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Monday, February 25, 2008

Monoline Bailouts: The Great Circle Jerk

On Friday, 15 minutes before the close CNBC’s Gasparino came on the air with ‘BREAKING NEWS’… right after these messages of course. He then proceeded to explain how a rescue package for Ambac may well be announced over the weekend, OR Monday OR Tuesday BUT that ‘it could still fall apart’. Either way, the shorts didn’t stick around to find out with only 15 minutes to the close and all that weekend headline risk. Equities went bid and peeled off the lows to close at the highs of the day.

Talk about meticulous timing. Fannie Mae (FNM) and Freddie Mac (FMC) were just downgraded in the morning. (In Fannie Mae, Freddie Mac ‘Closed The Gap’, Florida Screwed, I presented their charts predicted the price action that came to pass.)

Fannie Mae, Freddie Fall After Merrill Says `Sell' (Update2): “Fannie Mae and Freddie Mac fell in New York trading after Merrill Lynch & Co. analysts said the housing and debt market slumps will stifle earnings at the mortgage-finance companies through 2011.

The companies, which own or guarantee about 45 percent of the $11.5 trillion in U.S. residential mortgages outstanding, may need to raise more money to cope with loan defaults, the analysts wrote in a report today. Fannie Mae and Freddie Mac reported $3.4 billion in combined third-quarter losses and are expected next week to report similar results for the fourth-quarter.”

Then with equities at a critical support level, just about ready to slide into the abyss, (prices were below 1330 on the S&P) Gasparino’s cell rang and he was able to get the ‘good news’ out just before the close? How much you do you want to bet they had that story before the open on Friday with instructions to spill it just before the close? Nice setup though. Nice trap. Well played.

Ambac Rises as Banks Plan $3 Billion Rescue to Avert Downgrade: “Ambac Financial Group Inc. rose to the highest in a month on investor expectations the bond insurer may be rescued from crippling credit-rating downgrades by getting $3 billion in new capital.

Ambac, the second-biggest bond insurer after MBIA Inc., may announce an agreement this week, according to a person with knowledge of the discussions who declined to be named because the details aren't complete. The New York-based company plans to raise $2.5 billion by selling stock at a discount to existing shareholders and $500 million from issuing debt, the Wall Street Journal reported today, citing people familiar with the matter.”

First of all, $3 billion is nothing but a delaying tactic.

From The Big Picture: “The current rescue operation is for but $3B. This small sum is intriguing -- not just relative to the prior rumors. First, the duolines have potential exposure anywhere from $30 to $75 billion dollars. On top of that, the bank's counterparty and hedging exposure has been estimated at $150B to $200B. Can $3B really solve the problem?”

“Citigroup Inc. and seven other banks are working with Ambac to prevent rating cuts that would throw doubt on the credit quality of the $553 billion of municipal and asset-backed securities it guarantees. Banks stand to lose as much as $70 billion from any downgrades to Ambac, MBIA Inc. and FGIC Corp., Oppenheimer & Co. analysts estimated.”

Second the banks involved in the rescue package are the ones that would be hurt most by a monoline credit downgrade. These clowns would have the most to lose.

“New York Insurance Superintendent Eric Dinallo last month arranged a meeting with banks to help avoid a downgrade of the bond insurers. Dinallo told a congressional hearing this month that the companies may be forced to separate their municipal insurance business from their asset-backed guarantees.

Banks face losses from any rating cuts because they bought bond insurance to hedge the risks of collateralized debt obligations and other asset-backed securities that are now tumbling in value. CDOs package pools of securities then split them into pieces with different ratings.

UBS AG, Royal Bank of Scotland Group Plc, Wachovia Corp., Barclays Plc, Societe Generale SA 9, BNP Paribas SA and Dresdner Bank AG were also involved in the group discussing a rescue, said the person.”

So let me get this straight: The monolines wrote BAD insurance. They basically under priced it because they misunderstood the RISKS. Therefore, they will take a hit on this BAD insurance. That can’t be helped. However, the hit would be so large it would be FATAL. The monolines would blow throw so much of their capital paying these claims that they would get DOWNGRADED and lose their TRIPLE ‘A’ rating. Some of the weaker monolines have ALREADY gone BANKRUPT.

Those financial institutions who have purchased this BAD insurance would have to write their insured holdings down to MARKET, because the insurance would be WORTHLESS.

So, in a bid to avoid this, the very financial institutions that have purchased this BAD insurance, are going to BAIL OUT the monolines. In this case Ambac. But all the monolines are swirling the drain with bailout rumours hovering like dirty vultures. Suppose this seven bank consortium does follow through on the bailout. They would inject capital into Ambac. Then when the insurance claims are triggered they would go back to Ambac and literally take their OWN MONEY BACK.

This would suck the capital right back out of Ambac and the result would be a write down in the value of their investments in Ambac.

This is just one massive, zero sum, circle jerk. You see, the insurance written was BAD. The lossess WILL be taken. They CANNOT be avoided. Bailout or not. Its just a matter of how and when. Propping up the monolines would just CHANGE and POSTPONE the write-down… but not necessarily their size. Ultimately, their will still be write-downs.

Related Headlines:
Auction-Rate Bonds Force `Predatory' Yields on Cities (Update3)
Recession in U.S. More Likely in 2008, Economists' Survey Finds

Related Posts:
The Monolines: Such A Slow Death
Fannie Mae, Freddie Mac ‘Closed The Gap’, Florida Screwed


ams5995 said...

video of bill ackman discussing MBIA. kind of interesting.

ams5995 said...

perhaps this is why Warren Buffet is getting into the bond insurance business. He sees opportunity knocking.

Ben Bittrolff said...


Buffet does indeed see opportunity and he's taking advantage of it... in the Municipal Bond market.

Remember, that was the original bread and butter of the 'monolines'. Hence the name. Mono. Single. One. They only insured low risk 'muni' bonds. Then they got greedy for 'easy money' and became 'multi-lines'. They insured derivatives such as CDOs etc. Thats the side of the business that's in trouble. That's the side taking down entire complex.

You don't see Buffet getting into that crap.

Anonymous said...

Nice work Ben,

Does it count as a capital infusion when the banks consortium is simply back-stopping a $2.5 billion equity and $.5 billion debt offering?

ams5995 said...

financial ninja. thankyou for sharing your knowledge.

Ben Bittrolff said...


Simply backstopping the offer is the cowards way out. It practically screams, "Oh dear god, please don't make me take this risk." The banks are really really hoping they won't have to pony up the bling themselves. They are definately looking for suckers. (Never forget, if it really was a good deal, a no brainer, they'd charge in there themselves and leave nothing for you. Not even the crumbs.)

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