Big Bond Insurer Discovers That Layers of Risk Do Not Create a Cushion

NY Times ^ | December 21, 2007 | By VIKAS BAJAJ

[DeaconBenjamin]

On Thursday, shares of the nation’s biggest insurer of financial risk, MBIA, fell 26 percent... The move came a day after Standard & Poor’s downgraded another bond insurer and assigned a negative outlook to four companies, including MBIA.

MBIA’s disclosure, which came in a data table posted on its Web site late Wednesday without any explanation, highlights the crisis in confidence that has racked the credit market. Investors, specialists say, are scared of what they do not know and no longer trust what they are told by the professionals who are supposed to know.

* * *

MBIA, whose name once stood for Municipal Bond Insurance Association, has insured about $30.6 billion of complex securities known as collateralized debt obligations, which are holdings of bonds that are often backed by home mortgages. On Wednesday, the company disclosed that about $8.1 billion of the guarantees was for C.D.O.’s that own the bonds issued by other C.D.O.’s.

* * *

MBIA’s credibility problems resonated in the stock market, where its shares fell $7.07, to $19.95. Also Thursday, Fitch Ratings, one of the three largest ratings agencies, said it was considering a downgrade of MBIA’s AAA rating unless the company was able to raise another $1 billion in capital in addition to the $1 billion it raised this month from Warburg Pincus, the private equity firm.

* * *

On Wednesday, S.& P. said its analysis showed MBIA could face losses of $3.2 billion because of the mortgage-related securities it has guaranteed, noting that the company has a “capital cushion” big enough to absorb losses of up to $1.8 billion. S.& P. has assigned a negative outlook to the company’s AAA rating, as has Moody’s Investor Service.

[razorback-bert]

$8.1 billion of the guarantees was for C.D.O.’s that own the bonds issued by other C.D.O.’s.

So someone borrowed money on bonds used to borrow money.

Is there any real money left in the world?

[aaCharley]

Nothing odd about borrowing money and using bonds as collateral for the loan. If you owned some US Treasury bonds, don’t you expect that you could borrow against them if you wanted?

The problem with this situation though is that, since these bonds were collateralized by different pieces of other bonds - making it difficult to really figure out what the quality of the collateral was/is. There was an odd rating agency practice of assuming that a basket of, say, AA rated pieces could be combined to become AAA rated in the new package. Since higher rated securities pay lower yields to the purchasers, this practice allowed the sellers/packagers to make a little more price spread improvement for themselves.

[VOA]

bump

[Deathmonger]

MBIA and other monoline insurers have been propping up the value of trillions in securities by providing insurance against default to investors. When their ability to pay claims becomes suspect, the credit rating and therefore the value of the insured securities does as well. In many cases it will force institutions to dump securities that no longer meet their charter-required AAA ratings.

This threatens to further collapse the debt markets. It’s like your fire insurance company going out of business before they can pay the claim on your burned-down house. Suddenly, a large number of investors are on the hook for losses that they thought they were insured against. Watch for the federal government to try throw taxpayer dollars at it.

[NVDave]

That’s not what is really going on there.

The security that MBIA has is a “CDO made up of other CDO’s” - or, what is called a “CDO squared” in the finance industry.

http://www.housingwire.com/wp-content/uploads/2007/12/cdo-squared_nomura.pdf

A lot of people aren’t really “getting” the real scope of the financial market’s debt crisis because they don’t understand the actual instruments involved that are blowing up. The press keeps talking about only sub-prime mortgages; what folks need to understand is that with CDO’s, CMO’s, etc, these sub-prime mortgages have been diced, sliced and combined with other grades and maturities of debt, along with some derivatives and covenants and then sold as “AAA” or similar highest-quality debt.

The reason why the ratings agencies gave such absurdly high ratings to these CDO’s was that the ratings agencies didn’t understand the mathematics behind these synthetic securitized debt instruments.

CDO squareds take this to a whole new level of mathematical obfuscation.

[razorback-bert]

Trouble is these aren’t really bonds, nothing but glorified IOUs.

[razorback-bert]

I know that, justing keeping it simple, which they don’t.

[exhaustguy]

Could the ratings agencies be on the hook for lawsuits? If nothing more I would think their credibility would be shot. If they did not understand it, they should have said so and not rated the securities.