Where is the Real Risk in the Subprime Debacle?

This week we continue to look at an alphabet soup of problems: RMBSs, CDOs, Alt-A, BBB and - a new acronym to put on your radar screen - the very useful CDS. When does an AAA rating not mean an offering is ready for prime time? What type of contagion are we seeing from the Bear Stearns blow-up? I survey my friends in the hedge funds space, trying to find some evidence of cracks in the foundation, and let you know what I hear. We will again look at a wide variety of items and see if we can discern some connections.

I was writing last year that the subprime investment market would end in tears, as loans were being securitized as investment-grade that clearly were going to have problems. We are now witnessing the beginning of those travails, and the lawyers are gathering.

Let's review what I wrote in early January:

"We live in a world where there is an increased appetite for yield by investors at all levels; and armed with growing liquidity, they chase those yields down to a point where traditional risk-reward measures would suggest the potential for problems.

Honey, I Bet the Farm

"Let me give you a preview of a coming scandal, just to illustrate the chase for yields. In the US, about 25% of the mortgages on new homes are what is known as subprime mortgages. These are mortgages that are slightly less creditworthy and therefore offer higher interest rates. In the beginning this was a good thing, as first-time owners and those just starting out in life…