Aside from one's long-term views on the U.S. housing market, the new and relatively untested nature of the ABS CDS market has some wondering whether investors will agree as to who owes what - along with when and how. While many strides are being made toward further standardization for the trades and their documentation, new types of players in the sector and the specter of counterparty risk are two often-voiced concerns. What's more, a case on appeal to the United States Court of Appeals for the Second Circuit could call into question whether the contracts actually stand up in court.
Market players emphasize maintaining stability and confidence in the burgeoning ABS CDS sector is in the best interest of everyone involved. The increasingly poor performance of the bonds referenced in many of the trades, however, has definitely drawn new participants to this complex sector, many of which are hedge funds. The ability for subprime mortgage borrowers to pay their monthly mortgage payments is crumbling in some cases, amid slowing home price appreciation and looser underwriting standards. Mortgages originated in 2005 and 2006 - the two most widely referenced vintages in ABS CDS contracts - are expected to bear the brunt of poor conditions (see article on page 1).