

In the most recent week, Standard & Poors lowered its rating on 149 tranches worth $8.7 billion, and put another 54 on credit watch. The total is now 1,290 tranches from 402 CDOs worth over $83.5 billion in just a few weeks with 726 tranches on credit watch.

Amazingly enough, most of these tranches have been downgraded to junk, many with a low “C” rating. Just a few weeks back most were ‘AAA” rated. The CDOs covered by credit rating agencies only represent a fraction of the total outstanding. The other rating agencies such as Moody’s are also in a rush to downgrade the CDO instruments they cover.

The mad rush to downgrade formerly pristine CDO instruments to junk over the course of the past few months should make people wonder if the entire credit rating industry was asleep at the wheel, or even worse - complicit in unsound risk practices.