Comments on: The Monoline/Credit Default Swap Nexus (Not for the Fainthearted)

By: RK

RK — Wed, 16 Jan 2008 19:52:00 +0000

Hmm. MBIA brand new 14% bonds down 12% in a week? Can’t do that for too many weeks in a row.

By: RK

RK — Wed, 16 Jan 2008 13:24:00 +0000

In the end, the market will be the judge. This morning, Ambac is casting its vote. Anonymi, stay tuned for latest updates.

By: foesskewered

foesskewered — Wed, 16 Jan 2008 04:12:00 +0000

I agree with anonymous 9:31. As for the earlier anons, Yeah, the accounting standards allow for contingent liability but won’t be surprised if the final accounts show adjustments due to significant post balance sheet events, in other words, they may have to recognise it as “loss” vs mere contingent liability.

By: anonymous2

anonymous2 — Tue, 15 Jan 2008 15:27:00 +0000

anon 9:31

I agree totally.

By: Anonymous

Anonymous — Tue, 15 Jan 2008 14:31:00 +0000

Surely the point the article makes is a valid one? The fundamental point is the suggestion that by extending cover to bonds that are of poor quality, the monolines are going to incur liabilities when they default which will not be covered by the premiums charged or by their reserves?

If this is true, they will like any other insurer, go belly up?

So the question is, if the bonds you bought as a pension fund are AAA because insured by MBIA or Ambac, and would otherwise be BBB, what happens when all this stuff starts defaulting? First, the insurers go, second, the holders lose.

I don't quite see what is so silly about this scenario. The point is not who holds the bonds, the point is that huge credit defaults are coming, and this is going to mow down everyone in its way. Starting with the insurers.

Or are you anonmymouses saying this is not going to happen at all, and in particular not to MBIA and Ambac?

By: anonymous2

anonymous2 — Tue, 15 Jan 2008 14:11:00 +0000

Anon 8:52

You obviously understand perfectly the distinction I'm getting at.

"Filling up with contingent liabilities" would be a more accurate cut at it.

Given the enormous scope of each of cash funding and derivative categories that is being tossed around in the global discussion of impending catatrophe, I think its better to use words and their meanings accurately.

By: Anonymous

Anonymous — Tue, 15 Jan 2008 13:52:00 +0000

I don’t know much about insurance statutory accounting, but insurers are required to show potential losses as a liability. They have much more latitude in the way they do that than non-insurance financial companies, which are on a mark-to-market basis, which is probably why the monolines have been able to camouflage the state they are in, at least until recently.

While it is a colloquial way to put it, the “filling up with poor quality debt” doesn’t sound inaccurate to me in light of the consideration above, particularly since their liabilities due to their guarantees vastly exceed their funding liabilities (medium term notes, etc.).

By: Anonymous

Anonymous — Tue, 15 Jan 2008 13:25:00 +0000

Do you know what you are talking about? The article was clear, and what you said isn’t even remotely sensible. The article did distinguish between the risks of monolines insuring weaker rated credits, which is their sole reason for being, versus its impact on counterparties in the CDS markets if they lose their ratings. What does this have to do with GE, which is in a ton of businesses, even in its financial services area?

Yves (along with other blogs) has had a lot of posts on the outlook for the monolines, particularly a very good one yesterday. It is clear the monolines are toast. And the guy who wrote this article is a consultant, not an investor talking his book.

By: anonymous2

anonymous2 — Tue, 15 Jan 2008 13:23:00 +0000

“The monolines’ balance sheets fill up with poor-quality debt”

No they don’t. This is symptomatic of errors that permeate the analysis. And I would echo the comment above.

By: Anonymous

Anonymous — Tue, 15 Jan 2008 10:32:00 +0000

This line of reasoning makes no sense at all: if you applied it for example to GE (rated AAA) whose counterparties are mostly non investment grade, and whose clients are mostly non-investment grade (read their book of risk is JUNK), you would also have to conclude that they are not AAA.

Clearly that’s false, and there’s a lot more to a rating than the credit quality of your counterparties or book of risks. Cash (capital) for starters, makes a huge difference, plus more importantly, the temporal distribution of your obligations and the overall character of your revenue streams and outflows. The risks that the monolines take on are not debt: if you like, they are contingent debt: if one of the risks in their book has a default, they have to pay (timely interest and principal – not 100% of principal at the time of default). The non-defaulted risks are not obligations to make payment at a given point in time, they are only an obligation to make payments if the credit defaults.

So “leverage” has a completely different meaning when you apply it to corporate debt and when you apply it to a monoline’s par outstanding. This difference is crucial, and it is only by understanding it that you (1) can know what the heck you’re talking about when it comes to monolines and (2) can know how eggregious the blurring of these definitions is – and self serving, when it’s perpetrated by funds that are massively short these stocks.