Economic Amrageddon - Bond Insurers About To Default

Discussion in 'Economics' started by Trendytrader, Dec 20, 2007.

  1. Looks like the investment banks may fall like dominoes. The insurance on their defaulting CDOs is worthless when the insurer is going under! MBIA finally admit it tonight.

    The hidden bond insurers used by Wall Street firms are in the news, especially ACA Capital and MBIA. Implications are huge, with monumental ripple effects. Financial press reporting of the bond insurers is woefully inadequate. Moodys and Fitch are giving analysis review to nine ‘AAA’ rated bond insurers to see if they have sufficient capital to conduct their insurance operations. The list includes ACA Capital, MBIA, Ambac Financial, and Financial Guaranty Insurance. ACA Capital has only $1.1 billion in cash for payout of bond failure claims, but has lost $1 billion in the most recent quarter. More losses are assured. This insurer is very important, since it is widely abused by Wall Street banks to hide cratered bond derivative losses. If ACA insures a bond, then Goldman Sachs or Merrill Lynch for instance can take the under-water bond off the balance sheet. They can do so under fast changing rules, since any potential loss is not perceived to affect the firms themselves. ACA is widely called the ‘garbage can’ for Wall Street, where tremendous losses are concealed from stock investors, corporate bond investors, debt rating agencies, and bank regulators. But the Financial Accounting Standards Board (FASB) is changing against the firms, forcing firms to bring losing assets onto their balance sheets in droves. Several Wall Street firms own sizeable stakes in ACA, a ploy that enables them to hide gigantic losses in blatant collusion. Bear Stearns is the fifth largest US securities firm. They own a 39% stake in ACA Capital.

    Once again, leveraged mortgage bonds and mortgage-based Collateralized Debt Obligations (CDO) bonds are the root cause of the problem. Losses are amplified with the CDO packages of credit derivatives. My expectation is that mortgage bond losses will be an order of magnitude larger in 2008 than 2007, as prime adjustable mortgages face their nightmare, next on the debacle docket. JPMorgan bank analyst Andy Wessel claims if ACA defaults, banks would be forced to bring their ACA-guaranteed CDO bonds onto their books. Wessel says, “ACA is a likely candidate to get thrown to the wolves first.” If ACA loses ‘AAA’ rating, then possibly $60 billion in CDO bonds will be forced onto bank balance sheets in the banking sector generally. For instance, an ACA default would force Merrill Lynch to declare a $3 billion writedown of its CDO bonds. Expect this type of story to continue endlessly. Yesterday Morgan Stanley announced an additional $5.7 billion in bond writedown losses, making their recent total a robust $9.4 billion. Expect that their ultimate total will be three to five times larger. Bear Stearns is engaged in a parade of announced losses, each touted as the climax. Their latest made Thursday was for another $.19 billion. In my book, the entire gaggle of corrupted Wall Street broker dealers is insolvent, defending against bankruptcy with accounting shenanigans, all with the USGovt and Dept Treasury blessing.

    MBIA faces similar threats, as a bond insurer. They have faced a likely downgrade by Moodys for weeks, sure to put in grave doubt the status of $652 billion of structured finance bonds, as well as state and municipal bonds that they insure. The world’s largest bond insurer, MBIA beat the market to the punch in surprising admission of having $8.1 billion in CDO bond exposure. They also opened the door to discussion of ‘CDO Squared’ derivatives, which are leveraged instruments built recklessly atop other leveraged mortgage bonds securities. Expect the MBIA actual losses will ultimately be three to five times larger. MBIA, ACA Capital, and six other bond insurers sweat bullets over debt rating agency downgrades. A loss of their top rating would cast serious doubt on $2400 billion in asset backed debt securities collectively. Given the size of their total insured bond portfolios, Bloomberg Data estimates the downgrades could result in $200 billion in bond losses and bank writedowns. The rating agencies consider the bond insurers as a group to be holding far too little capital for to justify ‘AAA’ ratings as corporate entities. Remember, the entire US bank/bond risk management model is dissolving before your eyes!!!

    Finally on Wednesday this week, the bomb hit. Debt rating agency Standard & Poor lowered the ratings on Ambac and MBIA to NEGATIVE. S&P lowered ACA Capital was lowered to CCC grade, suggesting strong potential of actual default. The ripple effects to the bank/bond system will reverberate for weeks, if not months. In fact, my expectation is that successive ripples in 2008 will be larger than all previous. The ACA Capital ratings cut will lead to massive writedowns at Merrill Lynch and the Canadian Imperial Bank of Commerce (CIBC). The Toronto-based CIBC announced it will probably take a $3.5 billion loss from bond writedowns. Ironically, and surely mindlessly, Merrill Lynch and Bear Stearns are working to organize several major banks to bail out ACA. The giants are toppling. The exercise is mindless since whatever new capital is infused to ACA will melt in a matter of two to three months. They are trying to buy time, to hope for a recovery, a mirage in the desert. They are dying in public view, but with a very opaque lens trained on their balance sheets.

    The group of bond insurers combine to insure over 80,000 bonds and related securities. The insurers wrote contracts on almost $100 billion in risky CDO bonds backed by subprime mortgages as of mid-June, according to Fitch. The disaster that befalls ACA Capital will serve as the first true tough test of credit default swaps, those insurance contracts for corporate bonds and mortgage bonds. In June, the value of bonds linked to credit default swaps rose to a staggering $42.6 trillion, up from only $6.4 trillion at yearend 2004. These figures are supplied by the Bank for International Settlements in Switzerland. A melt-up precedes a melt-down.

    My contention is that the entire US financial engineering contraption is being dissolved, a crumbling pile of wreckage, with evidence of fraud throughout the structure. It is an historically unprecedented failure in innovation, a reckless extension to develop the inflation-based system. Such a system is destined for the scrap heap though, since every bubble in history suffered a contraction, this one no different, only bigger. The threat to the entire banking system has never been this great since the Great Depression. When comparison after comparison is made to magnitudes of this or fact factor never being so great since the Great Depression, one must raise the possibility that conditions are indeed similar and approaching such an outcome, but with central bank reactions assured. The Euro Central Bank infusion of $500 billion is such a powerful reaction, enough to soil the boxer shorts of any Deflation Theorist. My contention is that the inflation forces will ramp up considerably, in offset to the deflation forces building momentum, enough to create massive scheiss storms. The lightning, high winds, and resulting destruction will be enormous. Opportunity abounds.

    My expectation is that the USGovt will ultimately step in to offer a gigantic bailout to the bond insurers, the current focal point of destruction. The threat to the USDollar will then be known globally, from bank system collapse coupled with broad bond system insolvency. One might expect that some bond insurers will go bankrupt themselves. Imagine what your commercial building is worth if its insurance lapses. THE FIRST GIGANTIC RESCUE GESTURE IS NOT THE MORTGAGE FREEZE, BUT RATHER WILL BE THE USGOVT BAILOUT OF THE ASSET BACKED BOND INSURERS. Why? Because they serve as the operator of the dike main valve toward a flood of liquidations, the focal point of destruction. The impact on the reputations of the US banking system, the integrity of the US financial sector, the confidence in the US Federal Reserve, and of the viability of the USDollar by implication will surely suffer. If the USGovt fails to bail out the bond insurers, expect a monumental flood of well north of $300 billion in bond losses, extending to the municipals. Communities will not be able to continue, and will announce layoffs. It will not just be a California story. The most tragic, but absurd, yet hilarious, observation is that the investment community has yet to conclude that the US bank/bond system is officially bankrupt, broken, insolvent, and wrecked beyond repair!!! Imagine Homer Simpson sitting on his couch, watching television, while all the walls around him collapse.
  2. the current "situational awareness" of the American public is akin to the passengers of the Titanic worried about wet carpets.....
  3. Eddiefl


    Titanic cant sink, they told us it wouldnt,,,lol..

    Yeah right>>
  4. The market wont discount it right now. Because it is deemed unfathomable. Its just assumed that the government will magically make everything perfect !
  5. I would be interested in what one of the fixed income guys on here think of this?
  6. Is it legal and ethical for a bond holder to inject funds in to the bond insurer to prevent it from being downgraded?

    It may imply that they are just trying to delay the inevitable.
  7. The governments and the CB's of the world will do anything to prevent an economic debacle and thats what the market is betting on. Its worked in the past and thats what justifies the current optimism. We'll only know in hindsight if everyone was overly optimistic.
  8. jrkob


    ACA has never been AAA. They were, before the downgrade, single A only.
  9. my guess is the current situation will come unwrapped when a news story shows depositors standing in front of a closed bank demanding cash... (cash of what?? who knows)

    bank runs start with panic and the stepson is violence in the streets....
    #10     Dec 20, 2007