Repeat after me: On Tuesday, the "triple-B-minus-rated tranche of the ABX index" dropped to a new record low.
Even if you have no idea what that means, it's kind of fun to say, although thinking about it too long may bring on a bad case of the heebie-jeebies. My daughter frowns for a week if she gets a B- on a math quiz. A triple-B-minus? That's like, triple-un-good. And a new record low? That's always gonna hurt.
Joking aside, the easiest way to comprehend what a crash in the ABX index means is this: The ABX index is a way of measuring credit risk in the market for subprime mortgage-based securities. On Tuesday morning, one of the three big credit-rating agencies, Standard & Poor's, announced that it may soon downgrade the credit status of about $12 billion worth of such securities. Most of it is stuff that could well and truly be considered toxic waste -- bonds that are tied to the value of mortgages issued by such illustrious brokers as New Century Finance Corp. (now in bankruptcy proceedings) and Fremont General (forced by the SEC to sell its subprime lending business). But Standard & Poor's also announced that it was going to review its procedures for rating the rest of the hundreds of billions of mortgage-backed securities out there, which is making Wall Street worry that more bad news is yet to come. Thus the free fall in the ABX index. Risk is suddenly risky!
(The Dow Jones Industrial Average also dropped about 150 points on Tuesday, which hardly constitutes a major market correction, but could be a sign of more generalized nervousness. And after the markets closed, another ratings agency, Moody's, announced it was downgrading $5.2 billion worth of mortgage bonds.)
Felix Salmon, blogging at Portfolio.com, is generally a voice of calm and restraint when the rest of the econo-blogosphere is racing to the windows to see if the sky has started to rain suicidal investment bankers. He professes himself "utterly baffled" as to why a panicked subprime sell-off is occurring right now. It's not as if it is news to anyone on Wall Street that there have been problems in the subprime mortgage sector. "S&P's announcement today tells us nothing that we haven't known for months about the subprime market," writes Salmon.
But maybe the real question is not "why now?" but "why not back then?" Why has investor sentiment been holding steady for so long even as the stink became unbearable?
Other analysts are less baffled:
"S&P's actions are going to force a lot more people to come to Jesus," said Christopher Whalen, an analyst at Institutional Risk Analytics in Hawthorne, California. "When a ratings agency puts a whole class on watch, it will force all the credit officers to get off their butts and reevaluate everything. This could be one of the triggers we've been waiting for."
A lot of debt will be downgraded to junk status. A lot of that debt will have to be sold at fire-sale prices. A lot of pension funds and hedge funds that once thrived on the high returns they could get from investing in subprime junk will now lose a lot of money.
S&P's announcement is a death warrant for the subprime industry. No longer will mortgage brokers be able to help buyers lie their way into a home. Fewer stressed homeowners will be able to refinance their mortgage, thus extending and exacerbating the housing bust.
Homebuilders continue to report large losses for their most recent fiscal quarters. On Tuesday, HomeDepot also lowered its earnings goals for the year, a reflection of slackening consumer appetite for home remodeling. And on Monday, the Federal Reserve reported a sharp 6.4 percent uptick in the amount Americans were charging on their credit cards, which could be a sign that now that cash from refinancing is no longer an option, we're whipping out the plastic.
Triple-un-good.
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