Friday, February 15, 2008

FGIC wants to split the baby

The problem with the monoline insurers is that they had a boring, highly profitable sure thing business model insuring municipal bonds backed by the taxing power of municipalities. Their model was to remove information costs and a bit of the default/credit risk so that big money investors would not worry about buying $5,000,000 from the Steel Valley School District. The insurers would credibly assure the big investors that Steel Valley was good for the money, and get a bit of a fee from the school district for allowing them access to cheaper credit. The bond insurers took on the risk of being wrong, but overall, a nice simple, boring and very profitable business model. And this is why Warren Buffet wants to buy this segment of the market.

And then they went beyond their area of expertise into the CDO and CDS markets insuring things they did not understand and set themselves to be hammered. Ratings have dropped, capital requirements have increased and there is no chance of cheap bail-out money being available as no one has a good idea of what the monoline insurers' exposures to the debt market meltdown actually tallies up to.

FGIC, a major insurer has been hammered with its credit rating dramatically falling and thus incapable of attracting new and profitable business as its comparative advantage has disappeared. They are now trying to split the baby in half -- safe, boring municipal bond insurance which has a good chance of being profitable in the long run to one side, and then the toxic waste on the other.

FGIC Corp., the bond insurer stripped of its Aaa guaranty rating by Moody's Investors Service, asked to be split in two to protect the municipal bonds it covers, according to the New York Insurance Department.

FGIC applied for a new license so it can separate its municipal insurance unit from its guarantees on subprime- mortgages, David Neustadt, a department spokesman, said in a telephone interview.

The toxic waste pile will be massively undercapitalized and therefore the value of the FGIC guarantee will be extraordinarily questionable. This is self-strip mining of the highest order in the hopes that there is something valuable that the current management team and company can hold onto. Everyone else will be left twisting in the wind as losses will be marked to a much harsher model or market.

Banks, which bought protection for the CDOs, stand to lose $70 billion if bond insurers are stripped of their ratings, Oppenheimer & Co. analyst Meredith Whitney in New York said last month.

Concern that MBIA and Ambac may lose their top rankings has spread to the $300 billion market for auction rate securities. Investors, wary that the municipal debt they are buying may soon be downgraded, have fled the market, causing more than $20 billion of auctions to fail this week.

Splitting the baby will not restore confidence in the current monoline insurance practices.

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