Check VIDEO page: Flashback to Ambac CEO telling us Ambac is very safe, its portfolio in very good shape, all AAA

Effect of downgrading monoline on the underlying municipal bond securities

This is a big issue, and Moody’s tried to explain.  A municipal security apparently will then carry whichever rating is higher (its own or the monoline).

“If a security is wrapped by a financial guarantor, and has a published underlying rating that is higher than the guarantor’s rating, what is the Moody’s rating on the security?

A: The Moody’s rating is the higher of (i) the guarantor’s financial strength rating and (ii) any published underlying rating (i.e., absent consideration of the guaranty) on the security. For US municipal securities, we also consider any enhanced rating based on a state credit enhancement program. For structured finance securities, we also consider any published rating on a pari passu (i.e., at the same level of seniority) non-sequential tranche or more junior tranche of the same transaction.”  Read the entire Moody’s explanation on the Bond insurers/monolines page.

How to fix the bond insurer/monoline mess

We all know the monolines (bond insurers) are a huge mess.  Although they insure massive amounts of debt, they themselves appear to lack the assets to honor those obligations. How best to fix this mess? 

Bill Ackman’s recent presentation is highly recommended reading.  It has an A to Z analysis of how the bond insurers do business, financial condition, and — go to page 134 of his analysis — a very cogent outline of how the scenario will play out.  Spoiler:  he says downgrades, bankruptcy, receivership.

Here it is:  howtosavethebondinsurers.pdf

Criminal immunity granted to firm that did due dilgence for $1 trillion in subprime mortgages

Clayton Holdings, the largest provider of due diligence review of mortgages for the major mortgage bankers, has been given immunity by NY Attorney General Cuomo.  It appears from this news that the mortgage bankers wanted the due diligence reviews to find fewer “lending exceptions” in the subprime loans than actually existed.  It is suggested that the actual figure is 50%-80% of the loans had lending exceptions.  The due diligence reviews may have been limited to small numbers of loans within the portfolios, so that when the loans were bundled and securitized they would appear to be higher quality credits than they actually were. 

This is interesting for a number of reasons, including the question of the rating agencies’ culpability and the monolines’ liability.  Read the NY Times  story here:

Future of monolines irreparably destroyed? Ackman to Moodys: How do you justify giving Triple A ratings?

From Goode Value Investing  http://www.goodevalue.com/2008/01/22/bill-ackmans-letter-to-rating-agencies-regarding-bond-insurers/:  Bill Ackman is apparently asking the ratings companies the questions we all want answered.  It’s an excellent letter with a concise explanation of the facts, and the consequences of the facts.  The letter observes it is unlikely that MBIA, Ambac and other insurers will be able to continue as going concerns. Finally, the letter asks the ultimate question:  When the rating companies look at themselves in the mirror, how can they possibly say that MBIA and others deserve their highest (Triple A) rating? 

Here is text of the letter: 
January 18, 2008

Mr. Raymond McDaniel Mr. Stephen Joynt
Executive Chairman and CEO CEO and President
Moody’s Corp. Fitch Ratings
99 Church St. One State Street Plaza
New York, NY 10007 New York, NY 10004

Mr. Deven Sharma
President
Standard & Poor’s
55 Water Street
New York, NY 10041

Re: Bond Insurer Ratings

Ladies and Gentlemen:

As a Nationally Recognized Statistical Rating Organization, Moody’s, S&P, and Fitch
have been granted a level of authority that capital market participants and Federal and
State regulators have historically relied upon in evaluating the safety and soundness of
corporations, regulated financial institutions, and structured finance securities. To state
the obvious, because of your critical role in the capital markets, it is essential that the
ratings you publish are the result of comprehensive and accurate analysis.

Greedy monolines knew what they were doing – who should bail them out for playing with fire?

It’s no secret anymore that the monolines really don’t have the wherewithal to properly “insure” credit derivatives such as CDOs.  And the first hand evidence is piling in that the monolines apparently knew all along what they were doing — and kept right on “insuring” CDOs and other junky derivatives.  Why?  Profit, of course.  Where did all that money go?  Wherever it went, it’s high time for someone to go and get it back. 

My idea:  let the ratings companies (Fitch, Standard & Poors, et al.) who bestowed AAA ratings to this mess.  Perhaps they should disgorge all the revenue they collected as a result.  Seems as if they were unjustly enriched at the expense of …. all of us?

So – who spilled the beans?  Well, for one, former ACA Capital honcho (now literally put out to pasture?) as quoted at length in Bloomberg:

“Municipal bond insurers such as MBIA Inc. and Ambac Financial Group Inc. had a good thing going.  For years, they earned some of the highest profit margins in any industry — by writing coverage for securities sold by states and cities to build roads, schools and firehouses. 

Is your pension fund invested in credit derivatives?

This is the nightmare scenario:  pension funds invested in CDOs and/or other derivatives are swamped by the massive unwinding process underway.   Where then does the money come from to pay retirees? 

This great unwinding has potential consequences not only for U.S. pensioners, but certainly the U.K. and possibly beyond.  Here is a terrific and concise explanation of the relationship between CDO downgrades and U.K. pension funds by Ken Griffin and Jeff Moskowitz:

China hit by subprime credit crisis

* Chinese bank earnings will suffer because of subprime crisis and tighter monetary policy and macro-economic controls

* Chinese regulators and banks are studying the credit crisis

* Beijing expects bad loans may rebound this year (Adds comments from China’s banking regulator)

By George Chen

SHANGHAI, Jan 21 (Reuters) – Earnings at Chinese banks will probably be hit this year by the snowballing U.S. subprime mortgage crisis and Beijing’s moves to cool the economy, the president of the country’s sixth-biggest bank said on Monday.

“We have to be very realistic: we are facing many challenges this year which are not only from home but also abroad,” China Merchants Bank Co  President Ma Weihua told Reuters in an interview.

The bank, China’s biggest non-state lender, made some U.S. subprime-related investments in 2004 and sold them two years later for 13.4 percent returns.

But the country’s bigger, state-owned banks could suffer.

What will be real-life effects of monoline downgrades?

Monolines are in deep trouble.  That’s not news -  well-covered by FT Alphaville, Calculated Risk, Reggie Middleton, and Mish’s. 

 FT Alphaville notes today:

In a credit note sent out to clients on Friday, RBS started to outline what it thought was on the horizon for the monolines:

Institutions well aware of CDO meltdown risks

The risks of CDO meltdowns have been well-recognized for at least the last decade.  CDOs are necessarily dependent on the underlying collateral portfolio because CDOs necessarily separate the performance of the issuing bank from the performance of the issued notes.  The inherent risks of CDO nonperformance have long been known and discussed.  In her November, 1998 analysis, Karen Spinner gives an exceptionally cogent listing and explanation of these risks.  For example, Model Risk dictates that the investor consider the possibility that the rating agency’s models “may not bee 100% accurate.”  Liquidity Risk means that it is hard for an issuer to unwind a closed CDO structure. 

Her excellent piece is entitled “CDOs Under Fire – What will happen to CDOs if credit fears paralyze financial markets?”.  Too bad more institutional investors and other players apparently did not pay enough attention here.  Apparently the credit fears have now virtually paralyzed the financial markets and we’ll have to observe the actual consequences to these derivative instruments. 

Link to Spinner piece here:

http://www.derivativesstrategy.com/magazine/archive/1998/1198fea1.asp