Sub prime meltdown overdone? Not by a longshot

It seems the meltdown in the subprime mortgage market has taken a back seat, at least for the time being as US investors focus on the health of the economy and more specifically the all important housing data due out this week. However the sub prime story is far from over. To reiterate the comments of the Federal Reserve's top banking official Susan Bies

"this is not the end, this is the beginning"

There seems to be some sentiment around at the moment that the stock market's reaction to sub prime revelations was overdone, that exposure to low quality mortgages is contained to a narrow sector of the market. You see this time around it was different. Banks no longer hold the the mortgages they initiate, they've got more sophisticated and sold them off as mortgage backed securities which in turn have been gobbled up by derivative vehicles such as CDO's (see previous article for an explanation of CDO's). The risk has been spread over a greater number of investors so the damage will be lessened.

This new found sophistication and the abundance of cheap money combined with good old fashoined greed ensured a steady of flow of low quality mortgages even in the face of rising interest rates. Of course this new sophisticated approach of spreading risk is all smoke and mirrors. The music has started to slow and a few have been caught holding the bag. The latest to be handed a bag of goodies is H&R Block who have written down the value of their discontinued mortgage business to the tune of almost $30m with more writedowns looking likely before they can offload the business.

When the music stops completely there will be plenty of bags to go around. Imagine as a US investor waking up one moring to find that your 401k has been belted because it has exposure to sub prime mortgages via some derivative product you didn't even know about? Stay tuned as the subprime mess continues to unravel.