Paybacks' a bitch: We haven't heard the last of the Subprime Mortgage Crisis.

"The semiannual meetings of the world’s top finance and banking officials are predictable in one sense: Europeans and Americans often use them to lecture leaders of poor countries about the need to modernize their capital markets, promote transparency and adhere to sound investment standards.

What a difference a subprime mortgage crisis can make. Now developing countries are lecturing the West."

Tables Turned: Poor Countries Wag Fingers at Rich Ones - New York Times (21 October 2007)

Remember the Asian Financial Crisis of '97 when Thailand, Korea and Indonesia were bailed out by IMF and got an earful from Developed Countries as to how to run their economies?

Well, now, its America's turn with no end in sight for the subprime mortgage crisis.

"Collateralized debt obligations — made up of bonds backed by thousands of subprime home loans — are starting to shut off cash payments to investors in lower-rated bonds as credit-rating agencies downgrade the securities they own, according to analysts and industry executives."

Mortgage Security Bondholders Facing a Cut-back in Interest Payments - New York Times, (22 October 2007)

Bondholders who hold CDO bonds may face the possibility of having their coupons not paid.

"With such a re-evaluation, owners of collateralized debt obligations — investment banks, hedge funds, insurance companies and public pension funds — may be forced to write down mortgage investments beyond the billions they have already written off."

Oooohh kkkkaaayyy... *gulp*

One would think that a re-rating would be sufficient to sort out the entire problem but CDOs are a tangled barrel of worms. Its like having a pie made up of good and bad apples. The bad ones taint the whole lot.

Here's an insight into how complex the whole thing can be:

"A re-evaluation of payments by trustees who oversee the debt obligations is part of a long, complex chain reaction that is caused by the surge in mortgage delinquencies and home foreclosures. As more homeowners fall behind on payments and lose their homes, the pressure builds on large pools of mortgages that issue bonds to investors. Many of the riskiest of those mortgage bonds have been bought by the C.D.O.’s, which issue bonds of their own.

On Friday, Standard & Poor’s lowered the ratings on $22 billion in bonds backed by mortgages made to people with weak credit in 2006, citing the continued deterioration in the housing market. Another credit rater, Moody’s Investors Service, lowered a similarly large group of bonds earlier in the month.It is unclear exactly how many bonds will be affected and how quickly. Investment banks issued some $486 billion in debt obligations linked to mortgages in 2006 and the first half of 2007.

A majority of the bonds have high credit ratings, and the trustees of the debt obligations typically shut off lower-rated bonds first to accelerate payments to investors holding higher-rated debt.When ratings on the bonds directly backed by mortgages are lowered, it forces the trustees to discount the value of their holdings in a calculation performed once a month. Some C.D.O.’s also hold bonds issued by other debt obligations, so it can take months for ratings downgrades to work their way through the system."

Okay, so when will we see a bottom?

"Most mortgage securities have not yet had significant losses, which are only recorded when homes are foreclosed and sold. Up to two years can pass between a borrower’s falling behind on payments and an auction. Each mortgage security has a reservoir of excess cash to draw upon to pay bondholders when borrowers do not make monthly payments.

“As far as the security is concerned, it’s only once the property is effectively sold that a loss is recorded,” said Nicholas Weill, chief credit officer at Moody’s. “The process of foreclosure is a long process. It doesn’t just happen overnight.”

So there'll be at least 2 years of unfavourable investment conditions in the US.

So what are the banks doing to contain the problem?

"Problems with these investments has led big banks including Citigroup, Bank of America and JPMorgan Chase to develop a $75 billion rescue fund that could be used to buy risky mortgage securities and other assets from them, a move intended to ease pressure on an important part of the credit markets."

A US$75 billion dollar fund to increase liquidity in the trade of CDOs by Citigroup, Bank of America, JPMorgan Chase. Would it be enough though?