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.
`Played With Fire’
“I knew that if they played with fire long enough, they were going to get burned,” says Fraser, 66.
He left the company in 2001 over a dispute with the board about insuring CDOs, he says. Back then, it was debt of Enron Corp. and WorldCom Inc. — companies that later filed the two largest bankruptcies in U.S. history — that was being shoveled into CDOs.
“Companies that were having problems or were growing very fast began to turn up in all the deals ACA was offered,” says Fraser, who moved to Wyoming to run a 12,000-acre (4,856- hectare) ranch and turn a ghost town into a museum of the Old West.
Fraser, who first rated MBIA and Ambac in the 1970s as an analyst at S&P and later helped turn Fitch into one of the three major rating companies, says that while ACA’s original mission had been to help finance projects such as nursing homes and rural hospitals, the board didn’t want to allocate the capital needed to insure riskier municipal bonds.
Credit Default Swaps
Backing CDOs with credit-default-swap contracts was more alluring, Fraser says. Credit-default swaps are financial instruments based on bonds and loans that are used to speculate on a borrower’s ability to repay debt. They pay the buyer face value in exchange for the underlying securities or the cash equivalent should the borrower fail to adhere to its debt agreements.
By using swaps, ACA wasn’t limited to guaranteeing only securities with a lower credit rating than its own. It could compete with AAA-rated insurers to back top-rated CDOs while having to maintain less capital than the triple-A companies. The top-rated insurers collected annual premiums for insuring CDOs with swaps that were 50 percent of the capital the rating companies required them to maintain, S&P said in a July 2007 overview of the bond insurance industry. ACA was scooping up premiums that were 130 percent of its required capital.
`Very Low Risk’
“ACA has had good success assuming exposure to very low risk supersenior CDO tranches, where the goal of the counterparty is risk transfer and the associated mark-to-market relief,” S&P said.
By December, after S&P completed a “stress test,” it projected more than $3 billion of losses on those low-risk securities. Alan Roseman, ACA’s CEO, didn’t return a voice mail message seeking comment.”