Perhaps a little perspective is needed, bond insurer-wise.
Markets don’t seem to know how to react. It’s pretty clear that as far as trading monolines goes, equity investors are in hock to whatever the latest headline is. The WSJ’s Market Beat blog has a useful timeline here.
First up, Yves Smith at Naked Capitalism points us in the direction of a new scenario, which emerged Monday this week, via Morgan Stanley’s credit analysts: Downgrades might well come, but the consequent losses for banks might be negligable - between $5bn-$7bn.
We don’t see how MS figures’ can be the case. Take, for example, bond insurer ACA. Unlike some other monolines, ACA was required to post collateral against its insurance contracts in the event of a downgrade. It couldn’t manage that, and is on death row consequently - awaiting a declaration of insolvency, or a massive bailout. ACA has hedging agreements on $6.6bn of CDO paper with Merrill Lynch. That’s not reported in Merrill’s headline figures - which are all net of such hedges. If ACA goes bust, the contracts will, of course, be worthless, and Merrill alone will be instantly exposed to $6.6bn more of CDOs. ACA has another $55bn of such contracts with other banks.
Standard & Poor’s bore out that point on Tuesday, when they estimated banks had around $125bn of such CDO hedges with monolines in place. Morgan Stanley’s analysis looks optimistic then.
And S&P’s figure doesn’t even take into account the potential price crashes on the hundreds of thousands of other vanilla bonds monolines insure. Fitch, for example, put 172,168 muni bonds on ratings watch on Tuesday in line with its deteriorating outlook for MBIA.
Fitch indeed, leads the rating agency pack. Hat tip to Calculated Risk for pointing us in the direction of this Fitch statement - also on Tuesday:
Fitch believes that a sharp increase in expected losses would be especially problematic for the ratings of financial guarantors — even more problematic than the previously discussed increases in ‘AAA’ capital guidelines, which has been the primary focus of recent analysis of the industry. Expected losses reflect an estimate of future claims that Fitch believes would ultimately need to be paid by a guarantor. A material increase in claim payments would be inconsistent with ‘AAA’ ratings standards for financial guarantors, and could potentially call into question the appropriateness of ‘AAA’ ratings for those affected companies, regardless of their ultimate capital levels.
All of which makes talk of a bailout look premature. Banks are, of course, afraid of the Warburg Pincus/MBIA scenario - commiting money (at a time when they can’t afford to) to a black hole. Only the Europeans appear keen to assist. For Wall Street, better the CDOs you know, apparently. Whether that’s a wise strategy or not…
As is fast becoming the rule, the only people who seem to know what they’re doing are the hedge funds. Our money is still with Bill Ackman.
