One Bond, Many Obligors, So Where’s The Risk?

September 21, 2009 by · Leave a Comment
Filed under: General 

Intuitively you know that a multi-obligor security is a safer investment than a single-obligor. The risk of complete default is spread across hundreds of debtors, not just one. If one obligor fails, there are many others who are performing as agreed. Your loss is nominal.

Even if 15% of obligors flounder (which, on a nationwide average, is about the worst failure rate for home mortgages) you still have 85% performing. And in the case of bundled home mortgages or car loans, the foreclosed homes or reposed cars still have value. Not market value perhaps, but it is greater than zero. So in the worst case you haven’t even lost 15% of your investment.

So, why are multi-obligor securities being downgraded so ruthlessly?

It appears as though the issuers and ratings agencies have no clear idea what is in the multi-obligor bonds they respectively issued and rated. Hence they are downgrading the bonds to a point at which they are comfortable not knowing what is included in the multi-obligor bond. Their abundance of caution — now when it is too late — is causing a lot of pain for a lot of good people.

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