Posted on 01/17/2008 8:02:15 PM PST by Vince Ferrer
A growing crisis at Ambac Financial, one of the biggest bond insurers, is raising questions about Wall Street's exposure as counterparties to the bond-insurance industry coming off a period in which the big banks are reeling from more than $100 billion in write-downs of mortgage-related securities.
Late Wednesday, Moody's Investors Service said it might downgrade Ambac's
(nyse: ABK - news - people ) all-important triple-A financial-strength credit rating after the company forecast significantly higher-than-expected losses from insuring credit derivatives, many of them tied to subprime mortgages.
Raising the level of alarm a notch, Moody's and Standard & Poor's said they will be evaluating their ratings of other bond insurers.
Bond insurers use their top credit ratings to insure bonds issued by municipalities and others against default. That makes it easier for the issuers to sell the bonds at an attractive rate to institutional investors, like pension funds.
In recent years, Ambac, MBIA
(nyse: MBE - news - people ) and others have ventured into insuring credit derivatives and other relatively newfangled fixed-income products invented by and peddled by Wall Street. Ambac guaranteed $38 billion of debt linked to subprime mortgages and has exposure to $45 billion of other mortgage investments.
The banks, as counterparties, are on the hook for billions in insurance they bought to hedge credit-derivatives positions. The insurance policies, called credit default swaps, have exploded in popularity in the last few years, with some $45 trillion outstanding.
Closely watched bond guru Bill Gross of Pacific Investment Management calls banks' participation in the CDS market a ponzi scheme that may trigger losses of $250 billion.
Bank disclosure is sketchy, and the market is hard to evaluate for lack of information. Credit default swaps are sold over the counter, are not traded on an exchange and are outside the close scrutiny of regulators.
"The ultimate systemic risk caused by the weakened positions of the monoline insurers is overwhelming and scary," said CIBC World Markets analyst Meredith Whitney in a late-December research note. "The impact will be sizable and very negative for the banks."
On Wednesday, Merrill Lynch
(nyse: MER - news - people ) said it wrote down $3 billion of hedges with a counterparty that had slipped to junk grade during the fourth quarter, $2.6 billion of that write-down for hedges to asset-backed collateralized-debt obligations.
The counterparty was the troubled bond insurer ACA Financial Guaranty, which Moody's cut dramatically from A to triple-C one day in December. Canada's CIBC is also on the hook for $2 billion in insurance it bought from ACA to hedge its CDO positions.
On Monday, the Canadian bank said it has bought insurance for U.S. real estate exposure from other financial guarantors. "In the event that the credit ratings for one or more of these financial guarantors were downgraded, or if CIBC's own assessment of the credit status of any of the financial guarantors deteriorated significantly, it is possible that CIBC would make additional fair-value adjustments," the bank said. In other words, more write-downs are possible.
According to Fitch Ratings, Morgan Stanley
(nyse: MS - news - people ), Deutsche Bank (nyse: DB -
news - people ), Goldman Sachs (nyse: GS - news -
people ) and JPMorgan Chase (nyse: JPM - news - people ) were the biggest counterparties in terms of notional value outstanding at the end of 2006, and the market expanded substantially in 2007. Merrill Lynch, Citigroup
(nyse: C - news - people ) and UBS (nyse: UBS -
news - people ) were the top three underwriters of structured finance CDOs last year.
"There is systemic risk," says Eileen Fahey, managing director at Fitch Ratings and head bank credit analyst. "This could really damage the overall derivatives market."
Shares of Ambac swooned 60% in trading Thursday, and rival MBIA fell 40%. Fitch Ratings, which affirmed MBIA's triple-A rating on Wednesday, is still reviewing Ambac.
The company is struggling to hold on to the top financial-strength rating, as its capital position is severely strained by exposure to subprime mortgage securities that have deteriorated in value, triggering the possibility that Ambac and other bond insurers will have to pay out on the policies they wrote.
That business is unraveling. Earlier this week, Ambac ousted Chief Executive Robert Genader and said it expected a $5.4 billion mark-to-market loss in the fourth quarter, which, coupled with a $143 million loss provision, will bring the quarter's net loss to $32 a share. Ambac announced plans to raise $1 billion by selling equity and equity-linked securities.
Those plans seem seriously in jeopardy now that the stock has been pounded. "Ambac's ability to raise sufficient capital to avoid a downgrade is now in significant doubt," said CreditSights analyst Rob Haines in a research note Thursday.
"In view of the uncertainty generated by Moody's' surprising announcement, Ambac is assessing the impact of this action on the company's previously announced capital plan," the company said in a statement.
The New York State insurance regulator, who said Thursday he continues to monitor the Ambac situation closely, invited other companies to open up for business to ensure that there would be bond insurers to go around in case any of the big ones fell apart. Berkshire Hathaway
(nyse: BRKA - news - people ) jumped in last month with a newly formed bond-insurance company. Others are in the works.
That is a 15 TRILLION dollar market - all built on crap...
What idiot thinks that ‘sub-prime’, the lending of money to people who can not pay if back, is a good idea? What supper idiot thought it was a good idea to guarantee it?
Even in business the weak die first. It keeps the herd healthy.
GS, is it time yet to take our money out of the banks and put it back under the mattress?
I wish I understood these things.
That would be Greenspan, Bernanke, and Congress who encouraged this idiocy. The Administration of Bush and Clinton also encouraged this. These are our visionary leaders who do not understand the nature of man.....'here, Mr. Borrower. I want to loan you other peoples money, so I can collect a big fat commission." But wait, "You have no job or visible means of income....no problem....you qualify, here is a big fist of other people's money, minus my 8% fee. Thanks".
It is just that simple. Some people ought to have their nutsac cut and denutted.
There is a lot of fear in the markets, and no wonder. Major financial organisations are at risk.
Did you happen to catch Jim Cramer’s rant on CNBC yesterday morning... basically saying the same thing you’re saying - all these guys at the rating agencies are all part of the same club as the people who run the companies they’re rating and that these ratings are essentially worthless.
Fitch is the most honest of the bunch...
No, not quite. But I can tell you that at moment (since July, actually) I don’t have a penny in any stocks or bonds, except a cash preservation mutual fund that invests only in US Treasury bonds. Watch out for “high grade corporate bond” funds and similar labels. When bailing my 401k out of it’s usual S&P 500 home, I looked at the one mutual fund in my 401k plan that had that sort of description, dug a little deeper, and discovered it was 60% invested in mortgage-related bonds — suddenly the cash preservation fund with a history of earning a return of about 2-3% a year looked VERY attractive. FDIC-insured CDs meet my current criteria too — just make sure not to have more than the insured limit in any one bank.
Figuratively speaking, that's what's happening to quite a few of the investment bankers and hedge fund managers who fueled this charade. It really sucks to be unemployed when you have a $3 million mortgage on a house you paid $4 million for that presently has a market value of $1.5 million. And a wife who married you for your earning power and presumed ability to provide her and the kids with a luxurious lifestyle.
Thanks for the good advice.
My major worry now is that if we do experience a major stock market crash we could have a return to the politics of the 1930's, when extremist political forces on all sides became prominent worldwide. And you know what that led to: World War II. Are we setting the stage for World War III? A war that could go nuclear and kill maybe 1/6 to 1/4 of the human population in a few short months? 
“Housing market downturn leads to extermination of 1/4 of humanity” ping.
Nukes have made conventional war obsolete so who knows what WW3 (or WW4, whichever) will look like.
Our military is working on stuff that makes P.K. Dick look like he had a pipeline to the future--real scary in other words. I assume China and others are working on the same.
Future war will not be about direct land acquistion. More like letting loose super-bugs that eat computer motherboard circuitry or even self-reproducing nano-bugs that disassemble organic compounds (that's us) molecule by molecule.
There is only one cure and that is stopping runaway government spending--there are no reserves to mitigate this crises brought on by too much risky lending. All our money has been spent--the Fed can keep creating debt but hyper-inflation can come on just as fast as this credit-crunch has.
On the other hand, can't tell you how many times I thought the end was near--no option but to keep playing the game. I'll be buying stocks again just as soon as I think the bottom is in.
The very root, the BEDROCK of the national...and international...capital infrastructure is shaky. Risk is enormous, even for "guaranteed" investments.
Collapse, then a SLOW rebuilding of trust...or INFLATION are the only way out. It seems they have opted for inflation. Expect AGGRESSIVE rate cuts and deficit spending. Money will be literally falling from the sky.
Disclaimer: Opinions posted on Free Republic are those of the individual posters and do not necessarily represent the opinion of Free Republic or its management. All materials posted herein are protected by copyright law and the exemption for fair use of copyrighted works.