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The received wisdom here at FT Alphaville was that when serious trouble hit the monoline insurers - drawing downgrades by the major rating agencies - it was time to shut up shop and head to somewhere like Mozambique.

Monoline insurers are the financial guarantee companies that - ahem - underpin the actual structures of CDOs and other asset-backed securities. It is widely assumed that if it proved that these firms could not honour their commitments, then many holders of the underlying securities would become automatic, fire-sale sellers. Cue structured-oblivion
Well, it’s happened!

But, so far, it’s only at the thin end of asset-backed wedge. And, early-afternoon Wall Street time, the financial world seemed to be taking this latest (albeit ominous) development in its collective stride.

S&P declared on Wednesday:

Standard & Poor’s Ratings Services today announced various ratings actions on six financial guaranty insurance companies.

The rating actions were prompted by worsening expectations for the performance of insured nonprime residential mortgage backed securities and CDOs of asset backed securities. Based upon current stress test analysis, the details of which are being published simultaneously with this release, the affected companies may experience claims and/or capital consumptive negative rating transitions such that their capital resources may no longer be sufficient at their respective rating levels. Another consideration in the analysis, if there is a capital shortfall, is the magnitude of the shortfall and the extent to which the company has raised or is planning to raise new capital, and the viability of that capital plan.

One small name gets it in the neck immediately - ACA Financial Guaranty Corp - which has been moved from “A/WatchNeg” to CCC/WatchDev. In one swipe. Goodbye ACA.

Five other firms get serious warning shots, moving from “stable” outlooks to various levels of “negative” and “WatchNeg” labelling, namely: Connie Lee Insurance, Ambac (two units),  Financial Guaranty Insurance, FGIC (two units),  MBIA (four units), and XL Financial Assurance (two units).

Firms untouched by this action are:  Assured Guaranty, CIFG, Financial Security Assurance, and Radian. Separately, PMI Guaranty remains on “negative.”
So what happens now?  Well, the Calculated Risk blog has been running some insightful stuff on the subject, and there’s a good Bloomberg story here. Here’s a Gillian Tett column on this pending disaster, and also a handy guide on how the monoline market works.

Having been cut by 12 rating notches today, ACA needs capital - and fast. According to the New York Times, both Bear Stearns and Merrill Lynch are in talks to bail the company out. But that doesn’t provide us with immediate comfort. As of end June, ACA had sold protection to 31 counterparties through CDS structures on $61bn of securities.

Yes, that’s $61bn - and ACA is a tiddler in monoline terms.

Since banks used these swap arrangements to off-load risk - and avoid marking assets to market - we’d guess the risk is headed back towards the big, former bulge-bracket names.