Saturday, February 16, 2008
Monolines Death Throes
"Rescue plans are starting to take shape for struggling bond insurers, but they aren't likely to prevent further ratings downgrades for many of the companies. ... A group of banks--betting that the insurers still have some value--are working with the management and investors of New York-based Financial Guaranty Insurance Co. on a potential plan for FGIC. ... The banks, then would share in the proceeds that the bond insurers could make as they collect premiums and wait for their existing portfolio of policies to 'run off.' In this scenario, the most the banks are hoping for is that the bond insurers' credit ratings don't fall below double-A. ... 'It's just an indeterminable amount of losses on these assets and the final number could be far more significant than we had been envisioning,' Thomas Abruzzo, managing director at Fitch says. ... A key hurdle for the banks and the bond insurers is determining how much the banks should get in exchange for tearing up their credit-default swaps, and whether owning stakes in companies that could get further downgraded is fair compensation, says one person familiar with the discussions. Another option being banded about by the analysts and others is to form a new company, funded by the banks, which could take responsibility for meeting the obligations of some of their insurance policies--mainly the credit-default contracts--weighing on the bond insurers", WSJ, 7 February 2008.
"The financial crisis plauging municipal-bond insurers has some people wondering what the world would look like without them. The answer: maybe not as bad as you would think. ... Yesterday, Moody's Investors Service cut its triple-A rating on units of Security Capital Assurance Ltd., saying the bond insurer had been weakened by its exposure to the U.S. residential-mortgage market. ... But some regulators, investors and municipalities are starting to question the value of all that insurance. ... Municipal bonds with a double-B rating from credit-rating services have a cumulative average 10-year default rate of 1.74% since 1970. That is much lower than double-B rated corporate bonds which have a 29.93% 10-year cumulative default rate during the same period. ... Before the bond-insurer crisis, bond investors charged about 30% of the interest-rate savings an issuer would get. In recent months, that has climbed to 80% or 90% as the bond insurers try to extract as much premium as possible. For the issuers, though, that has reduced the value of the coverage. ... The market is also pricing municipal debt as though the insurance didn't exist anyway, says John Mousseau, vice president and portfolio manager at Cumberland Advisors. 'You're seeing insured bonds trading at 5% levels, as if they had no insurance', says Mr. Mousseau. ... Robert Shoback, managing director at Ambac, in U.S. public finance, says municipal-bond insurance 'has been and continues to be cost effective' for many issuers who choose to use the service because it reduces their payments. He also noted that insurance provides individual investors with a sense of security about the bonds they own", my emphasis, Liz Rappaport and Karen Richardson at the WSJ, 8 February 2008.
"What is good for Ambac, the bond insurer, is good for the country. Well, perhaps in the short run if it prevents a run on the shadow banking system. ... But not in the long run. ... The Ambac business model is as faulty now as was chairman Charles Wilson's forecast for General Motors more than half a century ago. ... In combination with overly generous triple-A ratings on not only these assets [subpime mortgages, SIVs and CDOs squared] but the monoline companies themselves, they have fostered a bubble of immeasurable but clearly significant proportions. ... How could Ambac, through the magic of its triple-A rating, with equity capital of less than $5bn (Pound 2.5bn) insure the debt of the state of California, the world's sixth-largest economy? How could an investor in California's municipal bonds be comforted by a company that during a potential liquidity crisis might find the capital markets closed to it, versus the nation's largest state with its obvious ongoing taxing authoroty? Apply the same logic to the gargantuan size of the asset-backed securities market it has insured in recent years--subprimes and CDOs in the trillions of dollars--and you must come to the same logical conclusion--this is absurd. ... As long as the illusion lasted, however, it is clear that monoline insurers fostered an expansion of our modern shadow banking system and therefore an extension of US and even global economic prosperity. ... But like General Motors a half century back, the sense of stability imparted to an oligopolistic industry with visible flaws is not likely to last, nor may the hope for a return to economic growth of recent years", my emphasis, William Gross (WG) at http://www.ft.com/, 8 February 2008.
Now Fitch says there may be "an indeterminable amount of lossses". Who needs these guys? The banks don't know how much to "get in exchange for tearing up their credit-default swaps". Poor babies. How anyone ever thought the monolines could honor their swaps is beyond me.
"The market is also pricing municipal debt as though the insurance didn't exist". It's about time. The insurance never existed. Shoback of Ambac states, "insurance provides individual investors with a sense of security about the bonds they own"; the insurance is and always was, a public relations stunt. Think about this: the 10-year default on double-B corporates was 17.2X (29.93% / 1.74%) that of double-B munis. What does "double-B" mean anyway? Anything? Also see my 13 December post.
WG says, "this is absurd". It always was. I long thought the monolines were akin to the Wizard of Oz, an illusionist. Yves Smith's post on WG's article at http://www.nakedcapitalism.blogspot.com/, 8 February 2008, is worth reading.