Why shouldnt they be accountable for taking on excessive risk; a lesson needs to be learned from this period of excess and it will only sink in, if there is accountability and losses which hurt the risk takers!!!!!!!

The press hasn’t been sufficiently clear (yet) but this effort to form a consortium is NOT to invest in the parent company. Dinallo regulates the insurance subsidiaries. This is about saving (or salvaging as best one can) the insurance ops. That means they go in runoff mode. No new business, whatever cash gets put in is part of a wind down operation.

As in LTCM, they will keep the people who are important to continuing to manage what remains, perhaps under a contract. Anyone involved in new business will clearly go.

Foesskewered,

The immediate motivation is to prevent further downgrades. The credit default swaps of the big monolines are trading as if (prior to today’s announcement) their odds of going bankrupt THIS YEAR was over 70%. And they are still rated AAA! No one with any brains believes the ratings, so the salvage operation won’t change that fiction.

But downgrade will force sales. The bonds they insured would in turn be downgraded, and many investors face rating-based restrictions on what they hold. Forced sales lead to crappy prices on already crappy paper, which leads mark-to-market institutions like banks and investment banks to revalue their assets lower, which leads to more ugly writeoffs.

invictus,

Thanks for your comments, and the problem you set forth is even worse when you get outside munis, since they’d be downgraded only a notch or two. CDO downgrades have been known to go as much as a dozen to sixteen grades at a shot.

Ben,

Those charts are cool, even if a bit OT. Where is a primer on technical charts for the curious?

Risk transfer examples can be found by examinations of Enron and that area of DD is well worth time. This was also an issue with AIG & Berkshire Hataway a few years back, when Spitzer busted lots of reinsurance scum.

This is funny: One auditor once said that risk transfer is like pornography–you can’t define it, but you know it when you see it.

That’s another aspect of the problem I was wondering about. Wouldn’t there be conflicts of interest? Banks actually owning the insurer might actually reinforce the view that the AAA ratings “lent” by these insurers to bonds are inherently flawed and opaque, making it even harder to assess these bonds on a “fair basis”.

Yves, could this lead to a “replay” of Spitzer’s investigation into the ethical “problems” of resesarch and investment calls issued by bank analysts in the sense that should any problems surface with bonds issued by the bank and insured by their “inhouse” insurer , it’ll be harder for any transparency to emerge. This could be the start of more problems for the banks and markets in general years down the line after all, this is an industry nnot unknown for its penchant to play dirty.

TheFinancialNinja

While not as intelligent on the economics of the matter as Yves, I can say from experience of working in Citi’s or Smith Barney Muni division that it is much easier to push AAA paper to funds. Further, many pension and fixed-income funds have stipulations requiring all or a certain % of assets to be invested in AAA rated paper. The underlying rating of many municipalities is AA or lower, or the bonds are funded by a unstable revenue stream which also can knock a AAA rated municipality to AA or lower. By forking up a small premium to be insured by Ambac or MBIA or one of the 5 others a municipality can receive a AAA rating which substantially increases the demand for the bonds and can also end up reducing the effective interest rate paid on the bond issue. So there used to be cost-saving advantages to being insured by a monoline. Now the market is in limbo, and the AAA insurance no longer results in cost-savings for municipalities. As Yves points out, many of the bonds were meant to be held until maturity. A forced sale of hundreds of billions of paper might occur if the monolines file for bankruptcy. And that paper does not have a strong underlying bid, and is unlikely to have a functioning market anytime soon.

The flip side of this is when Berkshire really enters the market to insure municipalities a premium will likely be put on their AAA insured paper, so once again municipalities will find benefits to being insured.

Hope this helps, I tried to keep this dangerously complex issue simple.

I have read elsewhere that if the monolines were compelled to pay a claim on a covered CDO or swap that they would really only have to pay out the regular revenue stream that such securities would generate and not the entire principal and interest at once. Is this true? If true, since they could probably do this for a while on any given stream isn’t all this predicated on multiple failures at once of many insured securities?
How likely do you think that scenario might be in the current environment?

How can the banks bailout the monolines and still be hedged through them?

If they have a stake in the monolines, then the risk has not been transferred.

Thoughts?

I’ve read a couple of stories in recent weeks about muni issuers discovering that they can do fine without insurance. You and others have pointed out more than once that writing muni insurance is a lucrative business, because defaults are rare. Well, how will Ambac, or even Warren Buffett, re-establish that business model after the issuers discover they were paying for an unnecessary service?

(Here, for example, is a Bloomberg story from late December:

“Muni Insurance Worthless as Borrowers Shun Ambac”

http://www.bloomberg.com/apps/news?pid=newsarchive&sid=an.YiMSuQ828)

So Ambac’s bank customers are being asked to bail out a company that is not merely insolvent, but is also losing its core business – why would they be interested in doing that?

The SIV industry was about $400 billion, but in the end, despite all the handwringing, the losses (not fal in NAV, that’s completely different measure) were (roughly) 2-3% of total assets. Hardly a crisis, but a big problem for CIti, who was numero uno in that market (and a lot of forced sales could have lead to bigger realized losses).

The two biggest insurers guarantee $2.4 trillion. There will be downgrades in the absence of intervention, and that alone will lead to a lot of forced sales of paper that, as one commentor pointed out, was often never intended to be traded. That in turn leads to mark-to-market writedowns at investment banks that are already short of capital.

So that is a long winded was of saying this is a real problem, while the SIV situation was overhyped.