Like the plague of old, the CDO mess continues to seep into parts of the markets that many had said were immune.  Contained?  Well not exactly.

The result is that a market shaking daisy chain of events is becoming more likely every day.

One of the places where it's most vulnerable now is in the businesses that have insured all of that bad debt-the bond insurer's. They are the companies that have to step in make the principal and interest payments on the bonds when the issuer can not.

They are one on the big reasons that the bonds themselves can achieve such high ratings in the first place-because they are essentially backstopped by highly rated insurers.

That's absolutely key in the bond world. In it ratings are everything, since the values of the securities rise and fall on them.

And like the bonds themselves the insurers are also rated by companies like Moody's, S&P, and  Fitch based upon their ability to meet the forecast for defaults.  And that's where the big problem may be.

Because the CDO market is such a tangle of defaults, the very integrity of the insurers has come into question.  At risk is not just their solvency, but also that ever important rating.

A lower rating for the insurers would only further depress the values of those already troubled CDOs, which is the last thing they need right now.  

A great story in Bloomberg yesterday highlighted the brewing problem.  And according to the story it could cost investors some $200 billion before it's over.

From the story:

"Lower ratings would force some investors to sell securities. About 110 municipal bond mutual funds are required to hold most of their assets in AAA debt, according to data compiled by Bloomberg.

When home sales soared this decade, insurers increased their guarantees of securities created from mortgages, including subprime loans to people with poor credit and home-equity loans.

They now guarantee almost $100 billion of collateralized debt obligations backed by subprime-mortgage securities as of June 30, according to an Aug. 2 report by Fitch.

``We shudder to think of the ramifications,'' said Greg Peters, head of credit strategy at New York-based Morgan Stanley, the second-biggest U.S. securities firm by market value. ``You have politicians, taxpayers, municipalities, states. It just opens up a Pandora's box. That is a huge destabilizing force.''

``The insurers can protect you from one unusual, idiosyncratic event, like a Hurricane Katrina,'' said Daniel Castro, chief credit officer of structured finance at GSC Group in New York, which oversees more than $24 billion of debt. ``What if you had 20 Hurricane Katrinas and everything is wiped out? That's what you have right now.''

It's a scary story to say the least, and just more evidence that the wave continues to build.

One Katrina was bad enough.