While prime, Alt-A and even some subprime mortgage loans look like they'd be able to weather as much as a 30% home price decline on the coasts and a 10% decline in the middle of the country - the swaps used in this year's vintages to hedge interest rate risk may end up significantly hindering some of those transactions in such a scenario, according to a simulated housing market decline scenario recently conducted by Standard & Poor's. In an environment of such rapidly declining home prices, analysts assumed falling short-term interest rates, positive for adjustable-rate borrowers and others in need of refinancing, but negative in terms of payouts from trusts to swap counterparties.

Similar to the scenario that contributed to later-vintage high-yield CDOs suffering numerous downgrades, overhedging for rising rates can be enough to push an already defaulting portfolio to eat through credit enhancement.

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