Whether or not the pan-asset wobble seen in June - triggered by the implosion of two Bear Stearns hedge funds geared to US subprime mortgages - proves to be anything more than a blip on the long term charts, markets got a sharp reminder on Tuesday that the subprime issue has not necessarily gone away.
In a move that seemed to confirm those who warned that, by definition, credit agencies were behind the curve since they focused on default (rather than market) risk, Standard & Poor’s announced it may cut the ratings on some 612 mortgage-backed securities. About $12bn of debt is directly affected.
S&P also unveiled a series of changes to its ratings methodology and said it was undertaking a deeper review of its approach to CDOs.
The result? Well, what Reuters described as a “precipitous plunge,” of course — or what one Deutsche analyst called a “meltdown.” Bid/offer spreads on the benchmark ABX index blew out to 3 points, while the index itself crashed from 55.5 to 49.
We say “crashed,” but falling back on the more classical terminology of the equities market, a near-12 percent fall in prices really is “a crash” — except for the fact that, until recently, the upwardly-vertical trajectory of the subprime ABX indicator renders such comparisons meaningless.
The great unknown here is how the underlying owners of subprime-related assets might react to specific downgrades. In short, will holders become forced sellers so as to stay in line with their stated investment criteria?
If the answer is “yes,” find yourself a tin hat. 
Here’s a chart on residential mortgage backed securities that should help concentrate minds:
