Bail-outs, billions and babble

Ilargi says:

We see the first signs of bail-out proposals for the US bond insurers (monoliners), and that of course is inevitable. If only because at face value, it seems to make sense.

After all, it was only last week that some of the ratings agencies indicated that they would be satisfied with capital injections of some $1 billion, in order for Ambac (and consequently all the bonds it insures) to keep the coveted AAA status. Obviously, other parties did the math too, and reckoned that this was a cheap bargain for restoring law and order in the sector, which tries hard to hold together $2.4 trillion in insurance for bonds, plus who knows how much for other paper.

A closer look, however, will show whoever tries this trick that what makes it seem like such a good deal, is exactly what kills it. Ambac is leveraged 143 times, and MBIA 147 times. This means that even if far less than 1 percent of their outstanding commitments go south and sour, they will, in theory, have emptied their covering coffers, which for Ambac hold less than $7 billion (which is why the $1 billion injection looks so appetizing!!), if memory serves. Ponzi works great on the way up, but not so after. This deal looks cheap, but looks deceive.

It will still be tried though, even if it’s a bad deal: the money needed on the table will come from the public purse, and that’s mighty easy to spend, always. Just to be on the safe side, they’ll raise $15 billion this time, by throwing in some private capital. Don’t forget that for the banks this is an excellent investment: they stand to lose more, by an order of magnitude, if the monoliners’ ratings fall below AAA for real and for good. The value of the bonds will drop off a cliff if that happens. Some people now start blaming the shifting (as in: more severe) focus of the ratings agencies for the monoline mayhem, but that's like saying the cart is supposed to push the horse.

Still, the biggest problem for the monoliners may well not even be in their core business. In the past few years, they, like few others, were "lifted up" by the party spirit, and started insuring and covering all sorts of securities as well. What enabled them to do this was partly the counterparty cover of banks such as CIBC and Barclay’s (and many -so far more or less hidden- others).

The most astonishing model here: bank buys or sells commercial paper, which is insured (either by same bank, or by another issuer) through the bond insurer. The next step is that same bank becomes the counterparty (in this case guarantor, or you could say insurer) for the paper, so the bank is the (end-) insurer for the paper that it just bought insurance for. That's a hard one to beat, brought to you by the 1998 repeal of Glass-Steagall by the US Congress.

Lastly, the main victims of the downfall of the bond insurers will be municipalities, counties and states. I’ve said it several times: they face a triple whammy slamdunk, which will drive many to the brink of the abyss. First, their tax revenue plummets when property taxes decrease through lower housing values. Second, the vast majority of them have reserves invested, often through third parties, in shaky shoddy not-so-securities. Now, number three comes a-calling: issuing bonds will become much more expensive (or less lucrative, if you will), if not downright impossible for many, if insurance at AAA level cannot be acquired.

These lower levels of government depend, for a very large part of their day-to day-finance dealings, on issuing and rolling over bonds. If that becomes a dead end, there will be no more capital to maintain infrastructure, let alone build new. Not only does that mean potholes and school closings, it will lead to a lot of unemployment in communities as well.

So yes, the stakes are high, and the temptations obvious. But if you’d ask the decision makers, off the record, if they feel confident in reviving the industry, the ones in the know would all shake their heads and wander off, possibly babbling incoherently, a condition sustained shock is known to inflict on human beings.

NOTE: we'll be back with a Debt Rattle news overview tomorrow morning, and keep the morning schedule, though it will be a "Rolling Rattle", with articles added as the day progresses.

Regulator offers hope for bond insurers

Hopes of a rescue effort is buoying sentiment in at least one corner of the equity market, with investors hoping that saviours will emerge for the hard-hit US bond insurers.

These monoline insurers, the biggest of which are MBIA and Ambac, are hanging on to their crucial triple-A credit ratings by a thread. Yet share prices for both Ambac and MBIA rose on Wednesday by 70 per cent and 30 per cent respectively on rising expectations of a capital injection.
The largest US banks are under pressure from New York State insurance regulators to provide as much as $15bn in fresh capital to support struggling bond insurers, people familiar with the matter said.

Eric Dinallo, New York insurance superintendent, on Wednesday met executives at the banks and has strongly urged them to provide $5bn in immediate capital to support the bond insurers and to ultimately commit up to $15bn.

Regulators in the US have worked round the clock to find some way of getting the monolines to patch up their capital bases after they miscalculated the risks associated with insuring payments on bonds backed by risky mortgage loans.

The Short View: Monolines and markets

This market crisis has not been prompted by macroeconomics as usual. Instead, it was triggered by fears for the architecture of the modern financial system - and the potential devastating effects its collapse might have on the economy.

Ever since the credit squeeze began last summer, every part of the edifice of securitised markets has been scrutinised. Bond insurers, many believed, were the critical weak point in the structure.

It is hard to overstate the fear in the market over MBIA and Ambac, the biggest bond insurers. Fitch's downgrade of Ambac, announced late on Friday, helped trigger Monday's sell-offs around the world.

Nevertheless, the importance of this rally can be overstated. Any bailout will be complex. The risk of a collective action failure is high. Even if bond insurers can be shored up, other systemic risks would remain. Confidence that emerging markets had "decoupled" from the US, a critical support for the market, has collapsed, and will not be restored by this rally.

Bond insurers surge on hopes for bailout

Bond insurers have been under intense pressure amid mounting concerns that mortgage-related losses will undermine their business models. Fitch Ratings cut New York-based Ambac's crucial AAA rating last week, and rival ratings agencies have warned they may have to do the same.

The stakes remain high because bond insurers are so intertwined with the rest of the financial markets. The companies guarantee billions of dollars of complex mortgage-related securities held by some of the world's largest investment banks and back more than $1 trillion of muni bonds.

In light of the widespread damage that might be inflicted by the collapse of a major bond insurer, regulators have begun working to avoid such an outcome.
Ambac "is in desperate need of $5 billion or more of capital or a guarantee from a very strong (backer) to preserve market confidence," said Egan-Jones Ratings, a rating agency that's paid by investors rather than issuers. "Some sophisticated investors claim that Ambac and MBIA must be saved or the write-downs and margin postings will be debilitating to most investment and commercial banks."

MBIA, Ambac Likely to Get Bailout, UniCredit Says

MBIA Inc. and Ambac Financial Group Inc., the biggest bond insurers, are likely to be bailed out to avert worsening credit-market turmoil, according to analysts at UniCredit SpA.

"A kind of bailout supported by monetary authorities or governments is the only chance for the industry to survive,'' Jochen Felsenheimer, the Munich-based head of credit derivatives research at UniCredit, Italy's biggest bank, wrote in a note to investors today. "This bailout seems to be highly likely given the important role of bond insurers in the current market environment.''

Ambac was stripped of its top AAA grade by Fitch Ratings last week and Moody's Investors Service and Standard & Poor's are reviewing Ambac and MBIA for downgrade, throwing doubt on the $2.4 trillion of bonds the industry guarantees. New York's insurance department said yesterday it is drafting stronger regulations to stabilize the market for bond insurers that have been pummeled by losses on securities linked to subprime mortgages.

Credit-rating downgrades may prompt forced sales by investors that are restricted to holding the highest-grade bonds, as well as further losses at banks that have already written down more than $130 billion on failed investments. "Forced selling triggered by a downgrade of the monolines would lead to a further deterioration of an already distressed market,'' Felsenheimer wrote.

New York's Insurance Superintendent Eric Dinallo said his office is drafting new regulations that would ``redefine'' the future activities of bond insurers. "The department is engaged with insurers, banks, financial advisers, credit-rating agencies, other regulators and government officials, and other stakeholders in examining and developing measures to help stabilize the market,'' according to a statement yesterday from Dinallo's office.

Credit-default swaps on New York-based Ambac and MBIA, in Armonk, New York, indicate the companies have a more than 60 percent chance of defaulting. The contracts cost $1.9 million initially and $500,000 a year to protect $10 million of debt from default for five years, according to CMA Datavision.