Debt Rattle, January 31 2008

UPDATE 5.00PM

Ilargi: The markets may be cheering the rhetoric from MBIA's conference call, raising the stock 10%, but Standard & Poor's doesn't like the drinks served at the party:

[Late Thursday, Standard & Poor's Ratings Services placed MBIA ratings on a watch list "with negative implications," which means there is a 50 percent chance the agency will drop the rating at least a notch within the next 90 days.]

FGIC loses "AAA" rating from S&P, MBIA may be cut

Standard & Poor's on Thursday cut its "AAA" ratings on FGIC Corp's bond insurance arm, and placed its top ratings on the bond insurance arm of MBIA Inc on review for downgrade. The rating agency also said it may cut the "AAA" rating of XL Capital Assurance Inc, the bond insurance arm of Security Capital Assurance.

The move comes as bond insurers are scrambling to raise capital required to hold their top ratings. Bond insurers are at risk of losing the ratings because of expected losses from risky residential mortgage securities in their insurance portfolios. S&P cut Financial Guaranty Insurance Co's "AAA" insurer financial strength rating by two notches to "AA." It also cut parent company FGIC Corp's long-term rating by three notches to "A," the sixth-highest investment grade, from "AA."

Forbes, Feb 1:

Bond Insurers Need Help--Fast

The New York Department of Insurance has been meeting with investment banks, which are exposed as counterparties to the bond insurers, to try to arrange a bailout of the industry, the demise of which could put thousands of municipal issuers at risk of being unable to raise money. But that bailout is slow in coming and some say not likely to happen. Three banks have 45% of the counterparty exposure, Citigroup, UBS and Merrill Lynch, making the chances of a banking industrywide rescue remote, even bank executives acknowledge. But banks are on the hook for billions of write-downs, up to $70 billion worth by Oppenheimer analyst Meredith Whitney's calculations. The industry needs solutions, fast.

Thursday, top MBIA executives tried to calm investor anxiety about the fate of the firm, saying the stock's plunge in the last year was an over-reaction to problems facing the industry and the result of "fear-mongering" and "distortions" by self-interested investors.
It was a clear shot at Pershing Square Capital, the New York hedge fund run by William Ackman, who released a letter to regulators Wednesday, along with a lode of data, to support his claim the bond insurers are headed for a swift demise.

Gary Dunton, MBIA's chief executive, said on a conference call Thursday that [MBIA has $16 billion socked away to pay claims.

So what's likely to happen at this point? In the absence of a bailout, the banks could get together and form a reinsurance company to relieve the bond insurers of some of their exposure. This is something New York insurance regulator Eric Dinallo has encouraged. Berkshire Hathaway jumped in the market in December and is seeking licenses to insure bond issues in all 50 states, and a spokesman for the insurance regulator said earlier this month that they were talking to other interested companies.

Another option: an injection of capital from an outside investor, and rumors have floated for several days that private equity firms would step in, as Warburg Pincus has already stepped in for MBIA. On Thursday, investor Wilbur Ross said there would be fallout in the industry but it was important to make sure troubles at the bond insurers don't disrupt municipal bond issuance, a $2.6 trillion market. Ross has been coy about whether he will step in and invest in Ambac or other bond insurers.

"If you throw municipal bonds into disorder, you're going to have a real world-class problem," Ross was quoted as saying at a luncheon in New York.

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Ilargi: Bill Ackman read 140.000 pages on MBIA, and ran very sophisticated computer models. But he cannot ask questions in their conference call today. Instead that call is used to throw terms at him such as "speculation", "fear mongering, "distortion", "nothing further from truth". Sounds like them's fighting words, except that MBIA doesn't have the courage to show up for the fight, and instead throws cheap punches at an adversary who can't defend himself..

As for the computer model: MBIA's CFO says that the analytical work was done by "an anonymous global bank", and that is simply not true. The analysis was done by a bank's highly developed software, which was this morning placed on the internet in Open Source format. We should hear findings of other parties running it with their numbers, parameters and expectations, soon. In the meantime, MBIA has gained a few more days in which they need not be transparent.

MBIA Says Capital Is Adequate, Rejects Speculation

MBIA Inc. Chief Executive Officer Gary Dunton said the world's largest bond insurer has more than enough capital to keep its AAA credit rating and dismissed speculation the company may go bankrupt.

Dunton, speaking on a conference call after Armonk, New York-based MBIA reported a $2.3 billion fourth-quarter loss, blamed "fear mongering" and "distortion" for driving the company's stock down more than 80 percent in the past year.
"It's very difficult to see the reputation of a company you love coming under fire," Dunton said. "The ground has literally opened up below us in the industry," he said.

MBIA is in the best position among its peers to survive the losses and downgrades on securities the industry guaranteed, Dunton said. MBIA's capital raising efforts will exceed the requirements necessary to keep its top credit ranking at Moody's Investors Service, he said, adding that speculation about MBIA's holding company liquidity risk is "nothing further from truth."

MBIA only allowed questions on the conference call today to be submitted in advance through e-mail. This was MBIA's way of ``taking the microphone away'' from people who had ``abused the privilege and ranted'' in the past, Greg Diamond, head of investor relations said on the call. These people had become adversaries, Diamond said, without naming anyone specific.

MBIA Chief Financial Officer Chuck Chaplin dismissed findings by Ackman yesterday that the company's CDO losses would reach $11.6 billion. The loss estimate was calculated using a model supplied by an unnamed investment bank, and the findings were sent in a letter to the Securities and Exchange Commission and New York Insurance Superintendent Eric Dinallo.

"It's important to point out that it is a letter demanding transparency where all the analytical work was done by an anonymous global bank that doesn't wish to be identified," Chaplin said in response to a question on the conference call today. He said there were flaws in the way the results were presented and said the model itself was a "black box."

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Ilargi: Bill Ackman’s letter on the bond insurers yesterday afternoon, as we reported, threw an icy cold shower on the hoped-for market revival in the wake of the Fed’s 0.5% rate cut. While the overall implications of Ackman’s well-timed action have yet to be assessed, there’s a chilling and deepening sense of fear in the US economy this morning.

MBIA can presumably be written off. The $15 billion rescue package initiated by New York Insurance Superintendent Eric Dinallo is laughably inadequate in view of recent events, since the company insures over half a trillion dollar 'worth' of paper that may not have been properly graded. There could be attempts by the Fed to act, but it's hard to see anything remotely enough to restore confidence. I've said before that the ratings agencies have their own problems with clients' trust in their work, and they will be reluctant to dig themselves into an ever deeper hole. And even if they'd wanted to, Bill Ackman's recent revelations leave them no choice.

“It is hard to fill a bucket with a hole at the bottom.”

William Ackman, the activist shorter of the monolines, has stepped up his one-man campaign to bring the beleaguered insurers down.He claims he has obtained the most detailed yet data on Ambac and MBIA’s exposure to CDOs, and has bunged it all onto an “open source” website for others to add to.

In an accompanying letter, which you can view here, sent to Eric Dinallo, the SEC and cc-ed (as you do) to Ben Bernanke and the US Senate, Ackman said the data - obtained from an anonymous bank - would mark “a departure from relying on the opaque, faith-based pronouncements that the bond insurance industry has promulgated to the marketplace.”

The hedge fund manager, who took short positions on the monolines back in 2002, says people should feel free to use the data to make their own loss estimates. His own sums leave MBIA and Ambac facing around $11.6 billion of losses apiece on their RMBS and ABS CDO net exposure

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Ilargi: In his letter yesterday, Ackman questioned the format of the MBIA conference call, which prohibited shareholders, and of course him, to ask questions directly.

Ackman posts MBIA questions ahead of call

Pershing Square Capital Management, a hedge fund, wrote an open letter to MBIA Inc on Thursday ahead of the bond insurer's conference call.

The conference call, which was to begin at 11 a.m., has an unusual format: Investors and analysts were asked to submit their questions in advance, or to submit their questions electronically. That means conference call participants may not be able to hear or see every question that is asked.

Pershing Square, founded by Bill Ackman, asked questions regarding possible uses for the company's cash, and collateral posting requirements at subsidiaries. The letter was likely intended to make Pershing Square's questions public even if MBIA chooses not to answer them on the call.

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Ackman Devoured 140,000 Pages to Prove 'MBIA Was Never AAA'

It was the $109,000 photocopying bill that hedge fund manager William Ackman says made him realize how much he'd read and underlined before betting against bond insurer MBIA Inc. in 2002.

His law firm charged him for copying 725,000 pages of financial statements and other documents, 140,000 of them about MBIA, to comply with a subpoena. Following New York and U.S. probes of his trading and reports, Ackman persisted in challenging MBIA's AAA credit rating for more than five years, based on his own research.

Ackman may soon be proved right. MBIA, the largest provider of insurance against defaults in the global credit market, today reported a fourth-quarter net loss of $2.3 billion because of a slump in the value of mortgage-related securities it guaranteed. The independent research firm CreditSights Inc. this week said MBIA's credit rating may be downgraded. Ackman had warned that MBIA was magnifying its risks by backing instruments such as those based on loans to the least creditworthy homebuyers.

"It's in the nature of a shareholder activist to be persistent,"says Ackman, now 41. "I've been persistent because it's an important issue. People are obsessive about stupid things. They are persistent about important things.''

In the MBIA documents, Ackman says he saw that the insurer was guaranteeing untested asset-backed securities. He also found a reinsurance transaction that allowed the company to downplay a loss. MBIA agreed in January 2007 to pay $75 million to settle U.S. regulators' inquiries into that deal.

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Ilargi: The following from the Financial Times’ Alphaville is a bit long, but that’s because it ties the picture together very well. Highly recommended read.

MBIA: Another morning, another monoline crisis…

Rate cuts or no rate cuts, the news just keeps getting worse for the big bond insurers, or monolines. On Thursday morning, or rather, just after midnight US eastern time, MBIA, the world’s largest bond insurer, posted its biggest-ever quarterly loss and said it is considering new ways to raise capital after a slump in the value of subprime-mortgage securities the company guaranteed.

At the same time, reports the Wall Street Journal, MBIA said it closed on its $500m stock sale to private equity investor Warburg Pincus, part of a deal announced earlier this month that will have Warburg invest up to $1bn in the troubled bond insurer. As part of the deal, two Warburg managing directors took seats on MBIA’s board of directors, replacing two current directors. In its press release, MBIA chief executive Gary Dunton said the capital-raising initiatives would offset the credit impairments the company expected to take, reports the Journal.

We can definitely believe Dunton’s statement that: “We are disappointed in our operating results for the year”. According to the Journal, MBIA’s Q4 derivatives write-down is more than 10 times as large as the $352.4m write-down it reported in the third quarter, an indication of the rapidly worsening US housing market and its effect on securities backed by loans made to credit-challenged customers. News of MBIA’s loss came a day after FGIC’s insurance unit became the third company to be stripped of its Aaa credit rating and downgraded to Aa.It also came just after shares in MBIA and Ambac, the second-biggest bond insurer, tanked in New York on Wednesday, sliding 15.9 per cent and 12.6 per cent, respectively, on fears of imminent downgrades.

Adding to the cheer, John Thain, Merrill Lynch’s new chief executive, told the FT on Wednesday that while individual credit insurers would most likely receive capital infusions from investors, it would be difficult to craft an “industry-wide” bailout for the beleaguered guarantors. In other words, the $15bn that New York State insurance superintendent Eric Dinallo is trying to persuade Wall Street banks to cough up for a sweeping monoline rescue plan is unlikely to appear.

And in a separate report, the FT has an update on the serious impact MBIA and Ambac’s troubles are having on the “normally sedate” world of municipal bond investing. Municipal bond yields have spiked sharply higher versus US Treasuries, “a sign that long-term investors are selling munis because of a perceived increase in risk” - and about half the $2,600bn municipal bond market is guaranteed by bond insurers led by MBIA and Ambac.

It is also a sign, according to the FT, of forced selling from a little-known but important group of short-term municipal bond investment vehicles - known as “tender option bonds” - that have run into acute stress in recent weeks, based on suspicions about the quality of bond insurers’ guarantees on the paper that they issue. TOBs have been popular with money market funds - which are required to invest in short-term and highly-rated paper and to maintain the value of every dollar invested. TOB programmes issue securities backed by long-term municipal bond assets, in a market worth about $400bn, according to FT estimates. Now, amid the growing likelihood that the bond insurers will lose their crucial Aaa ratings, money market investors are selling TOB paper to protect themselves from the risk of downgrades.

At the same time, MBIA is “reeling from an expansion out of municipal securities into guaranteeing CDOs”, notes Bloomberg, “and as the value of some CDOs plummet, ratings companies are pressing the insurers to add more capital”. Without the Aaa stamp, notes the FT, MBIA would be unable to lend a top rating to new securities, crippling its business and throwing ratings on $652bn of debt into doubt

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S&P Lowers or May Cut $534 Billion of Subprime Debt

Standard & Poor's said it cut or may reduce ratings of $534 billion of subprime-mortgage securities and collateralized debt obligations, as home loan defaults rise. The downgrades may extend losses at the world's banks to more than $265 billion and have a "ripple impact" on the broader financial markets, S&P said.

The securities represent $270.1 billion, or 47 percent, of subprime mortgage bonds rated between January 2006 and June 2007, S&P said today in a statement. The New York-based ratings company also said it may cut 572 CDOs valued at $263.9 billion. The downgrades may increase losses at European, Asian and U.S. regional banks, credit unions and the 12 Federal Home Loan Banks, S&P said. Many of those institutions haven't written down their subprime holdings to reflect their market values and these downgrades may force their hands, S&P said.

"It is difficult to predict the magnitude of any such effect, but we believe it will have implications for trading revenues, general business activity, and liquidity for the banks," S&P said. The ratings company will start reviewing its rankings for some banks, especially those that "are thinly capitalized." S&P downgraded $50.1 billion of subprime-mortgage securities, none rated higher than A+. More than 69 percent of the AAA rated subprime securities from 2006 and 46 percent from the first half of 2007 were placed on review.

"This one, I didn't see coming," said Mark Adelson a consultant at Adelson & Jacob Consulting LLC in New York, and a former asset-backed bond analyst at Nomura Securities. Some of the largest global banks have already taken "significant" losses and they aren't likely to have more writedowns, S&P said.

Ilargi: This last line below is one hell of a scary statement, especially when you realize this is not confined to the US, it's a global phenomenon. Thousands of small banks and large ánd small funds sit on trillions 'worth' of waste paper. When MBIA rattles its last breath, Jericho's dominoes will start tumbling..

Under accounting rules, many smaller banks haven't been required to write down their holdings until the credit ratings fell, enabling them to avoid the losses that have crippled Citigroup Inc., Merrill Lynch & Co. and UBS AG.

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Ilargi: We touched on the following topic yesterday. After the revelation that the ECB is secretly keeping Spain’s banks afloat for now, at the cost of taxpayers all over Europe (and they may be doing the same in other countries -Ireland?-), the UK wants to engrave “clandestine” help in its laws. At the cost of? Drumroll......., crescendo........Yes, indeed, see the highlighted line.

UK: Secret bank rescues to be allowed

Chancellor Alistair Darling is to give new powers to the Bank of England to mount secret rescue operations for banks requiring emergency funds. The plan will be unveiled today as part of sweeping regulatory reforms designed to prevent a repeat of the Northern Rock debacle, the BBC has learned.

He will also make the Bank of England's loans to a troubled bank rank first in the queue of creditors.

There will be a 12 week consultation period on the new legislation."It's unclear whether the devastating run on the Rock could have been prevented by the kind of clandestine help which the Bank may in future be able to provide," said the BBC's business editor Robert Peston. "Such secrecy would only apply where such emergency lending is temporary and limited in nature. "So the Treasury believes that the Rock probably needed too much money for too long for the Bank of England to be able to keep the rescue operation out of the public domain."

The tripartite system under which the FSA, the chancellor and the Bank of England work together to deal with emergencies has been criticised for failing to prevent the first run on a UK bank for more than a century. But that system is expected to remain in place under the new proposals.

The consultation is also expected to discuss what amount of bank deposits should be protected. Currently, savers have the first £35,000 in each account guaranteed, but the chancellor is likely to suggest extending that.
He may also propose that the protection scheme for depositors should be funded by the banks up-front.

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Merrill Plans to Cut Back on CDOs, Structured Finance

Merrill Lynch & Co., the world's largest brokerage, will cut back on packaging home loans and consumer debts into securities after the collapse of the subprime mortgage market eroded demand for the products.

"Opportunities in many areas"of structured finance and so-called collateralized debt obligations "will be minimal for the foreseeable future and our activities will be reduced accordingly,"New York-based Merrill said in an e-mailed statement. The firm will continue packaging corporate loans and derivatives into securities.

Merrill issued the statement after Chief Executive Officer John Thain told investors at a conference in New York earlier today that the firm planned to exit its CDO and structured credit businesses. Jessica Oppenheim, a spokeswoman for the company, said the statement was released to clarify Thain's remarks. She declined to elaborate on the statement.
"We are not going to be in the CDO and structured-credit types of businesses,"which generated 15 percent of the firm's fixed-income revenue, Thain said at the conference.

Merrill posted its largest-ever loss last year after writing down the value of its CDOs and other assets related to subprime mortgages by more than $24 billion. The New York-based bank was the biggest underwriter of CDOs from 2004 through 2006, and got stuck with some of the products as investor demand declined.

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Credit default swaps: how to spot the riskiest banks

The whole point about the 'credit crunch' - is that it means banks won’t or can’t lend as easily or as cheaply as they once did. The reason for this is that they are under-capitalised, either because losses have eroded their capital base or because they have had to take off-balance sheet loans back onto their books (in reality, much the same thing) This is a glorified way of saying that some banks are (at least technically) bankrupt.

Now, the system doesn’t like to admit such things - for obvious reasons - so we can expect the banks along with the central banks, such as the Bank of England and the regulators such as the FSA to lie about it. As such, it is highly unlikely that any bank will be allowed to fail (witness Northern Rock, which isn’t even a real bank) but that doesn’t stop the markets having a view as to who they are least comfortable lending to and which banks therefore need to pay more to get their hands on the cash they need to keep operating.

We can get a view on this by looking at the interest rates the banks off to us on their savings accounts - the higher the rate clearly the more desperate they are for cash. However another way to gauge the risk of your bank account it is too look at the credit default swap market. Credit default swap (CDS) spreads measure the premium to the risk-free interest rate that a bank can expect to pay in the market for 5-year loans. The higher the CDS for any given bank, the riskier the market thinks that particular bank’s debt is.

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GATA's advertisement in The Wall Street Journal

This advertisement, sponsored by GATA and costing $264,426.26, is scheduled to appear in The Wall Street Journal on Thursday, January 31, 2008.

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New UBS Writedown Dents Credibility

The $4 billion writedown announced by UBS on Jan. 30 doesn't come as a huge surprise. As far as is known, UBS has the largest exposure among European banks to U.S. subprime mortgages and collateralized debt obligations (CDOs), and the value of these securities is continuing to deteriorate—hence the need to acknowledge further losses. Other banks also are expected to take further hits.

"European banks involved in U.S. subprime will be making further writedowns," says Simon Adamson, an analyst at debt specialists CreditSights in London. Other European banks with potential for additional subprime losses include Royal Bank of Scotland, Deutsche Bank, Crédit Agricole, Credit Suisse, and Barclays, Adamson says.

UBS's foray into the U.S. mortgage markets has turned into an absolute nightmare. The bank, which had been considered one of Europe's best-managed financial institutions, has now written off a staggering $18 billion in exposure to subprime and other risky securities—comparable to the $16.7 billion in losses taken by Merrill Lynch and the $18 billion hit taken by Citigroup. With UBS's overall exposure to potentially toxic debt estimated by Adamson at $29 billion, this may well not be the last such announcement from the bank's stone-fronted Zurich (Switzerland) headquarters. UBS now acknowledges that on Feb. 14 it will report a loss of about $4 billion for 2007.

The terse announcement from UBS did not make clear exactly how the new losses came about. Unanswered questions, according to Adamson, include whether the new losses occurred because of concerns over the viability of bond insurers and whether credit problems are spreading into mortgages not classed as subprime. If the bank is writing down higher grades of mortgage debt, that would be a worrying development.

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The Real Recession Problem: Consumers Are at the End of Their Ropes

Perhaps the silliest part of an already silly stimulus bill is a provision giving corporations big tax deductions this year on the costs of new machinery, instead of spreading those deductions over several years, as is normally the case. The idea is to get businesses to invest in more machinery, which will stimulate the economy. But accelerated depreciation, as it’s called, doesn’t work. Almost the same tax break was enacted in 2002 and studies show just about no increase in business investment as a result. Why? Because companies won’t invest in more machines when demand is dropping for the stuff the machines make. And right now, demand is dropping for just about everything.

This tax break exemplifies the illogic of what’s called supply-side economics. If you reduce the cost of investing, so the thinking goes, you’ll get more investment. What’s left out is the demand side of the equation. Without consumers who want to buy a product, there’s no point in making it, regardless of how many tax breaks go into it.

Which gets us to the real problem. Most consumers are at the end of their ropes and can’t buy more. Real incomes are no higher than they were in 2000, while food and energy and health care costs are all rising faster than inflation. And home values are dropping, which means an end to home equity loans and refinancing.

Most of what’s being earned in America is going to the richest 5 percent, but the rich devote a smaller percent of their earnings to buying things than the rest of us because, after all, they’re rich -- which means they already have most of what they want. Instead of buying, the rich invest most of their earnings wherever around the world they can get the highest return. Add all this together and there’s just not enough consumer demand out there to keep the American economy going. We’re finally reaping the whirlwind of widening inequality and ever more concentrated wealth. Supply-siders who want to cut taxes on corporations and the rich just don’t get it. Neither does most of official Washington.

Robert Reich is the nation's 22nd Secretary of Labor

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2008 Outlook: Thrill Ride, Part III

See the megaphone formation?  It is called a wolf wave.  We are at a fairly good level of profits now, but it projects a nuclear winter in corporate profits dead ahead (see chart below).  From Record highs never seen in fifty years, to record lows also not seen in the same period, below the lows of 2001-2002.  This chart is a testament to how fiat money and credit creation has made steady growth and economic stewardship become more and more unmanageable over a long period of time. 

It is clear that monetary policy is also following this wolf wave pattern, either too hot or too cold.  Politicians (and their “something for nothing” constituents) in the western world see these enormous profits and are set to attack the creators and holders of this wealth.  They want the money and they will put in place new taxes and entitlement mandates to claw back this gusher of wealth, thereby accelerating the downside of this wave.  We all want business cycles that cleanse past excesses, but the up and downs are now out of control.  There is no consistency, no orderly form to the business and economic cycles, everything now is either booming or busting. 

As this pattern approaches what it is prophesizing we can look at 4th quarter 2007 profits -- which are now projected to have clocked in at a year over year LOSS of approximately (-19%) extending its slide from the 3rd quarters NEGATIVE (- 9%).  This Wolf Wave is afoot throughout the G7, it is not limited to the US and it is set to EAT these economies and asset markets for lunch.  As this earnings collapse unfolds so do incomes and tax receipts in Washington, Brussels, Paris, Berlin, Rome, etc., as well as statehouses, municipalities and the incomes of individuals.