Push for CDO Liquidation Will Cause More Market Volatility

Expect more liquidation and loss-taking in the coming weeks. “In addition, there was speculation that European firms have been selling some of the bad subprime debt held in the complex asset pools known as collateralized debt obligations, the economics firm said. The liquidation of low-quality assets often intensifies demand for safe assets.”

Finally, we have some good news. Demand for “safe assets” is precious metals bullish. But the larger issue is cleaning out the rot in the badly corrupted global financial system.

For the economy and the stock market to get back on solid economic footing, the past excesses and mis-allocated capital of the previous credit boom have to be liquidated. Banks must take losses. Fictitious assets must be marked down to their real value instead of held on a balance sheet.

“This is a credit market problem in the West which has to play itself out,” said Peter Spencer, a former British Treasury official in today’s Age. It could begin playing itself out this week as more CDOs liquidate, close up shop by creditors anxious to take their losses and get on with their financial lives. If creditors accept losses, it means we’re one day closer to CDO liquidation, and starting from a cleaner economic slate.

What precisely is happening in CDO-land? At Christmas,” The FT continues, “Thirty-three CDOs had triggered ‘events of default’. Mid January and that number had risen to 58. According to Standard & Poor’s that figure has now spiked to 80 – worth around $97bn. The number of defaulting CDOs has in fact increased by $13bn in the past week alone.

“But more worrying is the fact that senior creditors are now pushing for CDO liquidation – indicating the beginnings, perhaps, of a much-speculated-upon fire sale of CDO assets. A total of 18 CDOs, worth an estimated $18bn, have opted for liquidation as at Thursday. One is understood to have completed the process.”

All this means you should expect more volatility and selling in equity markets. Doing nothing is the first act of a cautious investor. With fewer buyers, prices should fall.

Dan Denning
Markets and Money

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.

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1 Comment on "Push for CDO Liquidation Will Cause More Market Volatility"

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Coffee Addict

There are some real bargains to be had, so long as the CDO does not have a significant residential mortgage component. Yes there is risk but I hear that some commerial debt based instruments with zero defaults are being marked to market at a discount of 40%. I know my comments here are usually bearish – and that the commercial default rate in markets such as Australia may rise – but this sort of discount for instruments of reasonable quality is riduculous!

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