Benchmark ABX subprime indexes traded at fresh new lows today amid concerns that a new wave of defaults in subprime mortgages will spur further troubles for holders of collateralized debt obligations (CDOs) and other mortgage securities.
Traders and investors continue to struggle to determine what they know and don't know about market risk.
The immediate worry revolves around troubles at two hedge funds run by Bear Stearns, which could force a fire sale that will drive prices for the derivatives still lower. Shares of Bear Stearns have fallen more than 4% today.
The bigger question is whether the subprime mess will spill over into the corporate credit market, which could have a potential impact on stocks.
There are some $250 billion of bonds and loans to be funded during the next several months to finance the recent leveraged buyout boom. Problems in the credit market could create problems for those deals.
There's also another shoe that could drop: As the collateral that underlies those securities deteriorates, ratings agencies will have to downgrade the securities. Some investors may not be able to hold that downgraded paper, which could spark a wave of selling.
Any sense of an asset fire sale or a run for the exits because of downgrades by ratings agencies could mean a problem beyond subprime risk and more about systemic risk to the larger financial system.