Financial News

While I'm on the subject (post below), I thought I would take a moment and comment on what's going on with the economy and stock market.

In case you didn't notice, the market tanked yesterday and isn't so hot today. The reason is that all those subprime mortgages are being reevaluated. As defaults rise, and defaults are rising significantly, the value of the bonds that back the mortgages are losing value.

Why does that matter?

This is where it gets interesting. The rating agencies, those that rate the risk/quality of the bond, had rated these bonds as lower risk than they really were (a whole story unto itself as you can imagine). Yesterday Standard and Poors, one of the key rating agencies, downgraded an whole bunch of those bonds, many of them to "junk" status.

Why does that matter?

Many money managers, insurance companies and portfolio managers can only own bonds that are above junk status. If a bond is re-rated downward to junk, they have to get rid of it. Problem is, there's zero market for these bonds at anything than cents on the dollar. That means big losses for these managers.

Why does that matter?

If you own shares of, oh say, Prudential Insurance and it owns a lot of subprime bonds (CDO's is the technical name) and they suffer large losses because of those bonds, their stock price goes down. And if portfolio mutual funds own Prudential shares that are falling, their shares go down in value. And so goes the merry-go-round. It's a lot like a polygamous husband having an affair and bringing a veneral disease into the family.

This is exactly how something like a problem in the mortgage market can become a "contagion" to the rest of the market. The negativity of the situation is not reassuring, but the losses reintroduce risk into the equation, something that has been significantly missing now for several years.

How far will the contagion spread? That is a (literally) million dollar question. Maybe billion or even trillion dollar question. The suspicion right now is that Bernanke and Paulson will put their heads together soon and add another shift to the government money printing presses to forestall any real damage.

Can you say inflation anyone?