“You’re only sunk if they go KerPlunk!”

From Bloomberg:

CDOs Lose Their Marbles; Credit Cries `KerPlunk!’

Investors asking how many beans make four in the market for collateralized-debt obligations are realizing that the likely answer is three if you’re lucky, fewer if you’re not.

“Their models are basically unable to predict any `normal’ behavior due to this overriding fraud factor,” Engineer wrote in a research report this week. “The right thing for the rating agencies to do for the 2006 vintage would be to withdraw all ratings.”

Mark Zandi, chief economist at Moody’s Economy.com, told CNNMoney.com that a record $50 billion of adjustable-rate mortgages will reset at higher levels in October. A borrower who got a $200,000 mortgage in 2005 at 4 percent has been paying $955 a month; that will soar to $1,331 after the reset.

No wonder RealtyTrac is predicting that more than 1 million borrowers will join the 761,343 already facing foreclosure proceedings this year.

Contagion from the allegedly self-contained implosion in the U.S. subprime mortgage market is drifting through the securities industry like mustard gas. It helped push the dollar to a record low yesterday, triggered the biggest deterioration in European corporate-bond risk in at least three years, and drove an index that tracks leveraged-buyout loans to a nine-month low.

Global credit markets face what fund manager Gary Jenkins calls “a KerPlunk moment,” referring to the children’s game in which players withdraw skewers while trying not to dislodge 32 marbles suspended in a plastic tube.

“Volatility to the markets is like a toy to a 5-year-old,” says Jenkins, who helps manage $650 million of bonds and derivatives at Synapse in London. “Your little darling really wants that toy. Then she leaves it in a corner and goes off to play with something else. When it isn’t around, we all want it, but when it gets here, we really don’t want it at all.”

As S&P and Moody’s work their way through the gazillions of CDOs they have assigned credit gradings to — last year’s $503 billion of new securities compared with $274 billion in 2005 and just $144 billion in 2004 — further rating cuts seem inevitable.

“If all the marbles fall, you lose it all!” went the pitch for KerPlunk, first sold by the Ideal Toy Co. in 1967 and later marketed by Mattel Inc. “You’re only sunk if they go KerPlunk!”

Those central bankers who have wondered how the brave new financial world of hedge funds and derivatives would cope in a crisis may soon have an answer. Let’s hope it’s not “KerPlunk.”

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