20 December 2007

Monoliners Heading for a Crash?

This post is kind of an extension of my previous post about ACA and MBIA.

First, a definition, care of The Daily Telegraph:
Monoliners are specialist insurers who earn fees by lending their AAA ratings to US states, counties, and cities for bond issues - the safest corner of the credit industry.

The nasty twist is that most have ventured into mortgage debt to spice returns. They now face enough losses to threaten their AAA standing.

A downgrade means that every bond bearing their guarantee must be downgraded pari passu. Pension funds and institutions will be forced to liquidate sub-AAA holdings. A fresh cascade of distress sales will ravage the $2,400bn 'muni' market.

The unthinkable now looms. Moody's said it was "somewhat likely" that top insurer MBIA would fall below the AAA capital requirement: Fitch warns of a "high probability" that CIFG Guaranty and Financial Guaranty will be placed on negative watch.
Does this sound familiar? It does to me.

Remember the people who were renting their credit to people with poor credit so that they could qualify for loans? It got shut down 6-12 months ago by all the major credit report agencies.

This is pretty much the same, only multiplied by about 100 million.

As Nouriel Roubiniputs it:
The forest issues is simple: a business – the monoliners’ insurance of securities and holding of risky ABS securities – that is fundamentally based on having a AAA rating is a business that does not deserve a AAA rating in the first place: it is clear to all that if a monoliner were to lose its AAA rating the essence of its business model would fail and such monoliner would have to close shop. But in any industry you have firms that can do business and thrive with an AA or A or even lower rating, even among major financial institutions. Here we have instead an industry that would go bankrupt as soon as its AAA rating is lost: by definition this is not an industry that can deserve a AAA rating. So the issue is not one of how sound these monoliners are managed or whether they have enough capital or whether they can raise new capital to maintain their AAA status. There is a fundamental and conceptual flaw in a business model that is conditional on a AAA rating and that is in a business that insures assets and firms that do not have a AAA rating. This is analogue to the voodoo finance of taking subprime and BBB mortgage backed securities and turning them into AAA by the black magic of CDO tranching.
This is not as the good Doctor Roubini admits, a painless process. This would involve losses in excess of $200 billion, but it is clear that this is a fraudulent practice, and the fact that the ratings agencies are giving these folks time to raise capital before a downgrade is merely supporting a "rotten business model".


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