TALK ABOUT TIMING: A WEEK AGO, MBIA (ticker: MBI) closed at 8.55, after sinking as low as 6.58 amid worries that the bond insurer and Ambac Financial (ABK) might lose their triple-A credit ratings. Our story (see “MBIA: Priced for Catastrophe,” Jan. 21) said that even in run-off — writing no new business and merely staying open to service old claims — MBIA might be worth as much as 40.

The stock soared last week, doubling in price by Wednesday, before settling back to around 14. Ambac also rallied. Word came last week that astute private investor Wilbur Ross is negotiating to buy Ambac. MBIA is a week or so away from getting $500 million in new capital from private-equity firm Warburg Pincus, with another $500 million capital to follow from a rights offering.

Then, too, New York State Insurance Superintendent Eric Dinallo talked with various major banks about providing some $15 billion in backing. Despite initial reports to the contrary, the funds wouldn’t be invested in the two companies, thus drowning shareholders with dilution. The money instead would be a backup line of credit, which more than likely would never be drawn on given the two insurers’ formidable claims-paying ability and the long, decorous pay-back schedules that bond insurers typically meet.

Certainly Wilbur Ross and Warburg aren’t particularly worried over Ambac and MBIA’s financial health. Any new bank financing back-up would be all to the good, in their estimation by instilling investor confidence in the companies and encouraging the credit-rating agencies to keep MBIA and restore Ambac to triple-A status. The credit line would constitute financial shock and awe, in other words.

– Jonathan R. Laing

This has led to shortfalls in capital needed to preserve triple-A credit ratings, and a crisis in confidence which has made it made it hard for MBIA and Ambac to get new business.

In a back of the envelope calculation, Geraud Charpin, analyst at UBS, said that a downgrade from triple-A to double-A would lead to an extra $10bn of higher counterparty risk at banks. Mr Charpin based this on the assumption that the insurers guaranteed about $2,200bn of debt, of which probably around $1,000bn is nonmunicipal debt.

“Of course, the writedown would be heavier in case of a complete failure [which would void the guarantee and force a full mark-to-market pricing of the securities],” Mr Charpin said. “At this stage we are not sure who already made appropriate – preventive – writedowns and who did not. It is possible the overhang of additional writedowns in bank books was overestimated by the market.”

Working out answers to these questions is now key, but not easy. One of the problems is that the level of losses associated with mortgage-backed assets is not yet known. Many analysts are now factoring in worst-case scenarios in terms of losses – a few weeks ago many only ascribed a low chance of that being the case.

Nigel Myer, analyst at Dresdner, said investment banks might be prompted to back a bail-out if they believe losses could be worse than currently expected.

“If structured finance valuations can be maintained and that market kept open, the cost of injecting new capital may be less than the writedowns that would otherwise be incurred should a [bond insurer] fall below double-A, which we believe to be a critical threshold,” he said. “Could a sweetheart deal within the industry work – we think it could, but the odds are against it because the incentive for each player is to stay out while others take part.”

I assume you are including the comment for the sake of irony. Yes, historically they held up very well because historically, they weren’t insuring risky structured credits they didn’t understanding.

The eventual losses is very different than the downgrade issue. The downgrade is what will precipitate a rolling calamity, since it will force some holders of guaranteed paper to sell. Failure will take longer because it will take ltime for losses to materialize. But consider: capital for the industry is 0.7% of exposures. That is simply not a viable business model unless you are assuming virtually no risk. and that is not what was happening here.

The loss of the liquidity facilities, the loss of the usefulness (for now and probably forever) of tax reductions against claims expenses, and the reinsurance issues with MBIA alone say these guys don’t deserve an AAA, and even an AA is a stretch.

This says Ross isn’t serious at all as regards Ambac, just using due diligence to get intelligence.

However, these folks underestimate the difficulty of building a business and getting licenses. Moreover. as loose as PE charters are, I have NEVER heard of a PE firm backing a startup (the idea of buying a piece of an existing entity might be to get around this probllem). This is not an area, either in terms of the business (insurance) or the process (building from the ground up) where they have any know-how. This just isn’t credible, or if there is any foundation for these rumors, the firms have lost any semblance of judgment. Their limited partners would take a dim view too.

These guys have no experience in financial services and this is the about the very last place I’d recommend pursuing (and I do know this industry). The monolines have a fundamentally unsound business model. If you capitalize them sufficiently to allow for the risks, the economics in the vast majority of cases just doesn’t work.

If these guys are dumb enough to proceed, they will get their heads handed to them.

Even though this was technically a letter to the rating agencies, I read it as an open letter, you know, the sort where Concerned Citizens (need to have some famous names) publish a letter in the paper addressed to Bush or some other recalcitrant figure. They aren’t expecting to influence him but the public at large.

But having said that, the errors he points out are pretty damning. The tax adjustment and loss of liquidity lines alone are pretty basic, and the issues with Channel Re are major. If it was one issue or two, it might be seen at best as a “gotcha,” at worst nitpicking, but this is a bill of indictment. And there is even more in his presentation.

Check the latest post on the blog. Rating agency Egan Jones has come up with VASTLY worse numbers than Ackman.