naked capitalism

Felix Salmon and I see the contretemps between MBIA and the New York Times quite differently, as our posts (and e-mail exchanges) illustrate. I like Salmon, but ironically, the way we got to know each other was when he savaged a Gretchen Morgenson piece, and I took issue with some of his arguments, so this latest discussion has an oddly familiar feel (I give Felix credit for being a good sport).

By way of update, Felix has weighed in twice on the MBIA/NYT contretemps (here and here) both times on the MBIA side. The second post addressed some of my and Sam Jones of FT Alphavillle’s issues with the MBIA retort to the New York Times article.

Felix seems to have missed the point of my post, which is clearly flagged in the headline, “MBIA Lies in Attack on New York Times,” namely, that MBIA’s attempts to rebut the NYT article were simply untrue as far as the main points at issue were concerned. And note that Salmon in his initial post said that he’d take the veracity of MBIA over the NYT (”According to MBIA, and frankly I trust them more than I trust the NYT on this…”).

Felix’s second post, instead of acknowledging where MBIA dissembled, plays up other arguments the company has made (”gee, things have changed, so we have better uses for the dough.”). That fails to address the lack of candor of the company, which is one of the reason it’s in the shape is in. It is no longer trusted in many quarters. As the case of Bear Stearns and Lehman make all too clear, trust in management is even more important in financial services than in other industries. Their financial statements have substantial opaque elements, as our buddy Charles Gaspario has noted, so investors are put in the position of having to take a lot on faith.

And if things have changed, and putting $900 million into its current sub makes no sense, why not dividend the money back to shareholders? That’s unconventional to be sure, but not completely unheard of (but we all know that no management will admit that they just went though a difficult, highly dilutive fundraising for naught). But if the executives were really out to maximize shareholder value, which is widely asserted to be their primary duty, that’s precisely what they’d do..

Most observers believe the monoline business model is dead, between the changes in muni bond rating procedures that are being forced on the rating agencies (ie, no more free lunches by insuring credits that were better than the rating agency marks suggested they weret) and the entry of Warren Buffet, who has an uncontested AAA, vastly more capital, and unlike the monolines, has very successful insurance operations that take real risks. Buffett will cherry pick the best risks (that’s Ajit Jain’s the head of his insurance op’s MO); good luck to anyone who’d go up against them (and that’s even assuming a new MBIA sub could get an AAA, particularly if required to reinsure the existing exposures on the current muni book, which Dinallo indicated was something the wanted).

And we have the additional complication that thanks to the fall in housing prices, which are the basis for real estate taxes on which many local authorities depend, this isnt’ exactly the greatest time to be seeking new business in the muni bond guarantee business. Historical models will prove singularly unrelaible. I find it difficult to believe that any new insurance operation under MBIA has a realistic chance of commercial success.

Felix also accepts the company line that MBIA is solvent. That is obviously currently true, but the idea that they will continue to be solvent is far more contested than he admits. He contends that (aside from the “strong” AA rating) critic Ackman and Dinallo have never disputed the solvency of the insurance ops. That is only narrowly accurate. Ackman called for both bond insurers to be put in runoff mode before the end of 2008 to keep the holding company expenses from draining funds needed to pay insurance obligations. Since that hasn’t happened, it isn’t clear what Ackman’s views would be now (he has closed his position and moved on). Dinallo is in an awkward position, having basically admitted the accuracy of Ackman’s analysis via his January-February efforts to have MBIA and Ambac raise $15 billion (the amount Ackman had indicated that the insurers would need to maintain their AAAs). It does not behoove Dinallo (or any financial regulator) to raise red flags about solvency unless a regulatory seizure is imminent. Given that he is in negotiations with MBIA, the NYT article may have been singularly unhelpful from his standpoint, since it paints a picture that the company has the upper hand.

The markets see the situation differently. As a recent Bloomberg article noted,

Moody’s Investors Service has created a new unit that surprises even its own director.

The team from Moody’s Analytics, which operates separately from Moody’s ratings division, uses credit-default swap prices as an alternative system of grading debt. These so-called implied ratings often differ significantly from Moody’s official grades.

The implied ratings frequently show that swap traders think debt is in more danger of defaulting than Moody’s credit ratings signify. And here’s the kicker: The swaps traders are usually right…..

Using CDS market prices, Munves’s unit assigns implied ratings of Caa1 to both MBIA and Ambac. That’s seven notches below junk and 15 below the official Moody’s rating.

This is the definition of a CCC/Caa rating:

Bonds of poor quality. Issuers may be in default or are at risk of being in default.

Similarly, Salmon eventually acknowledges the point made in the earlier post, that the NYT was correct in its contention that the investors would have the right to accelerate (demand immediate payment of) the credit default swaps in the event of a regulatory takeover, a point that MBIA attempted to dispute. Again, my main bone of contention with the company is the persistent dishonesty of MBIA management; I wouldn’t trust them to run a dog pound.

Felix argued that investors might chose not to exercise that option, citing the example of ACA, which was downgraded and has received a number of waivers from swaps holders. Again, correct, but he misses some key elements. For instance, he asserts the waivers are being used to permit the run-off to continue. Not exactly true. From the press release of the third waiver notice:

The extended forbearance period will permit the Company and its counterparties to continue their productive discussions to develop a lasting solution for the Company’s capital and liquidity issues. During this period, the Company plans to work with its financial advisor, The Blackstone Group, to further build upon the significant progress achieved since early December 2007. The Company seeks to finalize the terms of a solution by the end of this extended forbearance period and to proceed to closing as soon as practicable thereafter.

This basically says a liquidation or settlement of some sort is being negotiated.

More important, ACA is not a precedent for MBIA for a key reason: it’s muni operations are small relative to its total book. From FT Alphaville:

ACA was always a breed somewhat apart from the largest bond insurers, MBIA and Ambac. For a start since it started out with just a single-A rating – before being slashed to CCC – it had collateral posting written into its positions, hence its current difficulties. But that meant it was a less attractive prospect for the municipal issuers seeking a top notch rating in any case.

So the public finance portion of ACA’s (already much smaller) business is less significant – according to its website, last September, ACA had $7bn of gross par exposure in its public finance business against $69.1bn of notional exposure in its structured credit lines. So ACA is more bad bank, than good bank. Other monolines’ municipals operations are much larger overall than their lately forays into the world of structured credit.

MBIA or Ambac going asunder represents a very messy legal problem. For ACA, there is only so much in the way of assets for the policyholders to divide; the muni policyholders may or may not be treated fairly, but they are rounding error. The vast majority of claimants are in the same boat.

Per the discussion in Felix’s and our earlier post, MBIA’s CDS holders do have the right to jump to the head of the queue and take priority in payout of the insurer’s assets. The CDS holders interests are opposed to those of the municipalities who got guarantees. And to secure those rights, I think it likely that the CDS holders would threaten, or more likely, go as far as filing suit to secure their rights. Dinallo is more concerned politically about protecting the muni holders, but it isn’t clear that he can skew any settlement to (conceptually) a pro-ration among CDS and muni policy holders when the CDS policy holders clearly have a priority claim. It’s likely, though not guaranteed, that Dinallo would try to mete out an “equitable” settlement (being perceived to have screwed local communities is the kiss of death for anyone with political aspirations) and the CDS holders will be forced to pull the trigger by asserting their right to accelerate. That way, Dinallo could make clear that his options in working out a resolution were limited.

The only thing that might prevent CDS holders from asserting their rights is political considerations (for instance, pension funds who hold structured credits with CDS wraps would not want to look like bad guys with municipalities who are possible clients, ditto investment banks and banks). But these instruments got placed in a lot of hands, and it only take a few claimants to throw sand in the gears.; the others are effectively free riders.