The Estimated Losses for CDOs from Sub-prime Mortgages Begin to Roll In

According to Bloomberg the estimated losses for CDOs from sub-prime mortgages range $26B to $90B, yes that is B like in billion, depending on the source. (Personally, I think it will be on the high end of the forecast.) That is a lot of money. Who is going to absorb these losses and how will it be done?

Having witnessed this type of situation before in the oil patch crash of the mid 1980s and the S&L crisis of the early 1990s it is all about timing of the losses. Given enough time the losses can be absorbed by many of the institutions involved with limited damage. If, however, the events move very quickly the market will "crash" and some institutions will fail as a result. This is the hard part to predict, because at this time no one knows the catalyst or the timing that could cause a market crash.

Hence, the discussion in many quarters about the “perfect storm”. All the ingredients for the “perfect storm” exist, it is just that no one is sure if they will come together in the way required to form that storm.

Losses from bonds secured by U.S. subprime home loans may reach $52 billion amid rising foreclosures on the mortgages, analysts at Credit Suisse Group said.

Subprime defaults ``are clearly a huge problem'' for investors in collateralized debt obligations, Credit Suisse analysts led by Ivan Vatchkov in London wrote in a report. ``But we do not think that they are a systemic one.''

Banks are unlikely to lose more than $10 billion on the CDOs they hold because they typically keep the least risky portions of the securities, the analysts said in the July 6 report. CDOs package bonds and loans into varying pieces of risk, using their income to pay investors.

Delinquencies and defaults on U.S. subprime mortgages will keep rising as borrowers who received loans with less rigorous checks miss payments, Robert Parker, vice chairman of Credit Suisse Asset Management, said on July 5.

Investor losses from CDOs could range from $26 billion to $52 billion over time, the Credit Suisse analysts wrote. Deutsche Bank said June 29 that losses from bonds backed by subprime mortgages may reach $90 billion.

Banks may face a bigger risk from the loans made to hedge funds that invested in subprime CDOs than from their own holdings of the securities, the Credit Suisse analysts said.

European banks are likely to be less affected than U.S. lenders to CDO losses because they're among the ``most conservative'' investors in the securities . . . .