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The Light Bulb Finally Goes On

Whether it was the heat from global lawmakers, the angry mob at CalPERS, or divine intervention, S&P has done some soul searching and concluded that blind faith in a Monte Carlo model for CDOs may not have been the way to go.

The ratings firm will introduce tests -- both quantitative and qualitative -- to supplement its default-simulation model. S&P will also adjust its models to target AAA default rates it believes are commensurate with conditions of extreme macroeconomic stress, such as the Great Depression, as well as BBB default rates consistent with the highest actual coproate (sic) defaults over the past 28 years.

The result of all this good news? A cool half trillion spread across close to 5,000 CDO tranches is on downgrade watch. While super senior tranches may see a shoulder shrugging two to three notch downgrade, more junior AAAs could lose two As before the carnage is over. Given the level of potential damage, it almost provides credence to 'better never than late'.