Subprime Subdued

January 31st, 2008 12:17 pm | by John Jansen |

S and P downgrades a big chunk of the subprime universe late yesterday. I spoke with an aficionado of that market sector to discern the reaction. The reaction was muted and subdued. My interlocutor notes that most of the bad news is already reflected in current prices.( He noted that BBBs trade in the teens.)

What are the risks in the market? One risk I have addresed here in a post several weeks is the possibility that the servicers would bundle REO properties as auction them. Most of the BBB pieces are priced for a longer term foreclosure process and cash flow dribbling in.If the money were to paid out quickly those tranches would quickly deteriorate and would have been toxic waist for anyone who touched them at any point in their tortured life cycle.

For more senior tranches of the capital structure the risks are more macro based. Does Congress sanction muni bonds which will buy up the foreclosed properties? If so that would fuel a huge rally in AAA paper.

AA and A paper is where the smart money ( or at least considers itself smart)is playing and think it has the best opportunity to make a few bucks. Only time will tell if they are correct.

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