Subprime Securitization: How Much Spillover?

Experts debate the amount of the threat that problems with high-interest debt for homeowners present in other credit-related areas.

But the containment may not last forever, other experts caution. Credit cards and automobile markets might also face pressure, Kellogg’s Fishman says, as the same people struggling to pay back loans on their houses — and unable to use them as collateral for more borrowing — also may fail to pay off credit-card and car debts. “The people who tend to default on one tend to be the people who default on the other,” he notes.

The most likely spillover may be seen among CDOs, which are closely tied to the subprime real estate market. The strain on the subprime securitization could reduce the investor base for CDOs, as defaults lead ratings agencies to change their criteria. Of course, CDOs and securitizations already bear part of the blame for the subprime problem. “Some combination of the way the securitization market worked for subprime and the way the CDO market worked allowed these instruments to trade at values above what they were really worth,” according to Davidson.

As the Bank of England’s financial-stability report sees it, reliance on leverage in subprime commercial real estate and corporate credit markets could “magnify the market response” in the event that their underlying assets stop performing. However, corporate loans are less driven by demand than mortgage-backed securities, and they are more diversified in terms of their exposure to risk. Since the deals are generally bigger, credit analysis in corporate lending tends to face tougher scrutiny.

Subprime loans do face a steeper threshold now. At a hearing before the Senate Banking Subcommittee on Securities, Insurance, and Investment, David Sherr, the managing director and global head of securitized products at Lehman Brothers, said that subprime borrowers are facing stricter guidelines and are being contacted if a default seems imminent. Not only are standards rising, he said, but the volume of securitizations and the range for mortgage products are shrinking.

“Mortgage finance tends to be cyclical,” says Moody’s Harris. “And the corrections in subprime tend to be more severe.” The structural differences between subprime mortgages and other sectors so far may have helped prevent spillover into other securitization markets. But companies and investors also may take a closer look at underlying asset quality, the bedrock of an investment, in light of the subprime crash.

If such assets are overvalued, any underlying investment — whether composed of bricks and mortar, or plastic — well could collapse.


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