Sunday, March 16, 2008

Ambac Bailout?

"A consortorium of banks is considering injecting $3 billion into Ambac, the mono-line insurer that relies on its AAA rating to insure, amongst others, municipal bonds and CDOs (collateralized debt obligations). What appears as a rescue plan and may appease the markets short-term, may plant the seeds for disaster. ... The two developments caused the insurers to veer from their path: as public companies, mono-line insurers were looking for new income streams. Not only that, rating agencies told these insurers that they are not very diversified, that they may have to have a second look at the credit ratings if they did not broaden their insurance coverage to, say, securitized mortgage products. Rating agencies were eager to see the market of debt derivatives expand, so that they could facilitate a market by providing credit ratings to structured products. ... Think of a credit default swap as a put option that will pay you if a company or a security fails. With a perceived foolproof arsenal of financial tools, banks felt encouraged to carry a lot of complex financial products on their balance sheets. By buying insured securities, or by protecting against the default of an issuer, the banks reasoned, they could show stellar balance sheets. Banks are in the business of lending money; to do so, they require reserves. That arsenal of financial tools, however, is at risk of turning into an asinine collection of toxic waste if the securities held are not as secure as they seem or of the credit default swaps are not worth the paper they are written on. One risk that few talked about until recently, is counterparty risk. ... In [municipalities] view, mono-line insurers have betrayed them by risking their credit ratings through reckless veering into riskier lines of business. ... Banks are closer to being their own counterparty to their credit default swaps. ... We used to criticize Japanese shareholder crossholdings, building a house of cards that eventually had to collpase. U.S. financial institutions are laying the foundation for the same mistakes", Axel Mark (AM) at, 27 February 2008.

I think AM has this knocked. None of the monoline bailout plans make sense.

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