Mortgage Shakeout May Roil CDO Market; Subprime Defaults Lead to Wavering At Big Street Firms
For years, an obscure class of Wall Street investment vehicles has acted like a locomotive in the housing-finance business, driving growth by soaking up risky mortgage bonds and parceling them out to investors around the world.</br></br>Now, as mortgage problems mount and a wave of mortgage-bond downgrades looms, these investments, known as collateralized debt obligations, are starting to look like a different vehicle -- rockets overloaded with combustible fuel.</br></br>Some big investment banks have been wavering when launching new CDO deals because of problems in the subprime mortgage market, which caters to the least credit-worthy borrowers. The problems also have investors demanding much higher returns on the CDOs they buy, which makes them harder to sell and drives down their prices.</br></br>CDOs are an integral part of Wall Street's mortgage dicing-and- slicing machine. After mortgages are written, investment banks pool them together and use the cash flows they produce to pay off mortgage- backed bonds, which the investment banks underwrite.</br></br>The mortgage bonds, in turn, are often packaged again into CDOs and sold off in slices. Investors can choose to buy the risky pieces of the bonds or purchase slices with less risk.