June 24, 2007 (LPAC)--Standard & Poor's last week downgraded 45 bonds backed by subprime mortgages and said it may downgrade another 88, echoing earlier actions by Moody's Investors Service. Another major credit-rating agency, Fitch Ratings, announced it may cut its ratings on four collateralized debt obligations (CDOs) linked to second-lien subprime loans, with a face value of $3.1 billion.

CDOs are a form of asset-backed security, created by taking the income streams from bonds, loans, and other assets, and using that income as the basis for creating new securities (the CDOs). These CDOs are divided into tranches, often senior debt, mezzanine debt, subordinate debt and equity, with the senior debt having the best chance of being repaid and the equity the least. Since the assets on which the CDOs are based are themselves shaky, the values of the resulting CDO tranches are also shaky. Many of these CDOs are in reality worthless, their fictitious face values used as part of an elaborate accounting hoax to hide the bankruptcy of the system.

As we have seen with the recent Bear Stearns hedge fund/CDO meltdown, their value tends to evaporate whenever it is exposed to public scrutiny, and there is a lot more of it out there on the books, as we will see.