Friday, January 25, 2008

When $15,000,000,000 is mere piffle

I've been writing about the bond insurance market for a while now and how it could impact the city of Pittsburgh as recent refinancings and debt issues will begin to see balloon payments in the next couple of years. The basic story is that Pittsburgh has a mediocre credit rating and to get a better rate, it has taken out insurance with one of the major bond insurers (Ambac, MBIA, FGIC etc). These insurers agree to cover the payment of principal and interest to bond buyers if the city defaults on its obligations. They charge a fee that is less than the net present value of the differential between the enhanced credit rating that they supply to the bonds and the inherent credit rating/risk of the city of Pittsburgh.

The problem is that these insurers got greedy and went away from their core competency of very profitably insuring municipal bonds to insuring anything that they did not understand or want to understand including mortgage and other asset based securities. And they are getting burned right now as losses are much, much higher than expected from the CDO and ABS policies they issued. Some insurers have already lost their AAA ratings, and others are being treated as if they are nearly junk bond companies despite having a AAA rating.

The recent talk of bailing out the insurers through a collective Wall Street bail-out organized by the State of New York has released some of the pressure on the big insurers with the scariest risk profiles, but there is a simple problem of the size of the proposed bail-out may not match with the size of the exposure, first from Bloomburg:

Talks in New York with the unnamed banks are part of Insurance Superintendent Eric Dinallo's effort to stabilize the bond guarantors and bolster the market's finances, said agency spokesman Andrew Mais....

New capital may help preserve the top credit ratings for the bond guarantors such as MBIA, the industry's largest, and halt any erosion of investor confidence in the $2.4 trillion of assets they guarantee. Ambac, MBIA's biggest rival, lost its AAA grade from Fitch Ratings this month on concerns that losses tied to subprime mortgages may increase....

The infusion may be as much as $15 billion, the Financial Times reported

$15 billion in cash could still be considered mere piffle, even if one factors in a 10:1 leverage ratio as the problem. Calculated Risk is passing along this estimate via the London Times concerning the size of the potential exposure:

America's biggest mortgage bond insurers collectively need a $200 billion (£101 billion) capital injection if they are to maintain their key AAA credit ratings, a figure that dwarfs a plan by New York regulators to put together a capital infusion of up to $15 billion

Even leveraging up the $15 billion to hedge fund levels, there is not enough cash to cover probable contigencies. If I was in charge of $15 billion dollars, I would have bought myself Super Bowl tickets, and then used the rest of it to carcass pick the insurers of the good risks that are thoroughly vetted agaisnt a proven track record of analysis. The $15 billion dollars may be the vulture's payment for municipal bond insurance as that is a predictable market with known risk profiles, but it is a joke in the face of the asset backed bond tsunami and the earthquake from the CDOs insured by the bond insurers.

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