Debt Rattle, February 8 2008

Updated 4.30 pm

Ilargi: On this Friday afternoon, we can confidently state that the game is over for the bond insurers. Three articles below tell us why. This line in particular is important in what goes on:

... the banks [..] get to unwind their [..] credit default swaps even though the documentation in them clearly says that can't be done without the consent of the insurer

Why does a bank spend billions on buying out a bond insurer that is certain to be downgraded away from AAA, and will no longer be a 'going concern', i.e. a valid business? Because if it owns the monoline, it can give itself permission to unwind its CDS's. That's more or less the whole story.

Monolines: Resigned to Downgrades

The WSJ put an uncommonly-forthright forward-looking headline on its monoline story yesterday: "Rescue Plans Won't Prevent Downgrades". And it's right. If the monolines' plans for shoring up their capital bases come to fruition, they're still likely to suffer the loss of their triple-A ratings. Most of the story talks about the bank consortia looking to shore up Ambac (ABK) and FGIC:

The banks, then, would share in the proceeds that the bond insurers would make as they collect premiums and wait for their existing portfolio of policies to expire, or "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, but they aren't getting their hopes up for a return to triple-A glory.

One could excuse the monolines in question for being less than thrilled about this particular prospect. The loss of their triple-A ratings is one thing; "run-off", by contrast, is something else entirely, and implies that the companies will essentially become shells, collecting insurance premiums but writing no new business.

The proposed bank plan indeed looks much better from the point of view of the banks involved, which get to unwind their suddenly-toxic credit default swaps even though the documentation in them clearly says that can't be done without the consent of the insurer. Their plan, then, is essentially to take over the insurer, and rescue themselves first.

An interesting open question is whether the monolines could continue as a going concern, writing new insurance, with only a double-A rather than a triple-A credit rating. I've heard noises that such an outcome is indeed possible, although no one knows for sure.

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Super Friday for monolines? Moody’s cuts rating on XLCA

SCA’s bond insurance business, XL Capital Assurance, lost its crucial AAA rating on Thursday evening. But Moody’s didn’t just cut XLCA, the fourth largest bond insurer, from AAA to AA. It downgraded it by six notches.
The implications for other bond-insurers are troubling. Monoline downgrades have previously only been imagined as cuts of one or two notches, with the expectation being that a recovery might well be probable in the future.

Although XLCA’s situation is particularly dire relative to its size (it, like ACA, was heavily involved in CDO insurance) it does nonetheless bode ill for the two biggest players: Ambac and MBIA. Were they to be downgraded it would be bad enough, were they to be downgraded further than AA, it would be absolutely disastrous. XCLA has contracts on around $154.2bn of debt, which will be cut by at least the same number of notches - to A3, according to Moody’s.

An instant impact then, irregardless of what bond prices do, will be that banks holding those insured bonds will have to stump up a great deal of extra regulatory capital. AAA rated bonds require very little. But under Basel II, the extra capital needed for riskier tranches is considerable.

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Treasury Won't Take on Monoline Crisis

A top U.S. Treasury Department official said Thursday he expects a first-quarter release of a plan to modernize U.S. financial services regulation. In remarks to Wall Street securities analysts, Robert Steel, undersecretary for domestic finance, said the Treasury Department is putting together "a blueprint" to give both consumers and large investors appropriate protections.

"As we in the Treasury Department develop a blueprint for a more optimal regulatory structure, we must balance policies that allow for efficient movement of capital while also promoting a safe and stable environment," he said. "A regulatory structure that meets all of these conditions will invite capital by inspiring confidence among market participants."
Steel said, "While our work is still ongoing and no final decisions have been made, we expect to release our regulatory blueprint within the first quarter of this year."

Steel said parts of the new plan "will be unsettling to some people who are invested in the current (regulatory) scheme."
The plan will address regulation of securities, banking and insurance. He wouldn't say which area would be most affected by the new scheme but indicated that it is especially difficult to impose radical changes to insurance, since it is regulated primarily on a stat level.

In questions after his talk, Steel said Treasury is closely monitoring the current monoline insurance capital crisis but doesn't plan to directly intervene. It's a "private market-oriented situation," he said, referring to attempts by banks to work out plans to capitalize companies such as Ambac Financial Group Inc. that insure municipal and asset-backed bonds.
Some of the proposals could be put into effect immediately while others could require legislation, he said after his remarks to the group in New York

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Updated 12.30 pm

Western banks face Sovereign Wealth Fund backlash

Earlier this week, I chatted with a jet-lagged senior US financier. Like many of his ilk, he is flitting around the Middle East and Asia trying to extract finance from sovereign wealth funds and other investment groups. His latest travels have delivered a surprise: some funds are quietly getting cold feet about the idea of putting more capital directly into western banks, he says. “There is a backlash building,” he muttered into a crackling cell phone.

This is striking stuff. In recent months, many equity investors have taken comfort from the idea that sovereign wealth funds could ride to the rescue of Wall Street, if not the City of London too. For as the subprime scourge has spread, US policymakers have leant on the largest US banks to raise capital, almost at any cost. Consequently, they have passed the begging bowl around the sovereign wealth funds, with considerable success. Thus far some $40bn to 60bn worth of injections have been promised to groups such as Merrill Lynch and Citi, depending on how you measure the promises.

But having stepped into the breach so visibly late last year, some funds are now getting jitters. In China, for example, there are rising complaints that funds are foolish to shovel cash directly into risk-laden US banks when they could be using it in better ways, such as purchasing western commodity or manufacturing groups. “The Chinese are worried they are turning into [the source of] dumb money,” says one well-placed Asian financier, who partly blames the trend on the Blackstone saga, which produced significant paper losses for the Chinese investors.

Meanwhile, in the Middle East, the latest round of Federal Reserve interest rate cuts has created unease. For sure, some powerful Gulf investors have been heartened to see that the US authorities are acting in a resolute way. They are doubly relieved that the dollar has held up so well so far. But the dramatic scale of Fed cuts has prompted concern that Wall Street is still sitting on a putrid mess – contrary to what the US banks told the sovereign wealth funds late last year.

Unsurprisingly, this leaves Gulf investors cynical about promises from Wall Street banks. Now, it would be nice to think this sentiment shift does not matter too much for the US banks. After all, the recent infusion of funds means the largest Wall Street groups are looking pretty well capitalised on paper. It also means they should be able to absorb subprime losses, which banks such as Goldman Sachs think could reach $200bn for the banks soon.

However, the problem is that subprime is just one of several potential looming shocks. Defaults on other forms of consumer debt and commercial property could rise this year. So could defaults on corporate leveraged loans from 2009 on. Meanwhile, the monolines insurers are threatening to blast another hole in banks’ balance sheets. Indeed, if you tot up all the hits that could emerge in the next couple of years, it is easy to reach a sum of $500bn, or far more. This is sizeable, given that Goldman Sachs calculates that the banks’ capital is around $1,600bn.

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Bill Gross: Rescuing monolines is not a long-term solution

Those who put their faith in the ability of a finance-based economy to remain healthy are being similarly challenged today. A critic can find numerous examples of incredible, bubble-popping asset structures – from subprime mortgages to structured investment vehicles to collateralised debt obligations squared – that are threatening to reverse the expansion of the shadow banks and break our finance-based economy’s back. The most recent one, however, centres around the monoline insurers with Ambac as the most important link in the chain that presumably cannot be allowed to break.

Monoline insurers are so named because they originally covered just one line of business – municipal bonds. Today, however, because they do not insure lives, or automobiles or medical expenses, the name has stuck despite their additional reach into insuring financial assets of all varieties. In a real sense, the monolines have taken on their shoulders a supersized portion of the guaranteed solvency of modern asset structures. In combination with overly generous triple-A ratings on not only these assets but the monoline companies themselves, they have fostered a bubble of immeasurable but clearly significant proportions.

That the monolines could shoulder this modern-day burden like a classical Greek Atlas was dubious from the start. How could Ambac, through the magic of its triple-A rating, with equity capital of less than $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 authority?

Apply the same logic to the gargantuan size of the asset-backed 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. It is as if Barney Fife, television’s Sheriff of Mayberry in The Andy Griffith Show, promised to bring law and order to the entire country.

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Warning: Anger at Financiers Rising

While one data point does not constitute a trend, a first page article in today's New York Times, "Creators of Credit Crisis Revel in Las Vegas," may signal a shift in popular sentiment. Normally, "how the mighty are fallen" stories are exercises in shadenfreude. But this one, on the annual convention of the American Securitization Forum, the industry group that helped bring us subprimes and collateralized debt obligations, is openly outraged, at least compared to the usual anodyne tone of New York Times reporting. At a plush industry convention in Las Vegas, AFS members are sighted licking their wounds and plotting to find ways to profit from the crisis they helped bring about. While the article also mentions some of the losses that participants have taken, no one seems to be in dire straits. And there seems to be little in the way of remorse or self-recrimination.

Criminal investigations into Wall Street's securitization practices corroborates the public's increasingly dim view of the industry. Deep down, many subscribe to Balzac's view that great fortunes are built on great crimes.

Today's Wall Street Journal gives an update on the probes:

The Justice Department's U.S. attorney's office in Manhattan, based near Wall Street, has notified the Securities and Exchange Commission that it wants to see information the agency is gathering in its investigation of Merrill Lynch & Co., according to people familiar with the matter. The SEC is examining, among other things, whether the securities firm booked inflated prices of mortgage bonds it held despite knowledge that the valuations had dropped, the people say.

The move by the U.S. attorney's office comes as the SEC has upgraded its Merrill probe to a formal investigation... The interest by the federal prosecutors is preliminary; it is unclear whether the SEC has turned over information. But the U.S. attorney's office request could be a precursor to a criminal investigation, these people say.

In the last month or so, I have noticed a marked increase in hostility towards the financial services industry, both in the number of cynical, critical comments on this blog and the intensity of their venom. My personal favorite, in response to a post "Martin Wolf: Can We Corral the Financiers?" The model has already been put forward by the enragés:

On 2 June, Paris sections — encouraged by the enragés ("enraged ones") Jacques Roux and Jacques Hébert — took over the Convention, calling for administrative and political purges, a low fixed price for bread, and a limitation of the electoral franchise to sans-culottes alone. With the backing of the National Guard, they convinced the Convention to arrest 31 Girondin leaders, including Jacques Pierre Brissot. Following these arrests, the Jacobins gained control of the Committee of Public Safety on 10 June, installing the revolutionary dictatorship.

On 13 July the assassination of Jean-Paul Marat — a Jacobin leader and journalist known for his bloodthirsty rhetoric — by Charlotte Corday, a Girondin, resulted in further increase of Jacobin political influence.[9] Georges Danton, the leader of the August 1792 uprising against the King, was removed from the Committee. On 27 July Robespierre, self-styled as "the Incorruptible", made his entrance, quickly becoming the most influential member of the Committee as it moved to take radical measures against the Revolution's domestic and foreign enemies.

For those who don't know the history of the French Revolution, Danton was guillotined, as was Robespierre. In other words, let the mob exact bloody justice.

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Ilargi: Well, I guess we can call this progress: the banks trying to bail out the monolines have now accepted that MBIA and Ambac cannot be resurrected to an AAA status. That of course makes them dead ducks, unable to do new business. Still, the saviors seem to pin their hopes on the fact that their own reputation, and guarantees, will make investors happily buy (into) their nonsense anyway. Fat chance. The baby has drowned in the bathwater.

Banks may take bond insurers stake in rescue-sources

Banks are considering ending bond insurers' guarantees of their subprime investments in return for taking stakes in the troubled underwriters, such as Ambac Financial Group and Financial Guaranty Insurance Co, according to people briefed on the talks.

Under this scenario, the banks would lose guarantees on billion of dollars of exposure, but could stabilize the insurers and give the banks a chance of collecting funds from the bond insurers in the future. Separate bank groups are talking to Ambac and FGIC, in an effort to prevent the bond insurers' difficulties from creating market havoc.

The rescue talks, which also involve a New York regulator, may not prevent the insurers from losing their top "AAA" rating that is the basis to their current business. However, this plan could help stabilize the insurers at a lower "AA" rating, sources said.

Under one of several rescue scenarios being considered, the banks would unwind guarantees on the banks' collateralized debt obligations. In return, the banks would get stakes in the insurers, perhaps through warrants, as first reported in the Wall Street Journal on Thursday.

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Ilargi: Or we could just design a system in which there's no letter codes such as AAA anymore. That would free up buying space for lots of investors. Their rules say they can't buy below AAA, but nothing about there not being any AAA.

S&P unveils reforms amid US, European scrutiny

Standard & Poor's announced new reforms Thursday amid concerns about how influential credit rating agencies graded US mortgage securities which have triggered huge losses for some investors. New York-based S&P said it was overhauling its practices to beef up confidence in its credit ratings and to make its ratings process more transparent.

"By further enhancing independence, strengthening the ratings process, and increasing transparency, the actions we are taking will serve the public interest by building greater confidence in credit ratings," S&P president Deven Sharma said.
S&P, as well as rivals Moody's Investors Service and Fitch Ratings, has been criticized for being too slow to downgrade its ratings on subprime mortgage-related securities which have plummeted in value amid a US housing slump. US banking giant Citigroup reported a quarterly loss of almost 10 billion dollars last month which it largely blamed on soured subprime mortgage investments, linked to loans to persons with poor credit histories.

Investors often rely on S&P ratings when mulling whether to buy a particular security or other asset such as bonds a company may issue to raise capital. As such, its ratings are highly influential and can have a big effect on the value of a particular security or company. US and European regulators have launched reviews of the ratings agencies' practices in the wake of mounting losses from mortgage securities which have also sparked big losses at major foreign banks.

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Loan Losses May Spur Writedowns, Bank of America Says

Banks sitting on $160 billion of unsold leveraged loans may have to write down more losses after a plunge in the value of the debt, according to Bank of America Corp. analysts. Credit-default swaps showed the risk of leveraged buyout loan delinquencies rose to the highest on record today. Collateralized loan obligations that package the debt will be under pressure to wind down as the value of their assets falls, analysts led by Jeffrey Rosenberg wrote in a report published yesterday.

Banks including Citigroup Inc., Goldman Sachs Group Inc. and Morgan Stanley are unable to offload debt from last year's record $438 billion of buyouts as concern of a possible recession and losses from subprime mortgages drive investors to the safest government securities. "The substantial widening in loan spreads and the lengthening in expected maturities as refinancing options dim have now threatened an unwind in leverage,'' the report said. "A replay of last year's third-quarter bank writedowns for hung bridge exposure may be on the horizon."

Securities firms and banks have disclosed at least $146 billion of credit losses and writedowns since the collapse of the U.S. subprime market last year.

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Ilargi: We have warned in these pages for what is about to unfold in Britain. Here's a few "teasers". The scope of what’s about to unfold in the UK is becoming apparent. 10 million Brits are expected to default on their repayments for mortgages, credit cards or personal loans by the end of the year. At the same time, the government looks to swallow £90 billion of Northern Rock's liabilities, and that’s not all. They want to guarantee every single bank and depositor that might fail. As a commenter says: “they might as well nationalize the entire economy”. Bright minds in the US are floating similar ideas: letting the soon-to-be impoverished taxpayer fork over for the banks’ losses.

UK: 10 million 'may default on debt by end of year'

More than 10 million people may default on repayments for mortgages, credit cards or personal loans by the end of the year. A forecast from one of Britain's biggest accountancy firms, says that "the merry-go-round of credit is about to stop", as millions of people realise their take-home pay is not enough to service their debts. According to KPMG, 22 per cent of those adults with debts - equating to 6.6 million - are already finding it difficult to meet their repayments.

However, 35 per cent - or 10.6 million - are worried they will find it even more difficult to pay back their debts in a year. The figures come from a KPMG survey conducted by YouGov and commissioned by the ITV documentary Repossession, Repossession, Repossession.

The programme, to be shown on Wednesday night, is presented by Jeff Randall, The Daily Telegraph's Editor at Large, and exposes how a decade of cheap credit and rising house prices have conspired to leave millions of people with insurmountable debts. Consumer debts have trebled in the past decade with each household in Britain owing £51,730 on average - a total of £1.345 trillion. The country is more indebted than any in Europe.

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Northern Rock blows a hole in Chancellor's debt pledge

A key Government pledge on debt policy appeared to be left in tatters today after at least £90 billion of Northern Rock's liabilities were officially brought on to the public sector's balance sheet. The move, which covers all of the stricken Tyneside lender's wholesale borrowings, securitisations issues and customer deposits, makes it almost certain that the Treasury's "golden rule" on the ratio of debt to GDP will be breached.

It comes only weeks before Alistair Darling, the Chancellor, is due to present his annual Budget. The Government's "sustainable investment rule" states that debt should not represent more than 40 per cent of GDP. The ratio stood at 37.7 per cent in December, with public sector net debt at £536.5 billion. The Treasury declined to comment on whether the rule would be breached.

Martin Kellaway, a National Statistics statistician who co-authored a 26-page explanation of the reclassification, said Northern Rock's finances had been subject to scrutiny since November. He said National Statistics' estimate that the Rock's liabilities were roughly £90.7 billion for the purposes of the Government's balance sheet were based on its report and accounts as at the end of 2006. He said it was not clear whether the actual figure to include the period since then was higher or lower. It will take two to three months for National Statistics to establish a precise number for the liabilities.

Previous total taxpayer exposure to the Rock has been estimated at more than £57 billion, equivalent to a cost of about £2,000 for every Briton. Coming only a week after the Institute for Fiscal Studies, a respected think tank, gave warning that a hole in Government finances meant that taxes would have to go up by £8 billion, it represents yet another blow to the economic credibility of Mr Darling and Gordon Brown, the prime minister.

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More UK Madness

Everyone’s been blasting Ben Bernanke for cutting interest rates so sharply. Count me among them. That said, I still consider him the best of the current crop of clowns running the central banks worldwide. At least for now.
You have the Japanese guy who has kept rates damn near close to zero percent over a decade now. You have the French-Belgian movie star in Europe talking tough and keeping Euro rates high to help the carry trade speculators.

But the worst of them has to be the guy in England who has blown 25 billion pounds of taxpayer resources to delay the inevitable failure of Northern Rock. The British can hardly outdo themselves, yet they have. News reports are preparing the British public for a Bank of England pre-emption of any and all British banks that fail:

The Bank of England should take the lead if and when a U.K. bank gets into trouble, lawmakers said in a report on the crisis at mortgage lender Northern Rock PLC published Saturday. The House of Commons Treasury Committee recommended that a new unit be established at the central bank to identify and step in to prevent the failure of problem institutions. The report comes just days before Chancellor of the Exchequer Alistair Darling reveals his plans to beef up bank regulation to ward off future crises.

He had indicated that the Financial Services Authority will be given greater powers to intervene preemptively if a financial institution finds itself in difficulty. But the treasury suggested that it will incorporate some of the Treasury Committee’s findings into its proposals. A source familiar with the situation said the government’s final set of proposals will be “a little bit different” from those that Mr. Darling had previously pointed to, and will “take into account” the committee’s recommendations.

At this rate, they might as well nationalize the entire economy and transfer legal ownership of all production to the bankers. I had speculated that Britain would be prepared to repeat its Northern Trust actions with other British banks, and with a delusional socialist prime minister who actually ignited the UK housing bubble, it looks like this may very well come to pass.

It’s times like this when you see with glaring clarity what the real purpose of a central bank is. It’s not to defend the currency or control inflation (what a joke) or to manage economic growth prudently. Quite simply, the primary purpose of a central bank is to enable unabated expansion of the state while protecting the downside risk for the financial sector when things go bad. It is not ironic that elitists’ poker hand is being shown in Britain, as the world’s first central bank was invented there.

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Futures drop on recession fear; MBIA slides

Stock index futures dropped on Friday as worries about the economic outlook swelled after a Federal Reserve official said a recession might not be avoidable. Concerns about bond insurers remained after Moody's Investors Services cut its "AAA" ratings for XL Capital Assurance, a unit of Security Capital Assurance. Shares of MBIA Inc , the world's largest bond insurer, slid 11 percent to $12.65 before the bell it sold $1 billion of shares on Thursday to raise capital. The sale was at a discount to the MBIA's closing price.

San Francisco Federal Reserve Bank President Janet Yellen, speaking in Honolulu, indicated a willingness to cut U.S. interest rates further, but she also said she was not confident a recession can be avoided this year. Stocks snapped a three-day string of losses on Thursday, but their performance can be swayed by psychology, an investment strategist said.

"Every time we try to rally, one of these Fed governors comes out and opens their mouth and knocks the steam out of the market. I wish they would all just shut up," said Paul Mendelsohn, chief investment strategist at Windham Financial Services in Charlotte, Vermont. "What is going to cause this recession is psychology. You don't want to foster a negative psychology. People want some source of confidence."

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Prosecutors Widen Probes Into Subprime

U.S. Attorney's Office Seeks Merrill Material; SEC Upgrades Inquiry

Federal criminal prosecutors are stepping up their interest in Wall Street's mortgage-securities activities.The Justice Department's U.S. attorney's office in Manhattan, based near Wall Street, has notified the Securities and Exchange Commission that it wants to see information the agency is gathering in its investigation of Merrill Lynch & Co., according to people familiar with the matter. The SEC is examining, among other things, whether the securities firm booked inflated prices of mortgage bonds it held despite knowledge that the valuations had dropped, the people say. The move by the U.S. attorney's office comes as the SEC has upgraded its Merrill probe to a formal investigation, which requires approval of the full commission and gives the agency broad power to require firms and individuals to produce information.

The interest by the federal prosecutors is preliminary; it is unclear whether the SEC has turned over information. But the U.S. attorney's office request could be a precursor to a criminal investigation, these people say.A spokeswoman for the Manhattan U.S. attorney's office declined to comment. A Merrill spokesman said the firm had no comment, except to say that Merrill cooperates on regulatory matters when asked. The interest of the Manhattan U.S. attorney's office follows a series of investigations being pursued by state and federal regulators with criminal and civil enforcement powers around the nation into the financial industry in the wake of the mortgage-securities market collapse.

As reported by The Wall Street Journal last week, federal criminal prosecutors in another U.S. attorney's office in New York, this one in Brooklyn, have launched a preliminary criminal investigation into whether UBS AG improperly valued its mortgage-securities holdings; that comes amid a formal investigation by the SEC in the matter. The UBS probes are examining, among other things, an incident detailed in a page-one Journal article detailing how a trader at a UBS unit was confronted and then ousted after he valued mortgage securities at prices below the values assigned to the same securities elsewhere at UBS.

The federal prosecutors in Brooklyn also are examining the circumstances surrounding two failed hedge funds at Bear Stearns Cos. Those funds collapsed last summer because of losses tied to mortgage-backed securities. Meantime, the Federal Bureau of Investigation is looking at 14 companies involved in the subprime meltdown, and the New York attorney general's office, which can bring criminal securities-related cases, is investigating whether investment banks disclosed enough to investors and to credit-rating firms about the securities.

How much of a threat these investigations pose to Wall Street depends on what the probes turn up, lawyers say. "Whether we will see a large number of criminal cases come out of this remains to be seen, because it's dependent on a lot of subjective information, such as how to value securities in an uncertain marketplace," says Michael McGovern, a former federal prosecutor and white-collar lawyer in New York. "There's enough here to suggest that any case prosecutors might want to bring, they'll have pause because of the complexity, the availability of defenses and the difficulty of proving intent," he says.

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Bear Stearns Faces Indictment Over Collapsed Hedge Funds

Bear Stearns may be in serious legal jeopardy over the collapse of two credit hedge funds last year.
Already facing hundreds of millions in claims from aggrieved investors, who lost $1.6 billion in the High-Grade Structured Credit Fund and a more levered sister vehicle, the Wall Street firm is now facing the prospect of a federal indictment.

Federal prosecutors are in talks with high-ranking Bear executives, CNBC’s Charlie Gasparino reports, and have already spoken with Rich Marin, the former head of Bear Stearns Asset Management. According to Gasparino, an indictment of the firm is possible. The two Bear funds went bankrupt last year after huge losses in subprime mortgage-linked bonds and other credit assets.

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MBIA raises $1 billion capital

MBIA Inc, the world's largest bond insurer, sold $1 billion of shares on Thursday, raising capital that could protect its top credit ratings, but its smaller rival XL Capital Assurance lost its top ratings, in the latest sign that the sector is ailing. MBIA's ability to raise capital at all in this environment is noteworthy. Ambac Financial Group Inc. last month withdrew a planned offering for at least $1 billion of equity, citing factors including difficult market conditions.

Times are tough for bond insurers, which are expected to have to pay out billions of dollars after guaranteeing repackaged subprime mortgages and other risky debt. Deutsche Bank chief Josef Ackermann has warned that the bond insurers' difficulties could lead to the next financial crisis.
Banks are working hard to rescue bond insurers including FGIC Corp and Ambac, and are considering giving up guarantees from the companies in exchange for equity stakes or warrants, people familiar with the matter said.

But the difficulty of rescuing bond insurers is evident from the experience of XL Capital Assurance. The unit of Security Capital Assurance would need to have at least $6 billion of capital to support triple-A ratings, but only has an estimated $3.6 billion of claims paying resources, Moody's said. Its future revenue might be strained as demand for its bond insurance decreases, the rating agency said. Moody's slashed XL Capital Assurance's ratings six notches. The insurer guarantees some $150 billion of debt.

Bill Ackman, who has been shorting shares of bond insurers since at least 2002, has told U.S. regulators that the rescue efforts are not a good idea and the bond insurers' holding companies should be allowed to fail. Ackman said the insurers in recent years have become a means for banks to avoid reporting their full credit exposure and make their capital ratios appear stronger.

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Moody's says subprime loss review takes time

A review by Moody's Investors Service of the top ratings of bond insurers is taking time because "we're taking a great deal of care to get the answer right," Moody's Chief Credit Officer Andrew Kimball said on Thursday.
Ratings agencies are under fire for failing to signal risks in mortgage-backed securities and in structured deals that include them, which had previously been considered very safe and in many cases held top "AAA" ratings.

As the U.S. housing markets have deteriorated, mortgage-backed securities have plunged in value, and ratings on many deals have been slashed from high investment grade to deep junk territory. Kimball added that there is "hysteria" in the markets over the expected cumulative losses from subprime residential mortgages, but at the end of the day no-one really knows how large they will be, saying "it's a crapshoot," he told a conference organized by the New York Society of Security Analysts. "At the end of the day we'll make that call with due care," Kimball told the group.

The potential for a rating downgrade to drive an insurer out of business, and the potential knock-on effects from any possible downgrade require that care is made in reviewing the companies, Kimball added. Bond insurers are under review because ratings agencies argue that they do not have enough capital to hold the top "Aaa" ratings due to exposures to risky residential mortgages in their insurance portfolios.

Kimball said that rating agencies, like markets, have been susceptible to "group think," and "fashionable think." Had the rating agency stepped back from its analytical models and looked at residential mortgage backed securities with its gut feeling, it may have been better able to predict the market downfall, he added. "I have to believe we could have done better," he said.

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Moody's cuts SCA's rating

Moody's Investors Service cut its rating on Security Capital Assurance Ltd. (NYSE:SCA) on Thursday, imperiling the beleaguered bond insurer's prospects for new business and threatening the value of hundreds of billions of dollars in bonds. Moody's cut Security Capital Assurance's financial-strength rating to 'A3' from 'AAA.' The insurer's financial strength is now 'high quality,' whereas it was previously 'maximum safety.'

A bond insurer without top-caliber financial strength ratings will have trouble winning new business. Also, downgrades of a bond insurer are likely to drag the value of the bonds the company insures, because insured debt is only as safe as the reliability of its insurer. Security Capital Assurance, based in Bermuda, writes insurance policies promising to repay bondholders when borrowers miss payments on their bonds. Moody's said in order to cover the claims the company is likely to face, Security Capital needs $6 billion in 'claims-paying resources,' or cash it can access. The company only has access to $3.6 billion, Moody's said.

Moody's expects to issue a list of SCA-insured bonds the ratings agency will downgrade because the company's balance sheet is not as sound. Security Capital insures $150 billion in debt. After Fitch Ratings downgraded SCA, the ratings agency downgraded more than 37,500 bonds the company insures, including debt floated by government borrowers like the Bernards Township Board of Education in New Jersey and the Wayne County Public Library in Ohio.

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Exploding ARMs Roil Bernanke's Drive to Calm Markets

The estimated 1 million homeowners with $500 billion of option ARMs are beyond the help of interest-rate cuts by Federal Reserve Chairman Ben S. Bernanke. While subprime borrowers face an average increase of 8 percent or less when their adjustable- rate mortgages reset, option ARM homeowners may see their monthly payments double after their adjustments kick in.

"We call them neutron loans because they're like a neutron bomb," said Brock Davis, a broker with U.S. Express Mortgage Corp. in Las Vegas. "Three years later the house is still there and the people are gone." Once option ARM borrowers' loan balances reach a predetermined limit, called a negative amortization cap, usually 110 percent to 120 percent of the mortgage amount, their payment rates immediately increase. They also automatically shoot up after five years. Otherwise, increases typically are capped at 7.5 percent of a borrower's initial payment per year.

"These could be called long-fuse, exploding ARMs," said Kathleen Keest, former assistant Iowa attorney general and now senior policy counsel at the Center for Responsible Lending in Durham, North Carolina. "I've heard people say they are the most complicated product ever offered to consumers. They are the real liar loans." The loans accounted for 8.9 percent of the almost $3 trillion in U.S. home loans made in 2006, up from 8.3 percent in 2005, according to an estimate by industry newsletter Inside Mortgage Finance. Originations of option ARMs fell 50 percent during the first nine months of last year, the newsletter says.

One in five option ARMs packaged into bonds last year required less than 10 percent down payment and no proof of a borrower's income, according to a Jan. 22 report by New York- based analysts at UBS AG, Europe's largest bank by assets. Two percent required no down payment at all from the borrower, the analysts said. [..]

Delinquencies of more than 90 days on option ARMs increased to 5.7 percent in the fourth quarter from 0.6 percent in the same period of 2006 on loans held by Countrywide Financial Corp., the Calabasas, California-based company said in a regulatory filing last week. Lenders hold loans in their portfolios when they don't bundle them into securities for sale to investors.

Countrywide had $28.3 billion in option ARMs in portfolio at the end of October, according to Inside Mortgage Finance. The only banks with more were Charlotte, North Carolina-based Wachovia Corp., with $117.8 billion, and Seattle-based Washington Mutual Inc., with $57.9 billion, according to the Bethesda, Maryland-based newsletter. Option ARMs, which can adjust monthly, are more attractive for banks to keep in portfolios than fixed-rate loans because they adjust at the same time as savings accounts and other deposits used to fund the loans.

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Ilargi: The WallStreetExaminer reports on the proposals we covered yesterday, published in a NYT (yes that rag) op-ed, to let the US government (read: taxpayer) guarantee all subprime mortgages for 15 years, freeing up space for the banks to re-enter the happy lending cycle, while offloading the losses on those who don’t understand what’s about to happen.

Elites Float U.S. Bank Bailout Plans

The wretched scenario that I had reported on in the United Kingdom may be coming to America. If you even slightly care about this issue at all (and you should), you need to become politically involved. What the bankers are asking for is a bailout, and they will package it in the most populist way to get it passed. Or they will have it passed any way possible, much like they did the Federal Reserve Act or the income tax amendment.

I have already laid out the new public finance Ponzi scheme being proposed to reflate Britain and burden its subjects. You may want to familiarize yourself with that post before you continue further. I’ll give you a minute…..

The Anglo-American alliance has set the rules of global finance for close to 200 years. Okay, maybe in the early part of the 19th century, the American part was useless. British capital funded the expansion of American capitalism. The Anglo-American alliance also aided Britain’s attempts to return to the gold standard after World War I, and they planned the passing of the torch from the pound to the dollar as the world’s reserve currency after World War II.

Many won’t believe the fact that although many countries participated in Bretton Woods, it was these two countries that laid out the architectural blueprint that everyone else had no choice but to accept in 1945. It should be no surprise that the actions being undertaken in Britain to deal with the credit bubble crisis is now going to get its hard sell here, as this nexus has usually planned the most important phases of the global financial system together.[..]

Do you know what guaranteeing the principal of mortgages in this environment means? It means the government is effectively paying the mortgage principal because so many people will default anyway regardless of rate resets. The price of homes is falling and that is enough to induce people to quit their payments, saddling the U.S. taxpayer with an absurd amount of debt guaranteed by current and future generations of Americans. If you want to see an unintended dollar collapse, this would be it.

This is being sold as for the benefit of the banks and homeowners and the economy of course; in reality, it is simply the socialization of private risk. Global capital has manipulated every political and economic system to ensure that it either gets repaid by the original borrower or gets reimbursed by someone else. It once was that foreign capital bullied Third World countries through puppet institutions like the IMF and World Bank, but foreign capital has its bullseye squared right on the globe’s biggest debtor nation. The op-ed’s author implies that the situation could be dire if foreign capital were to stage a full-scale strike of U.S. debt, which would cripple the Wall Street-controlled global finance monster:

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FDIC Chairperson Bair: "Housing Crisis Has Just Begun"

I know everyone out there, builders and Realtors included, constantly cry that it’s we in the media who are forever sounding unnecessary alarms in the housing market. Well, I don’t know that I can do much better than the Chairperson of the FDIC, Sheila Bair, who is telling a Senate Banking Committee panel today that the mortgage crisis has only just begun.

Bair says: :"foreclosures continue at an unacceptably high level while true loan modifications are lagging", but that’s just the tip of the iceberg. She also warns that in 2009, $600 billion worth of prime borrowers will see their “non-traditional” mortgages reset, and many won’t be able to find the cash.
Bair has been calling for a systematic, rather than individual, approach to loan modifications, but by warning about prime borrowers, it feels like she’s now bringing in the big guns.

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The Bush Financial Bust of 2008: "It's All Downhill From Here, Folks"

On January 14, 2008 the FDIC web site began posting the rules for reimbursing depositors in the event of a bank failure. The Federal Deposit Insurance Corporation (FDIC) is required to “determine the total insured amount for each depositor....as of the day of the failure” and return their money as quickly as possible. The agency is “modernizing its current business processes and procedures for determining deposit insurance coverage in the event of a failure of one of the largest insured depository institutions.”

The implication is clear, the FDIC has begun the “death watch” on the many banks which are currently drowning in their own red ink. The problem for the FDIC is that it has never supervised a bank failure which exceeded 175,000 accounts. So the impending financial tsunami is likely to be a crash-course in crisis management. Today some of the larger banks have more than 50 million depositors, which will make the FDIC's job nearly impossible. Good luck.

It's worth noting that, due to a rule change by Congress in 1991, the FDIC is now required to use “the least costly transaction when dealing with a troubled bank. The FDIC won't reimburse uninsured depositors if it means increasing the loss to the deposit insurance fund....As a result, uninsured depositors are protected only if a bank acquiring the failed bank will pay more for all of the deposits than it would for insured deposits only.” (MarketWatch) Great. That's reassuring. And there's more, too. FDIC Chairman Shiela Bair warned that “as of Sept. 30, there were 65 institutions with assets of $18.5 billion on its list of "problem" institutions;” although she wouldn't give names.

So, what does it all mean? It means there's going to be an unprecedented wave of bank closures in the US and that people who want to hold on to their life savings are going have to be extra vigilant as the situation continues to deteriorate. And it is deteriorating very quickly. Right now, many of the country's largest investment banks are holding $500 billion in mortgage-backed securities and other structured investments that are steadily depreciating in value. As these assets wear-away the banks' capital, the likelihood of default becomes greater. This week, Fitch Ratings announced that it will (probably) cut ratings on the 5 main bond insurers (Ambac, MBIA, FGIC, CIFG,SCA) “regardless of their capital levels”.

This seemingly innocuous statement has roiled markets and put Wall Street in a panic. If the bond insurers lose their AAA rating (on an estimated $2.4 trillion of bonds) then the banks could lose another $70 billion in downgraded assets. That would increase their losses from the credit crunch--which began in August 2007---to $200 billion with no end in sight. It would also impair their ability to issue loans to even credit worthy customers which will further dampen growth in the larger economy.

Structured investments have been the banks' “cash cow” for nearly a decade, but, suddenly, the trend has shifted into reverse. Revenue streams have dried up and capital is being destroyed at an accelerating pace. The $2 trillion market for collateralized debt obligations (CDOs) is virtually frozen leaving horrendous debts that will have to be written-down leaving the banks' either deeply scarred or insolvent. It's a mess.

MSN Money's financial analyst Jim Jubak summed it up like this:

"Actually, I'm worried not so much about the junk-bond market itself as the huge market for a derivative called a credit-default swap, or CDS, built on top of that junk-bond market. Credit-default swaps are a kind of insurance against default, arranged between two parties. One party, the seller, agrees to pay the face value of the policy in case of a default by a specific company. The buyer pays a premium, a fee, to the seller for that protection.

This has grown to be a huge market: The total value of all CDS contracts is something like $450 trillion..... Some studies have put the real credit risk at just 6% of the total, or about $27 trillion. That puts the CDS market at somewhere between two and six times the size of the U.S. economy.

All it will take in the CDS market is enough buyers and sellers deciding they can't rely on this insurance anymore for junk-bond prices to tumble and for companies to find it very expensive or impossible to raise money in this market."

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Financial Crisis: Asset Securitization - The Last Tango

Endgame: Unregulated Private Money Creation
What had emerged going into the new millennium after the 1999 repeal of Glass-Steagall was an awesome transformation of American credit markets into what was soon to become the world’s greatest unregulated private money creation machine.

The New Finance was built on an incestuous, interlocking, if informal, cartel of players, all reading from the script written by Alan Greenspan and his friends at J.P. Morgan, Citigroup, Goldman Sachs, and the other major financial houses of New York. Securitization was going to secure a "new" American Century and its financial domination, as its creators clearly believed on the eve of the millennium. Key to the revolution in finance in addition to the unabashed backing of the Greenspan Fed, was the complicity of the Executive, Legislative and Judicial branches of the US Government right to the Supreme Court. In addition, to make the game work seamlessly, it required the active complicity of the two leading credit agencies in the world—Moody’s and Standard & Poors.

It required a Congress and Executive branch that would repeatedly reject rational appeals to regulate over-the-counter financial derivatives, bank-owned or financed hedge funds or any of the myriad steps to remove supervision, control, transparency that had been painstakingly built up over the previous century or more. It required that the major government-certified rating agencies give their credit AAA imprimatur to a tiny handful of poorly regulated insurance companies called Monolines, all based in New York. The monolines were another essential part of the New Finance. The interlinks and consensus behind the massive expansion of securitization among all these institutional players was so clear and pervasive it might have been incorporated as America New Finance Inc. and its shares sold over NASDAQ.[..]

The dubious revenue streams from sub-prime mortgages and similar low quality loans, once bundled into the new Collateralized Mortgage Obligations or similar securities, then often got an injection of Monoline insurance, a kind of financial Viagra for junk quality mortgages such as the NINA (No Income, No Assets) or "Liars’ Loans," or so-called stated-income loans, that were commonplace during the colossal Greenspan Real Estate economy up until July 2007.

According to the Mortgage Brokers’ Association for Responsible Lending, a consumer protection group, by 2006 Liars’ Loans were a staggering 62% of all USA mortgage originations. In one independent sampling audit of stated-income mortgage loans in Virginia in 2006, the auditors found, based on IRS records that almost 60% of the stated-income loans were exaggerated by more than 50%. Those stated-income chickens are now coming home to roost or far worse. The default rates on those Liars’ Loans, which is now sweeping across the entire US real estate market, makes the waste problems of Tyson Foods factory chicken farms look like a wonderland.

None of that would have been possible without securitization, without the full backing of the Greenspan Fed, without the repeal of Glass-Steagall, without monoline insurance, without the collusion of the major rating agencies, and the selling on of that risk by the mortgage-originating banks to underwriters who bundled them, rated and insured them as all AAA.

In fact the Greenspan New Finance revolution literally opened the floodgates to fraud on every level from home mortgage brokers to lending agencies to Wall Street and London securitization banks to the credit rating agencies. Leaving oversight of the new securitized assets, hundreds of billions of dollars worth of them, to private "self-regulation" between issuing banks like Bear Stearns, Merrill Lynch or Citigroup and their rating agencies, was tantamount to pouring water on a drowning man.

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Cohrs, Jain Say 'Nein' to 'Sprechen Sie Deutsch?' Avoiding Loss

Deutsche Bank AG, Germany's biggest bank, got almost half of its profit last year from a pair of executives who don't even speak German. The investment-banking unit run by London-based Anshu Jain and Michael Cohrs earned 447 million euros ($647 million) before taxes in the fourth quarter, the worst quarter ever for the securities industry. Jain, 45, and Cohrs, 51, scaled back Deutsche Bank's holdings of debt securities infected by the subprime crisis and traded against Wall Street rivals who bet on a recovery in the U.S. housing market.

"The subprime crisis and its effects had considerably less impact on Deutsche Bank than on many of our international peers," Chief Executive Officer Josef Ackermann said in a speech in Frankfurt yesterday after announcing that profit fell 48 percent, less than expected, to 953 million euros.

Jaipur, India-born Jain runs debt and equity sales and trading, the company's biggest source of revenue, while Cohrs, an American and former Goldman Sachs Group Inc. banker, oversees corporate finance. Together they increased their share of fees paid to the biggest investment banks by 50 percent last year, data compiled by Bloomberg show. At the same time, the worst U.S. housing market in a quarter century led to more than $145 billion of subprime-mortgage-related losses and markdowns at competitors.

Unlike Zurich-based UBS AG and Citigroup Inc., the largest banks in Europe and the U.S., Deutsche Bank reported no net writedowns from debt holdings in the fourth quarter and marked down only 44 million euros on loans for leveraged buyouts. Charges of 2.3 billion euros for the year compare with about $18.4 billion at UBS, $22.1 billion at Citigroup and $24.5 billion at Merrill Lynch & Co., the biggest U.S. brokerage.

"In the wake of UBS's calamitous results, and compared with many European and U.S. competitors, this is a remarkable outcome," said Simon Adamson, a financial services analyst at CreditSights Inc. in London.

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Kerviel Haunts Credit Agricole, HSBC and Toronto-Dominion Too

The more people ask how Societe Generale SA's Jerome Kerviel made bets that led to a 4.9 billion-euro ($7.1 billion) trading loss without his bosses' knowledge, the more they are learning about other Kerviels who haunt trading floors from New York to London to Johannesburg to Stockholm. Credit Agricole SA said in September an unauthorized proprietary trade at its investment bank in New York cost the company 250 million euros. The same month, Swedish regulators fined D. Carnegie & Co., a Stockholm-based investment bank, for failing to exercise proper control over three traders who inflated portfolios by 630 million kronor ($98 million).

"What happened with SocGen is of an extraordinary size, but it's not extraordinary in nature," said Angela Hayes, who heads the financial services group at law firm Lawrence Graham LLP in London. "If there is more money to be made then people are more likely to indulge in that sort of behavior." The five biggest Wall Street firms paid an estimated $39.3 billion in bonuses for 2007, up from $19.8 billion in 2003. Kerviel told police he was expecting a 300,000-euro bonus for 2007 as he amassed trades worth 50 billion euros in January. Liquidating the positions led to a net trading loss that was five times the $1.4 billion of losses by Nick Leeson that brought down Barings Plc in 1995.

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Ilargi: Hilarious, the infamous "rogue trader" made so much profit that he felt obliged to lose it.

Kerviel accused of €1.4bn profit cover-up

Jérôme Kerviel, the man accused of masterminding a record rogue trading loss, was caught in the process of trying to cover up a hidden €1.4bn ($2bn) profit he made for Société Générale last year, people involved in the French bank’s inquiry said. Financial Times interviews with SocGen executives, board members, investigators and rival bankers found that Mr Kerviel delayed the settlement date on the profitable trades to stop the bank receiving a surprise €1.4bn gain that would have exposed him. The 31-year-old trader, who rose through the ranks at SocGen to reach its prestigious equity derivatives trading floor in 2005, made bigger and ultimately loss-making trades in early January that the bank suspects were designed to cover up his earlier profit.

“His trading early this year was possibly to hide the previous gain,” François Martineau, SocGen’s lawyer, told the FT.
Mr Kerviel’s decision to delay the payment of a €1.4bn profit – worth about half the profits of the entire investment bank – shows how his complex and increasingly frantic system of hidden but colossal bets on European stock markets was coming undone. “Maybe he was trying to lose the profit he made in 2007,” said Jean-Marie Mustier, SocGen’s head of investment banking, who questioned Mr Kerviel for nine hours with a team of 15 staff soon after his secret trades were discovered

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Kerviel Placed in Custody as Second Trader Questioned

French judges placed Jerome Kerviel, who is accused of causing a 4.9 billion-euro ($7.2 billion) trading loss at Societe Generale SA, in custody as police questioned an employee of futures brokerage Fimat. Prosecutors challenged a decision by investigating magistrates to release Kerviel, 31, following a 48-hour detention for questioning last month. Kerviel will appeal today's ruling, his lawyer said. "I don't know what the motivation was," Kerviel's lawyer, Elisabeth Meyer, said. "I can't explain it, nothing has changed."

Societe Generale, France's second-largest bank, said last month that it discovered Kerviel's unauthorized bets on Jan. 18 and unwound them all by Jan. 23, resulting in the biggest trading loss in banking history. If he remained free, Kerviel might tamper with evidence or witnesses and was a flight risk, prosecutors said. The police questioning of the second trader follows a raid yesterday on Fimat's headquarters, Isabelle Montagne, a spokeswoman for the Paris prosecutors' office said. The man was identified as Moussa Bakir by the office of his lawyer, Jean- David Scemama.

Fimat, owned by Societe Generale, merged last month with Credit Agricole SA's futures brokerage to form a new company, Newedge. Societe Generale's lawyer Jean Veil said the questioning of the new suspect cast doubt on Kerviel's assertion that he acted alone. "The court was astounded by the accumulation of lies” from Kerviel, Veil said.

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Bear Stearns Makes $1 Billion Bet on Subprime Market Decline

Bear Stearns Cos., the U.S. securities firm that posted its first-ever loss last quarter on mortgage writedowns, is betting more than $1 billion that subprime home loans and bonds will continue to decline.

The wager, a "short" position on subprime mortgage securities, was increased from $600 million at the end of November, Chief Financial Officer Sam Molinaro said today at an investor conference in Naples, Florida. The company also reduced its holdings of so-called collateralized debt obligations and underlying bonds, Molinaro said.

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