bof – you are absolutely correct regarding loss limitations on the underlying assets (mortgages) as well as the potential credit contraction due to loss of appetite for mortgage-backed securities.
Another aspect to consider is the impact of credit derivatives. We’re potentially talking about trillions of dollars in credit derivatives at stake as the default process unfolds. So a hedge fund or investment house’s exposure on derivatives may far exceed their exposure on CDO’s. Therefore, potential losses are not limited to the underlying asset alone.
