Bubble, Bubble, Toil and Trouble

Bloomberg's attention was captured by the housing market this afternoon. Four of the top six stories as of 4:45P CDT:

• U.S. Stocks Tumble, Led By Financials as Mortgage Slump Worsens

• U.S. Subprime Mortgage Delinquencies Reach Four-Year High of 13.33 Percent

• Accredited Home, New Century Shares Plunge After Lenders Demand More Cash

• GMAC Reports Fourth-Quarter Loss at ResCap Mortgage Unit on Loan Reserves

This is what's got 'em all nervous. Bloomberg (03.13.07):

"Bond investors rattled by mounting losses in subprime U.S. mortgages say trouble is brewing in collateralized debt obligations, the same securities that fueled the boom in leveraged buyouts and cut-rate finance."

Sales of CDOs, which package loans, bonds and derivatives into new securities, rose by almost half to $918 billion last year, according to data compiled by JPMorgan Chase & Co.

CDOs May Bring Subprime-Like Bust for LBOs, Junk Debt

"CDOs were first set up in 1987 by bankers at now-defunct Drexel Burnham Lambert Inc., the home of one-time junk bond king Michael Milken. Junk, or high-yield, debt are rated below Baa3 by Moody's and BBB- by Standard & Poor's."

"Bankers bundle what is often speculative-grade securities into a CDO, dividing it into pieces with credit ratings as high as AAA."

In other words, there's a lot of this stuff out there, and a lot of it contains varying amounts of subprime loans. As the expected default rate of the skanky loans begins to exceed original allowances, these guys are gonna freak.

Then you'll see some hell breaking loose.