As Halloween approaches, problems in the debt markets continue to haunt Wall Street. Hard to believe as it may be, the already battered markets in structured debt could take new hits in coming weeks. Some esoteric markets, including those asset-backed commercial paper markets for structured investment vehicles and collateralized debt obligations, may soon be the sites of downgrades and selloffs. Rating agencies Moody's and Standard & Poor's have been downgrading residential mortgage-backed securities, many of which have been packaged into CDOs and sold to various investors. Much of the debt has already been substantially written down by CDO holders, which include pension funds, insurance companies, hedge funds and banks. But the pain for players like UBS ( UBS), Citigroup ( C), Bear Stearns ( BSC), JPMorgan ( JPM) and Washington Mutual ( WM) may only be beginning. "The unambiguous effect is it will encourage selling," Douglas Lucas, head of CDO research at UBS, says of additional mortgage securities downgrades. He says the issue is further complicated by the fact that there are few buyers remaining to take on subprime CDO-tainted paper. One New York-based CDO manager and trader expressed worry about the impact of eventual downgrades -- not just on the CDO market, but on the hobbled market for structured investment vehicles. "CDO downgrades expected soon ... will elevate pressure on SIVs," the manager told TheStreet.com via an email during the trading day.
Already, SIVs run by London-based Cheyne Capital Management and Germany's IKB Deutsche Industriebank have been unable to repay maturing short-term debt. Further downgrades are expected to lead to more troubles in SIV land, according to a report by Bloomberg. SIVs, which are essentially investment funds set up to benefit those who borrow short-term to buy longer-dated securities, have ties to investments in mortgage-related commercial paper. Uncertainty about credit quality has caused widespread panic in these vehicles, which have been primarily set up as arms-length vehicles of financial firms such as Citigroup and JPMorgan. The U.S. Treasury along with Citi, JPMorgan and Bank of America ( BAC) are hashing out a superconduit that would theoretically help alleviate some of the distress being felt. But it remains unclear how the vehicle would be set up and which firms would benefit from its creation.