Debt Rattle, February 23 2008

Updated 2.00 pm

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Ilargi: Wall Street cheers after a [possible] $2-3 billion infusion for Ambac is announced. Remembering that for instance Sean Egan estimated some $30 billion will be needed for every single bond insurer, not 10% of that for just one of them, we are singularly unimpressed.

In fact, if a banking industry that wrote down $150 billion in the past few months has such a hard time to come up with a measly $3 billion to “save” a company’s rating, from which they stand to lose another $70 billion or more, we might soon feel compelled to downgrade our ‘impression rate’ to junk status.


Bond rescue rumours shot in the arm for Wall Street

Wall Street staged a 225-point turnaround in the closing minutes of trade on Friday night to end slightly higher for the day amid news that a bailout of one of the country's troubled bond insurers may be sealed early this week.

US-based Ambac Financial Group Inc, the bond insurer in rescue talks with banks, may announce a deal that would save its AAA credit rating and avoid losses on $US566 billion ($A615 billion) of debt, according to a person familiar with the discussions. Banks may invest about $3 billion in the company, said the person, who declined to be named because no details have been set. The New York-based company rose 16% in New York Stock Exchange trading after CNBC Television said Ambac and its banks were preparing to announce a deal.

"Everything is being considered," Ambac spokeswoman Vandana Sharma said. "These are complicated things. We hope to have something shortly." She wouldn't discuss any specific plans. A rescue that enabled Ambac to retain its AAA rating for the municipal and asset-backed securities guaranty units would help banks and municipal debt investors avoid losses on securities it guarantees. Banks stood to lose as much as $US70 billion if the top-rated bond insurers, which include MBIA Inc and FGIC Corp, lose their credit ratings, Oppenheimer & Co. analysts estimated.

"It's been on the table for a while and if it happens it will certainly be a good thing for any bond insurer that gets a capital infusion," said Donald Light, a senior insurance analyst.

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Ilargi: Right. Now back to reality. Turns out it's all politics all the time, after all.


S&P, Moody's slammed for downgrade delays

A downgrade of municipal bond insurers -- and in turn, billions of dollars in bonds -- could destroy wealth on financial markets and corporate balance sheets and deal another blow to banks already stung by the ongoing credit crisis. Yet investors have waited impatiently for credit rating agencies Standard & Poor's and Moody's to act, and while they have taken some steps, like Moody's downgrade of insurer FGIC last week, the market believes there's more to come. Meanwhile, S&P and Moody's are increasingly being criticized for their inaction -- and also for not warning investors about the risks that the bond insurers have taken -- by insuring risky subprime mortgages -- even as they were charged with eliminating hazard in the credit markets.

There are conflicting pressures on the agencies -- some of them political. Federal Reserve Chairman Ben Bernanke has warned that downgrades would be harmful to the financial system. And it's true that financial institutions and investors still hold pools of subprime debt marked "AAA" that has not been discounted to reflect its slight worth, and that downgrades of the insurers would compel these assets to be priced lower and the financial companies to take more write-downs. "The guys on the trading floor have a joke that the reason the agencies don't issue the downgrades is that if they do they will be audited by the Fed into oblivion," said T.J. Marta, a fixed-income analyst at RBC Capital Markets.

"This joke is a way of expressing the belief that this is a political game at this point."

The ratings agencies dispute that the downgrades are being delayed. Moody's spokesman Abbas Qasim said his agency will wrap up its decision on downgrades "within the next few weeks." At S&P, MBIA and Ambac continue to dangle on the agency's downgrade watch list. Although MBIA's capital strains have been known for weeks, S&P did not put it on the watch list until Jan 31. S&P spokesman David Wargin said only the agency would act "when we believe events warrant such action."

Some analysts believe the downgrades will come. "I think the agencies want to do the downgrades," said John Atkins, fixed income analyst at IDEAGlobal.com. "They feel they need to because conditions have changed so radically. Whatever they assumed in the past no longer matters." A third agency, Fitch Ratings has been more aggressive. It has issued downgrades for Ambac and two smaller insurers that blocked them from bond deals. Fitch also has put another five insurers on its watch list for possible downgrades.

Other observers think the agencies will issue more downgrades and are laying groundwork to justify the chaos that will be set off in the financial system. No matter what happens to the bond insurers, in the end, the rating agencies are finding their reputations badly hurt by their ratings, and their slowness to downgrade. A big criticism grows out of the fact that bond issuers who pay them more -- and subprime issuers were able in the past to pay more than state and local governments who issue muni bonds -- have gotten higher ratings.

"There is a feeling that the agencies have been making up the ratings as they go along and investors don't think the ratings mean anything," said John Atkins, fixed income analyst at IDEAGlobal.com. "People now think the whole thing has been a scam. It is as if you can get an 'AAA' rating by dropping a sack of cash on a desk."

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Ilargi: And here's another, let's say, "tasty morsel".


MBIA enters the Bermuda triangle

MBIA dropped 6% in trading Friday, a day after the bond insurer raised eyebrows by dropping out of a trade group it had belonged to for more than 20 years. Friday’s selloff came as investors worry that the rating agencies might downgrade MBIA and rival Ambac, setting off a wave of forced selling of bonds whose rating is dependent on the insurers’ guarantee. CNBC reported a downgrade could come in the next few days, though New York insurance regulators have been working on a plan aimed at avoiding or lessening the impact of any downgrades.

Meanwhile, MBIA’s statement to drop out of the Association of Financial Guaranty Insurers drew a preplexed response from the Albany, N.Y.-based group. “AFGI members are surprised at the withdrawal of MBIA from AFGI,” the group said in a press release Thursday evening. AFGI also took issue with MBIA’s suggestion that it withdrew because of conflicts with the group’s stances on the appropriateness of the structured finance business and a possible regulator-inspired breakup of insurers along policy lines. “AFGI has not taken a position on member firms’ organizational structures, lines of business or execution formats, such as credit default swaps (CDS) or policy forms,” the group said.

Most puzzling was MBIA’s claim that it disagreed with AFGI’s stance on “the ability of U.S. financial guarantors to reinsure U.S. domestic financial guarantee insurance transactions with foreign affiliates without paying U.S. corporate tax rates.” AFGI said it wouldn’t go beyond its statement, and MBIA reps didn’t return calls seeking comment. But the comment by MBIA could pit the company against several members of AFGI that are based in Bermuda, in an ongoing debate over how insurance profits are taxed beyond U.S. borders.

Last fall the Senate Finance Committee held hearings on rules covering the taxation of insurance companies with overseas affiliates. The congressional Joint Committee on Taxation said last fall that purchases by American subsidiaries of reinsurance from their parent companies in Bermuda doubled between 2001 and 2006, the New York Times reported. MBIA and Ambac were listed as members of the Coalition for a Domestic Insurance Industry, which argued that the tax laws hurt U.S.-based insurers.

Other members of the AFGI such as Assured Guaranty (AGO) - an MBIA competitor that stands to benefit from the company’s recent image problems among risk-averse bond issuers  - are based in Bermuda and thus stand to benefit from keeping the laws as they stand.

It’s impossible to know what’s behind MBIA’s sudden interest in tax law, but it appears the company has seized on its U.S. domicile as a rare asset in its many public relations battles.

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Ilargi: I’m not the only one thinking this Ambac ‘Save a Seal’ deal is a little ...... little. And late.


Will Ambac Have a Deal Next Week?

Note: the banks aren't making an equity infusion. As I read this, they are merely backstopping a public offering by Ambac. This is the most lukewarm form of support they could provide.

Why haven't the banks stepped forth more wholeheartedly? Analyst James Bianco of Bianco Research, in an e-mail this evening, goes through the history and is mystified as to why a deal hasn't been wrapped up long ago:

The Monoline bailout hysteria started January 23.

The New York Times - (January 24) Next on the Worry List: Shaky Insurers of Bonds

Regulators fear a possible chain of events in which the troubled bond insurers, MBIA and Ambac, might be unable to keep their promise to pay investors if borrowers default on their debt.....the talks focused on raising as much as $15 billion for the companies … Eric R. Dinallo, the New York insurance superintendent who regulates MBIA..... suggested that the group move in as little as 48 hours to get a deal done ahead of any downgrading of the bond guarantors by credit ratings firms.

So the bailout was suppose to be done by Janaury 26 and total $15 billion. We have been told that a monoline downgrade is critical to the entire financial system. UBS estimates it will cost the banking system $203 billion in additional writedowns. Barclays estimates it will cost $143 billion in writedowns. Oppenheimer estimates that it will cost Merrill, Citi and UBS $40 to $70 billion alone.

Today we learn that a bailout is again very close.

The Financial Times - (February 22) Banks to aid Ambac with up to $3bn

A group of banks is preparing to inject $2bn to $3bn into the troubled bond insurer Ambac.... The money from banks would be part of a plan to split Ambac’s operations, people involved in the discussions said. Ambac is also considering raising equity from shareholders and it is not yet clear how much capital it will need, or what credit ratings the split businesses will have.

Let me get this straight.

If the monolines get downgraded, the banking system is at risk for $143 billion to $203 billion of losses. This is why they were 48 hours from a $15 billion deal on January 23. Now on February 22, they are again 48 hours away from a $3 billion deal for just Ambac spread among eight banks. So the longer they talked the smaller the number got.....

My questions - If the fate of the financial system only needs $3 billion to get “fixed,” why did it take eight banks a month to negotiate coughing up $300 million each? Don’t they pay Robert Rubin more each year? B of A took less much less time to bailout Countrywide with a $4 billion deal all by itself.

Something just doesn’t make sense here. If they are staring at hundred of hundreds of billion in losses, and $300 million each stops all this, why was their even a negotiation? Just write the check and move on to the next issue.

What am I missing?

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Economic Barrage Awaits Wall Street

Investors will have a full slate of U.S. economic data to contend with next week, following mostly disappointing data in recent sessions. The market will be greeted Monday with January existing home sales, which are expected to fall slightly. On Tuesday the February Producer Price Index, a key inflation measure, is due before the open, as is the S&P/Case-Shiller home price index for December and the entire fourth quarter. Tuesday also gets February's consumer confidence reading, followed Wednesday by a report on durable orders from January, new home sales, and the weekly mortgage application figures.

Thursday features perhaps the most important piece of data for the week, a preliminary reading on fourth-quarter U.S. GDP. Economic growth is expected to tick higher after a 0.6% reading in the third quarter but remain slow. Various reports over the past few weeks have shown signs of sluggishness, especially in manufacturing. Soaring commodity prices have also fanned fears of inflation. Last week was mixed, but mostly negative, for U.S. stocks. Even after a late rally pushed the market to a gain Friday, the Dow still fell 0.7% for the week, the S&P edged 0.4% lower, and the Nasdaq dropped 1.8%.

In corporate news, CNBC reported Thursday that a bailout plan for struggling bond insurer Ambac Financial Group could be announced as early as Monday or Tuesday. Ambac and its peers have been hammered over the past few months as their risky structured finance operations have caused massive write-downs and jeopardized the health of their core municipal bond insurance business. Ambac has already lost its key triple-A financial strength rating at Fitch Ratings, and could be in danger of losing it at Moody's Investors Service and Standard & Poor's.

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Ambac May Get $3 Billion in New Capital From Banks

Ambac Financial Group Inc., the bond insurer facing a crippling credit-rating downgrade, may get $3 billion in new capital as part of a rescue agreement with banks, according to a person with knowledge of the discussions. An announcement may come early next week, said the person, who declined to be named because no details have been set. The New York-based company rose 16 percent in New York Stock Exchange trading yesterday after CNBC Television said Ambac and its banks were preparing a deal.

A rescue that enabled Ambac to retain its AAA rating for the municipal and asset-backed securities guarantees would help banks and municipal debt investors avoid losses on securities it insures. Banks stood to lose as much as $70 billion if the top- rated bond insurers, which include MBIA Inc. and FGIC Corp., lose their credit ratings, Oppenheimer & Co. analysts estimated. "It's been on the table for a while and if it happens it will certainly be a good thing for any bond insurer that gets a capital infusion," said Donald Light, a senior analyst covering insurance at Celent, a consulting firm in Boston.

Ambac spokeswoman Vandana Sharma declined to comment specifically on the discussions. "Everything is being considered," Sharma said in a telephone interview. "These are complicated things. We hope to have something shortly." She wouldn't discuss any specific plans. Eight banks including Citigroup Inc. and UBS AG formed a group to consider providing financing, a person familiar with the matter said earlier this month. Royal Bank of Scotland Group Plc, Wachovia Corp., Barclays Plc, Societe Generale SA, BNP Paribas SA and Dresdner Bank AG, were also involved, said the person, who declined to be named because details hadn't been set.

The banks face losses because they bought bond insurance to hedge the risks of collateralized debt obligations and other asset-backed securities that are now tumbling in value. CDOs package pools of securities then split them into pieces with different ratings.

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Moody's may cut rating on bond insurer CIFG

Moody's Investors Service on Friday said it may cut its top "Aaa" ratings on bond insurer CIFG, citing its exposures to risky residential mortgage backed debt. "The rating action reflects the weakened capital profile of the group as a result of its mortgage and mortgage-related Collateralized Debt Obligation (CDO) exposures, as well as uncertainty over CIFG's future strategic direction," Moody's said in a release.

CIFG owners Banque Populaire and Caisse d'Epargne in aDecember injected $1.5 billion in capital into the insurer in an attempt to sure up its top ratings. The loss of its top rating is expected to dry up demand for its business of insuring securities, which includes municipal bonds and mortgage-backed debt. The capital injection increased CIFG's claims paying resources substantially, Moody's said.

Since then, however, Moody's has increased its loss expectations for residential mortgage backed securities, and under the new estimates CIFG's capital adequacy is no longer sufficient for an "Aaa" rating, Moody's said.

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Moody's cuts Channel Re, MBIA's reinsurer

Moody's Investors Service on Friday cut its top "Aaa" ratings on Channel Reinsurance, which provides reinsurance of policies written by bond insurer MBIA Inc, due to its exposures to residential mortgage-backed debt. The downgrade may negatively impact the value of the reinsurance policies it has written for MBIA, its only customer, Moody's said in a statement.

Moody's cut Channel Re's insurer financial strength rating three notches to "Aa3," the fourth-highest investment grade, from "Aaa." Channel Re reinsured a number of large asset-backed collateralized debt obligations (CDOs) in the last 18 months, with aggregate ABS CDO exposure representing 12 percent of Channel's total net par outstanding, Moody's said.

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No Bond Insurer Is an Island

Embattled financial guarantor MBIA wants to put some distance between itself and its peers. The Armonk, N.Y.-based bond insurer has announced that it is withdrawing its membership in the Association of Financial Guaranty Insurers (AFGI), an industry trade group that the company says no longer shares its views on the business of insuring debt. The move represents the first major initiative by the newly installed CEO Jay Brown. It may ring hollow with investors, because MBIA seems unduly focused on splitting from trade organizations while its peers Ambac Financial and Financial Guaranty Insurance are battling to save their businesses.

"It has become clear that MBIA and the other members of AFGI no longer share a common vision for the industry," Brown wrote in a press release issued late Thursday. "For one thing, we believe that the industry must over time separate its business of insuring municipal bonds from the often riskier business of guaranteeing other types of securities, such as those linked to mortgages. "Additionally, we disagree with AFGI's positions on the appropriateness of monoline financial guarantors insuring credit default swaps and the ability of U.S. financial guarantors to reinsure U.S. domestic financial guarantee insurance transactions with foreign affiliates without paying U.S. corporate tax rates," Brown continued.

Monoline insurance companies have been under fire from rating agencies to raise billions in capital to protect against losses in risky businesses that they began to provide guarantees on in the late 1990s early 2000s.. Although MBIA -- the largest of the litter -- has raised some $2.5 billion in fresh capital from private-equity firm Warburg Pincus and public investors, it is being threatened with the prospect of being stripped of its coveted triple-A rating, which would send values on the debt it insures tumbling and make the costs of the guarantor doing future business less economical.

FGIC and Ambac are considering their own options to survive as triple-A insurers, which might include splitting the healthy part of its business -- backing the safer municipal debt -- from the riskier structured finance business. In the face of those odds, MBIA's splintering from AFGI, which the company has been associated with for the past 22 years, is not exactly the breakup announcement that Wall Street observers were expecting.

Brown has been quick to distance himself from the failings of a company he ran from 1999 into 2004 as CEO. He also served as its chairman until May of last year, but openly chastised his firm and other guarantors for getting involved in the business of insuring funky mortgage-tainted securities, which offered the underwriters richer premiums than the staid business of muni insurance. Brown's defection on principle from AFGI at this point seems more like grandstanding than a genuine effort to remediate a company in dire need of guidance and a restructuring. It is likely to further ostracize the troubled firm, it has been the bull's-eye of short-selling nemesis hedge fund manager Bill Ackman since 2002.

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Ambac sparks rebound on Wall Street

Financial stocks rushed into positive territory yesterday on reports of a plan to bail-out Ambac Financial. The Financial Times said a group of banks would provide capital as part of a plan to split Ambac’s operations, separating municipal bond insurance activities from the riskier business of insuring structured credit products. Ambac’s shares rose 16 per cent to end the week at $10.71, up 4.8 per cent. Investment banks climbed into positive territory amid hopes they can avoid losses linked to the monoline insurers. “If the market felt the monoline situation was being taken care of that would be a huge step,” Jim Paulsen chief investment strategist at Wells Capital Management, said.

Investors are concerned that banks’ corporate earnings could yet reveal more problems. Many analysts are concerned that the next problem on the horizon could be the fate of government-sponsored enterprises (GSE), which guarantee about 40 per cent of outstanding US mortgage debt. Freddie Mac and Fannie Mae, were downgraded from “neutral” to “sell” by Merrill Lynch. It said the GSEs’ stock prices did not reflect “the severity or duration of the financial headwinds facing the companies”.

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Barclays: Counterparty Risk in Credit Default Swaps Only $36 to $47 Billion

This post comes in significant degree from jck at Alea, who has access to the report, "Counterparty risk in credit markets," from Barclays Capital and was kind enough to post the summary of key points. Despite the link, I seem unable to download it, but the summary is sufficiently detailed that I don't think I am missing much.

The bottom line is that the authors estimate the impact of a $2 trillion in notional amount failure (yes, that's a big failure) at producing a maximum of $36 to $47 billion in losses. That is a comparatively low number when you consider that the size of the potential financial train wrecks these days for the most part have larger price tags attached. And while the Barclay's report also said this number would be reduced by netting, it also pointed out that a large default could roil other OTC derivatives markets and that collateralization may be less than ideal. My big concern with any analysis is that the knock-on effects are hard to anticipate. Two month agos, no one would have dreamed of massive failures in the auction rate securities markets. The reaction seems vastly disproportionate to the risk at hand, yet we are where we are.

Consider the panic with SIVs last year. Money market investors were fleeing them due to the perceived potential for losses. However, it was the investors in the subordinated slice, the capital notes, who were taking the hits (this is generally medium term, not money market paper); the commercial paper, which was the paper held by money market investors, was senior to that and thus at much less risk of losses. I have never seen loss figures published across the SIV sector, but my impression is that the total damage across the $400 billion SIV market were 3% ish (that's why the industry in the end decided to take the funds on balance sheet for the most part. The losses were painful but not catastrophic).

Money market funds are loss intolerant, ditto enhanced cash funds, but nevertheless, one would think a $12 billion-in-losses event wouldn't have systemic consequences, particularly when they were second in line to take a bullet. Yet it led to the shutdown of the asset-backed commercial paper market, which it turn led a lot of borrowers to tap lines of credit unexpectedly and all at once, which led to unanticipated balance sheet demands on the part of banks (utilized credit lines have capital charges attached) which lead to banks being reluctant to lend to each other, which led to a big rise in interbank rates relative to risk free rates, which led to panic and extraordinary measures among central banker.

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Housing stimulus

Lawmakers eye home-buyer tax credit as way to move inventory

Senate Democrats reportedly already have crafted a measure that includes a credit for taxpayers who help take down the record inventory of unsold homes. And when the Senate Finance Committee meets in a few weeks, Republicans are likely to join them in pressing for a version of a plan that worked in the mid-1970s to help clear off a then-record glut of completed but unsold houses.

Whether the renewed interest in a tax credit is a result of some hard-nosed lobbying on the part home builders is anybody's guess. But earlier this month at its annual convention in Orlando, Fla., the National Association of Home Builders took the unprecedented step of suspending all political contributions to federal candidates and their political action committees.
The unusual move was taken because lawmakers failed to include two of the group's pet projects -- the tax credit and a provision that would allow builders to carry back net operating losses for an extending period of time -- in the initial $168 million stimulus package.

"More needs to be done to jump-start housing and ensure the economy does not fall into a recession," NAHB President Brian Catalde said at the convention. The tax-credit proposal is just one of the ideas floating around Washington to shore up the ailing housing market. The New York Times reported on Friday that several plans are being kicked around that would help homeowners who face trouble with their mortgage payments, especially borrowers who owe more on their mortgage than their home is worth, a situation known as being "underwater."

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Will the G-7 Nations Impose Capital Controls?

Finance ministers and central bankers from the G7 -- the United States, Canada, Japan, Britain, France, Germany, and Italy -- said that financial market turmoil was serious and persisting. They also said more work was needed to restore markets to good working order and safeguard global growth. The European Central Bank believes that turbulence on financial markets could continue for months.

Consequently the €-group have agreed that if there are "irrational" price movements in the markets, "we will collectively take suitable measures to calm the financial markets". The markets will not be forewarned of such action, "otherwise it will lose its effect if it is explained."

No action has been seen yet so no-one is too perturbed it seems. But we are, very perturbed! Could there be a more dramatic warning from the richest nations of the world for us? It may seem easy to assume that all they are going to do is to manipulate the froth out of the market. But they did not say that. How can one "calm" markets? And why will such action "lose its effect if it is explained?" Such statements are so strong they need to weighed carefully.

The succinct admission that turbulent markets will continue being turbulent for some time to come, while stating the obvious, is a warning from the entire body of major financial nations Finance Ministers [not warning from mere newsletter writers]. They are clearly concerned about the veritable Tsunami of Capital that is ready to rush from weak markets to strong, or the disappearence of such that is happening in the credit markets [like the pullback of the sea before the wave hits] and is being replaced by freshly issued money from the Central Banks. They are fully aware that volatility is here, as a market feature, to stay. They realize that such swings destroy the stability of world markets and make the markets malfunction, badly. The situation certainly has to be dire for them to issue such a warning?

The G-7 nations are giving us warnings of their coordinated action. Therefore, it has to be action to 'calm' international movements of capital. As has been the case in the past and will be in the future, such action will attempt to leave international trade untouched and unhindered to go its merry way of keeping the system going amongst a regime of stable [relatively] exchange rates. Hence, the chief tool has to be Capital Controls or exchange Controls. These measures will be far more than punitive simple "Witholding Taxes" that penalized the export of capital seen in the States in the past. They will have to be immediate and effectively halt "irrational movements". Only Capital and Exchange Controls fit the bill.

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GMAC Barrels Downhill

More bad news from Motown: General Motors' troubled GMAC financing subsidiary got a sharp bond-rating downgrade on Friday, with warnings of further cuts to come. GMAC and its Residential Capital mortgage unit were cut several notches deeper into junk status by Standard & Poor's, which said mounting mortgage losses might require new capital injections from General Motors and Cerberus Capital Management.

S&P Friday downgraded GMAC three notches to B-plus, its fourth-highest junk grade, from BB-plus, and cut ResCap four notches to B from BB-plus. Its rating outlook is negative, suggesting further downward pressure. A B rating suggests the issuer could easily develop problems paying off its debts. S&P's new ratings mirror those assigned by Moody's. That credit rating agency on Feb. 5 downgraded GMAC debt to B1, and ResCap debt to B2.

GMAC, formerly known as General Motors Acceptance Corp., was created as the automaker's financing arm. In 2006, before the problems in the U.S. mortgage market were widely apparent, GM sold 51% of GMAC to a consortium headed by Cerberus Capital -- which now also owns Chrysler -- for $14 billion.GM still owns the other 49% of its finance unit.

ResCap made residential mortgage loans, which were rocked by the U.S. housing downturn. GMAC has been exploring options for ResCap, including asset sales, acquisitions and joint ventures. ResCap is the largest independent U.S. mortgage lender after Countrywide Financial. For example, in November investors learned that GMAC may buy a non-U.S. lender to combine with its struggling ResCap, diluting the problems of that unit, which is exposed to the crumbling American mortgage market. GMAC is based in Detroit, and ResCap in Minneapolis.

GMAC lost $2.3 billion in 2007 because of ResCap's $4.4 billion loss on rising customer defaults, falling loan volume, and write-downs. S&P said the housing slump, a weak economy and tight credit markets will make it difficult for ResCap to return to profitability after five straight quarterly losses. Its industry is tough: more than 100 mortgage lenders quit the business in the last year. Standard & Poor's John Bartko wrote that further losses could cause ResCap to breach a $5.4 billion tangible-net-worth covenant in its borrowings, requiring more support from GMAC, and thus GM and Cerberus. ResCap ended 2007 with a $6 billion tangible net worth.

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Scottish Re may sell units after losses, downgrade

Scottish Re Group Ltd, a struggling life reinsurer, said on Friday it may sell its international life reinsurance and wealth management units, and plans to cut costs after suffering mortgage-related losses and a credit rating downgrade. The Hamilton, Bermuda-based company announced the changes less than a year after receiving a $600 million equity injection in May 2007 from private equity firm Cerberus Capital Management LP and MassMutual Financial Group's affiliate MassMutual Capital Partners LLC.

These investments gave Cerberus and MassMutual a majority stake in the company. Scottish Re's market value was about $43 million on Thursday, Reuters data show. Cerberus spokesman Peter Duda and MassMutual spokesman Mark Cybulski did not immediately return calls seeking comment. Scottish Re said it is changing its strategy because it is losing money from investments tied to subprime and "Alt-A" residential mortgages, and because a Jan. 31 downgrade by Standard & Poor's will make it harder both to compete and to expand its core life reinsurance business.

The company said it plans to continue focusing on its North American life reinsurance business, "through strategic alliances or other means," and cut costs to preserve capital and liquidity. It said it has established a financial incentive program to retain "essential" employees. S&P on Jan 31 downgraded Scottish Re to "B," its fifth highest "junk" grade, from "B-plus," and its Scottish Annuity Life Insurance Co unit one notch to "BB" from "BB-plus." It said the company's deteriorating financing condition "has severely disrupted Scottish Re's ability to generate new business and potentially to retain existing business."

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Ilargi: I personally find the good news and light exposure in Canada, just like in many other parts of the world, suspect.

Some Canadian banks have revealed more charges, but costs could deepen

Some of Canada’s biggest banks have already said they’ll endure more writedowns in the first quarter, linked to the languishing U.S. credit market, but a few costly surprises could emerge when earnings start to be issued this week. Analysts suggest the nightmare, which has gripped most of the banks, will continue to cast a shadow over earnings and CIBC could add to its billion-dollar writedowns.

Meanwhile, Royal Bank’s silence on whether they face further writedowns in the first quarter could mean that any impact on the horizon probably won’t be huge. “Arguably Royal has plenty of exposures that could give rise to charges,” said Mario Mendonca, an analyst at Genuity Capital Markets. “What we could be looking at is a $400 (million) to $500 million charge for Royal. But perhaps the reason why we haven’t heard anything yet is because they have sufficient other forms of earnings or gains that could offset that.”

In January, the bank said it would write down the full amount of its exposure to a U.S. bond insurer believed to be ACA Financial Guaranty Corp., a liability valued at $104 million months ago. Royal Bank of Canada is scheduled to report on Friday. This quarter the Canadian Imperial Bank of Commerce, which has the biggest exposure to troubled asset-backed commercial paper, could break through the $3 billion writedown for writedowns, Mendoca suggested.

“The underlying securities — the subprime that underlies those transactions — has deteriorated in value since CIBC last priced their exposure,” he said. So far, CIBC has written off about $2.5 billion to account for exposure to the U.S. credit markets. CIBC is scheduled to issue its results on Thursday.

Then there’s Bank of Montreal, which has been hit from all sorts of directions over the past year — from gas trading losses to the credit market. Last week, the bank said it’ll log a $490-million charge in the first quarter from market fallout south of the border. Analysts reacted to the disclosure with caution, and some suggested that BMO could reel in its dividend hikes for the rest of the year as it battles tense markets. The bank reports on March 4. Scotiabank is considered a safer bet because their U.S. exposure is limited.

“They’re not quite as dependent on those capital markets revenues, in our view, as some of the other banks are,” said Craig Fehr, a financial services analyst with Edward Jones in St. Louis. “My expectation is that there might be another dribble of a writedown but certainly nothing material from them.” Scotiabank has reported a mere $190 million in writedowns to date, which is considered minimal alongside its Canadian competitors. Only TD Bank has come out clean and posted no writedowns. Last month, the bank insisted that rumours it would be slapped with exposure through its acquisition of Commerce Bancorp were false.

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A ‘Moral Hazard’ for a Housing Bailout: Sorting the Victims From Those Who Volunteered

Over the last two decades, few industries have lobbied more ferociously or effectively than banks to get the government out of its business and to obtain freer rein for “financial innovation.” But as losses from bad mortgages and mortgage-backed securities climb past $200 billion, talk among banking executives for an epic government rescue plan is suddenly coming into fashion.

A confidential proposal that Bank of America circulated to members of Congress this month provides a stunning glimpse of how quickly the industry has reversed its laissez-faire disdain for second-guessing by the government — now that it is in trouble. The proposal warns that up to $739 billion in mortgages are at “moderate to high risk” of defaulting over the next five years and that millions of families could lose their homes.

To prevent that, Bank of America suggested creating a Federal Homeowner Preservation Corporation that would buy up billions of dollars in troubled mortgages at a deep discount, forgive debt above the current market value of the homes and use federal loan guarantees to refinance the borrowers at lower rates. “We believe that any intervention by the federal government will be acceptable only if it is not perceived as a bailout of the bond market,” the financial institution noted.

In practice, taxpayers would almost certainly view such a move as a bailout. If lawmakers and the Bush administration agreed to this step, it could be on a scale similar to the government’s $200 billion bailout of the savings and loan industry in the 1990s. The arguments against a bailout are powerful. It would mostly benefit banks and Wall Street firms that earned huge fees by packaging trillions of dollars in risky mortgages, often without documenting the incomes of borrowers and often turning a blind eye to clear fraud by borrowers or mortgage brokers.

A rescue would also create a “moral hazard,” many experts contend, by encouraging banks and home buyers to take outsize risks in the future, in the expectation of another government bailout if things go wrong again. If the government pays too much for the mortgages or the market declines even more than it has already, Washington — read, taxpayers — could be stuck with hundreds of billions of dollars in defaulted loans.

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Ilargi: Whether on purpose or not, Mish misses out on the one “choice” that will be most prevalent: Fast and steeply reduced services.


"Free Lunch" Era Is Over

Florida and California continue to make the news. Just yesterday in More Budget Cuts in California, New Jersey, and Florida I noted the following.

• California's budget deficit grew from $14.5 billion to $16 billion in the last two months.
  
• New Jersey is facing a budget freeze
  
• lorida is threatening to layoff circuit court employees for 11 of the next 19 weeks without pay
  
• Akron, Ohio wants to sell its sewer system to give "free" tuition to city residents

Clearly the Matter Of Choice keeps growing larger and larger. California already has to make 10% budget cuts and I can't help wondering when that will become 20%.

Here Are The Choices

1. Raise Taxes
   
2. Fire workers
   
3. Reduce Pay

The Era of the Free Lunch is Over.

Failing muni auctions in conjunction with the likely bankruptcies or defaults by Ambac (ABK) and MBIA (MBI) mean the days of perpetually floating more bonds to meet current expenses has dried up.

It had to end sometime and so it did. The end of the free lunch is over for California (and many other states too). Real choices now have to be made. Furthermore, the sinking dollar at some point will put an end to the Free Lunch Era at the national level too.

Those addicted to the "free lunch" are headed for a forced withdrawal. While misguided talk of a second half recovery is emanating from Bernanke, Bush, and Paulson, budget cutbacks and a commercial real estate implosion are going to ensure this recession is both long and deep. Sadly, hardly anyone is prepared for it.

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Auditor: Roads suffering as funds fall

A growing shortage of state transportation dollars is showing up in worsening road conditions in Minnesota, and a growing reliance on debt to pay for day-to-day maintenance of the state’s roads and bridges. Those were among the findings in a new report from the state’s legislative auditor, released this week.

The report appears to boost the arguments of many in the Legislature who are seeking an increase in the state’s gas tax as a way to keep pace with the rising costs of highway maintenance and construction. Legislators hope to have a new transportation bill on Gov. Tim Pawlenty’s desk by the end of the month, and that bill is almost certain to include a provision for a gas tax increase. Pawlenty has already promised a veto.

Yet, according to the legislative auditor, the value of the state’s existing gas tax has fallen 16 percent since 2003, due to the effects of inflation. The state’s gas tax has remained at 20 cents per gallon since 1988, but the increasing amount of fuel usage in the state generally helped offset the losses to inflation, until 2003. That’s when higher fuel prices began to prompt the state’s drivers to change their behavior.

That loss of effective revenue has forced MnDOT to rely more heavily on borrowing to cover its costs. As recently as 1998, the auditor found that the gas tax funded about two-thirds of the department’s operations. By last year, however, that had fallen to about half. Since 2003, the state has made substantial use of debt financing techniques to support the state trunk highway system,” stated Legislative Auditor James Nobles, in the report. The state had relied on no bonding through 2000, but has been bonding in excess of $100 million a year since 2004.

Despite the additional borrowing, the quality of Minnesota’s trunk highways is slipping, according to MnDOT’s own data. In 2002, 72 percent of the state’s trunk highways were rated in good condition, but by 2007 just 66 percent of trunk highways were rated that highly. Lesser Minnesota roadways also saw deterioration, according to the report, with just 59 percent now rated in good condition, compared to 66 percent five years earlier

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Homeowners Losing Equity Lines

In one brief phone call, Nancy Corazzi's lender yanked away what was left of the $95,000 home equity line of credit that she and her husband took out five months ago. The lender informed her that her Howard County home had plummeted in value and the company did not want the risk that she would owe more than the house was worth.

"I got off the phone and I was shaking," said Corazzi, who was using the money to pay preschool tuition for her twins ."I was near tears. We needed this credit line to get us through some tough times." Several of the nation's largest lenders, along with smaller ones, are shutting off access to home equity lines in areas where home values are declining. It's an unusually aggressive move as the industry grapples with fallout from the mortgage crisis that began unfolding last year.

Now that home prices have dropped in many parts of the country, lenders are nervous that they may never collect the money that they extended to borrowers. They are responding by freezing or lowering the credit limits on home equity lines, leaving thousands of borrowers like Corazzi in the lurch. "Nearly all the top home equity lenders I know of are doing this or considering doing this," said Joe Belew, president of the Consumer Bankers Association, which represents some of the nation's largest home equity lenders. "They are all looking at how to protect themselves as real estate values go down, and it's just not good for the borrowers to get so overextended."

Countrywide Financial, the nation's largest mortgage lender, suspended the home equity lines of 122,000 customers last month after reviewing their property values and outstanding loan balances. The company, like others, has an internal automated appraisal system that tracks values. The company declined to disclose how many of the affected borrowers lived in the Washington area. About 381,000 borrowers in the region had home equity lines at the end of last year, according to Moody's economy.com.

USAA Federal Savings Bank froze or reduced credit lines for 15,000 of its customers, including Corazzi, and will not reconsider its decisions until "real estate values improve substantially," the company said in a statement. Bank of America is starting to do the same and is contacting some borrowers, said Terry Francisco, a bank spokesman. "We know this can cause hardship to our customers," Francisco said. "If they used the credit to make payments that are in the pipeline, we will work with them to make sure the payment goes through."

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The three trillion dollar war

The cost of direct US military operations - not even including long-term costs such as taking care of wounded veterans - already exceeds the cost of the 12-year war in Vietnam and is more than double the cost of the Korean War. And, even in the best case scenario, these costs are projected to be almost ten times the cost of the first Gulf War, almost a third more than the cost of the Vietnam War, and twice that of the First World War.

The only war in our history which cost more was the Second World War, when 16.3 million U.S. troops fought in a campaign lasting four years, at a total cost (in 2007 dollars, after adjusting for inflation) of about $5 trillion (that's $5 million million, or £2.5 million million). With virtually the entire armed forces committed to fighting the Germans and Japanese, the cost per troop (in today's dollars) was less than $100,000 in 2007 dollars. By contrast, the Iraq war is costing upward of $400,000 per troop.

Most Americans have yet to feel these costs. The price in blood has been paid by our voluntary military and by hired contractors. The price in treasure has, in a sense, been financed entirely by borrowing. Taxes have not been raised to pay for it - in fact, taxes on the rich have actually fallen. Deficit spending gives the illusion that the laws of economics can be repealed, that we can have both guns and butter. But of course the laws are not repealed. The costs of the war are real even if they have been deferred, possibly to another generation.

On the eve of war, there were discussions of the likely costs. Larry Lindsey, President Bush's economic adviser and head of the National Economic Council, suggested that they might reach $200 billion. But this estimate was dismissed as “baloney” by the Defence Secretary, Donald Rumsfeld. His deputy, Paul Wolfowitz, suggested that postwar reconstruction could pay for itself through increased oil revenues. Mitch Daniels, the Office of Management and Budget director, and Secretary Rumsfeld estimated the costs in the range of $50 to $60 billion, a portion of which they believed would be financed by other countries. (Adjusting for inflation, in 2007 dollars, they were projecting costs of between $57 and $69 billion.) The tone of the entire administration was cavalier, as if the sums involved were minimal.

Even Lindsey, after noting that the war could cost $200 billion, went on to say: “The successful prosecution of the war would be good for the economy.” In retrospect, Lindsey grossly underestimated both the costs of the war itself and the costs to the economy. Assuming that Congress approves the rest of the $200 billion war supplemental requested for fiscal year 2008, as this book goes to press Congress will have appropriated a total of over $845 billion for military operations, reconstruction, embassy costs, enhanced security at US bases, and foreign aid programmes in Iraq and Afghanistan.

As the fifth year of the war draws to a close, operating costs (spending on the war itself, what you might call “running expenses”) for 2008 are projected to exceed $12.5 billion a month for Iraq alone, up from $4.4 billion in 2003, and with Afghanistan the total is $16 billion a month. Sixteen billion dollars is equal to the annual budget of the United Nations, or of all but 13 of the US states. Even so, it does not include the $500 billion we already spend per year on the regular expenses of the Defence Department. Nor does it include other hidden expenditures, such as intelligence gathering, or funds mixed in with the budgets of other departments.

From the unhealthy brew of emergency funding, multiple sets of books, and chronic underestimates of the resources required to prosecute the war, we have attempted to identify how much we have been spending - and how much we will, in the end, likely have to spend. The figure we arrive at is more than $3 trillion. Our calculations are based on conservative assumptions. They are conceptually simple, even if occasionally technically complicated. A $3 trillion figure for the total cost strikes us as judicious, and probably errs on the low side. Needless to say, this number represents the cost only to the United States. It does not reflect the enormous cost to the rest of the world, or to Iraq.

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