naked capitalism

I should never underestimate the relentless optimism of US equity investors (or perhaps the cleverness of MBIA’s flacks picking the middle of the night to release a fourth quarter earnings announcement that fell considerably short of already-low expectations).

Thursday we had the remarkable spectacle of MBIA CEO Gary Dunton making statements that can only be characterized as existing at the outer edge of credulity. As Bloomberg reported:

MBIA Inc. Chief Executive Officer Gary Dunton said the world’s largest bond insurer has more than enough capital to keep its AAA credit rating and dismissed speculation the company may go bankrupt.

This is breathtaking, and I am staggered that his attorneys would let him represent anything of the kind. Standard & Poor’s and Moody’s have said in no uncertain terms that both of the big bond insurers, MBIA and Ambac, need to raise more capital, pronto. Duncan’s statement, as far as his standing with the rating agencies is concerned, is patently untrue. And as we discuss later, S&P felt compelled to say as much in short order.

Similarly, New York state attorney general Eric Dinallo has been trying to get a $15 billion industry-wide rescue effort off the ground. The rating agencies were in the early meetings. If they though this initiative was unnecessary, they certainly would have spoken up.

Admittedly, Dunton has to put forward as brave a face as possible. He somehow, against all odds, managed to extract $500 million from a supposedly sophisticated private equity firm, Warburg Pincus. The last thing he can do on the heels of closing the deal is intimate that he sold Warburg Picus a bill of goods.

It is remotely possible that the company is badly deluded (and the deluded are usually more convincing than con artists, which may explain the successful placement with Warburg Pincus). A page one Wall Street Journal story, which gives a blow-by-blow recount of MBIA’s declining fortunes, has this revealing section:

The next day, Mr. Dorer [of Moody's]and his colleague, Stanislas Rouyer, published new concerns about MBIA’s capital position, saying it was worse than previously thought. MBIA shares slid 16% on the news. On Dec. 10, MBIA announced it had raised $1 billion from Warburg Pincus, which it viewed as a victory because some of its peers were also seeking such financing.

Nevertheless, on Dec. 14, Moody’s put MBIA on “negative outlook,” the first step in considering a downgrade, jolting executives in Armonk who thought they had bought some time with the Warburg deal.

Mr. Dorer and his Moody’s team were changing their minds about MBIA’s situation, their published reports indicate. The company, they concluded, had slipped from one of the better positioned insurers to the middle of the problem, in large part because of its holdings of risky CDOs that held subprime mortgages.

Mr. Dorer says MBIA had increased its portfolio for much of 2007, just in time for the mortgage downturn. As far back as the summer, he says, “it became apparent that these were exposures that could have some significant volatility.”

By the end of the year, Mr. Dorer and his team were delivering bad news to MBIA in near-daily calls. In mid-January, Moody’s put MBIA on “review” for a downgrade, the next step in considering such a move. In a downbeat note, Moody’s predicted the business of bond insurers could be damaged for years.

These are “unprecedented market conditions,” says Mr. Dorer, who started following MBIA and other bond insurers in 1998.

Moody’s decision “caught us a bit by surprise,” says MBIA’s chief financial officer, Mr. Chaplin. He adds that he expects the company’s credit outlook to return to “stable” in the future.

There is absolutely no appreciation of how perilous their position is or, more important, how their business model is no longer viable. Return to stable? When they are losing new business to fears over their ratings stability and will have the best risks picked off by Berkshire Hathaway, which has an undisputed AAA?

But what is even more surprising is that the markets bought this garbage barge and staged a late afternoon rally. Even though Felix Salmon scores this as a win for MBIA and a sign that investors are tuning out, I see this differently.

First, Ackman (not that this is Ackman versus MBIA; in fact that is part of MBIA’s strategem, to personalize this as evil short seller versus misunderstood maligned company) and the other monoline skeptics are winning the war in the court of market opinon despite a wee setback. Even after Thursday’s perk up, the stock is way down, and credit default swaps are being priced as if bankruptcy is imminent. And the short interest is so massive that any upward move would lead to some protective buying.

Second, regardless of what Dunton says, conditions are deteriorating, his new business is falling off, and analysts ex Ackman are far more often than not coming out with even worse loss estimates. Ackman (and by implication, the unnamed Global Bank that supplied him with its model) are up to $23.2 billion in losses for MBIA and Ambac. Egan Jones puts industry losses at $80 billion, Oppenheimer at $70 billion, JP Morgan at $41 billion.

Third, the January 30 letter presents a financial model and more important, the full security-by-security list of ABS CDOs and RMBS guaranteed by the two big monolines in from 2005 to 2007. This is disclosure that MBIA and Ambac have been unwilling to make; it will enable the rating agencies and regulators to analyze the bond insurers’ exposures with more precisions, and also enable them to ask tougher questions.

One element that has been a bit misunderstood is the time frame of exposures. Optimists have asserted that the bond insurers will pay out their claims over many years, therefore the payment is considerably mitigated.

RMBS are fairly ahort-lived instruments; the typical effective maturity is five years or less due to sales and refinancings. And thanks to the Fed’s rate cuts, good borrowers will refinance, shortening the life of the pools and removing the better credits. These deals are somewhat seasoned, so the remaining average life in the part of the portfolio that is at the greatest risk is probably two to four years.

So back to Felix, what does the rally really portend? Most investors don’t know bupkis about the woes facing the bond insurer beyond the fact that downgrades would be Very Bad Indeed. I read it that the 125 basis point Fed funds rate reduction has revived bullish spirits a bit. As before, the market is interpreting news in a positive light.

And far more important, it really doesn’t matter what Dunton says but what the rating agencies do. S&P downgraded number four bond insurer FGIC on Thursday from AAA to AA, demonstrating that it is prepared to cut ratings, and came as close as it could under the circumstances to giving Duncan a slap. From the Wall Street Journal:

“Although MBIA has succeeded in accessing $1.5 billion of additional capital, the magnitude of projected losses underscores our view that time is of the essence in the completion of capital-raising efforts,” S&P said.

Coming within hours of Dunton’s pronouncement that MBIA has sufficient capital, this statement can only be seen as a rebuke.