Bond Insurer ACA Still on Life Suport

A bit late to this item due to the holiday. Bond insurer ACA, which was in breach of its collateral requirements last week and therefore en route to being liquidated, received a stay of execution from teh Maryland insurance regulator, which gave the company until February 19 to wind down existing credit default swap contracts.

Note this article also contains the first discussion I have seen of the notion of the need for the Fed to orchestrate a bailout of bond guarantors.

From Bloomberg:

ACA Capital Holdings Inc., the bond insurer being run by regulators after subprime-mortgage losses, won a month’s grace to unwind $60 billion of credit-default swap contracts that it can’t pay.

ACA, under the control of the Maryland Insurance Administration, extended an agreement that waives collateral requirements, policy claims and termination rights until Feb. 19, the New York-based company said in a statement on Business Wire late yesterday.

The insurer said it’s working with trading partners “to develop a permanent solution to stabilize its capital position” after losses of $1.04 billion in the third quarter.

Standard & Poor’s cut ACA’s rating 12 levels to CCC last month, casting doubt on the company’s guarantees and triggering collateral requirements. ACA, which lost 97 percent of its market value in the past 12 months, caused Merrill Lynch & Co. to write down $1.9 billion of securities last week and Canadian Imperial Bank of Commerce to sell more than C$2.75 billion ($2.7 billion) in stock to cover writedowns.

Bond insurers’ shares plunged last week and credit-default swaps rose to a record on concern the companies may be unable to meet their obligations as the subprime-mortgage securities and collateralized debt obligations they guarantee slump in value….

The tipping point came last year when the three major rating companies downgraded thousands of CDOs. Ratings on more than 2,000 CDOs were cut in November alone, according to a Dec. 13 UBS AG research report.

Maryland Insurance Administration held off filing delinquency proceedings last month while ACA sought capital. ACA was required under its credit-default swap contracts to post collateral if its rating fell below A-.

ACA gained 2 cents, or 4 percent, to 48 cents in over-the- counter trading on Jan. 18 in New York.

“The monolines are dead, their business model is dead,” said David Roche, head of investment consultancy Independent Strategy in London. “The government is going to have to recapitalize this industry or there will be communities in the U.S. where they can’t even flush their toilets” because they can’t afford the services….

New York State Insurance Superintendent Eric Dinallo is examining whether to limit the types of debt that can be guaranteed by bond insurers, department spokesman David Neustadt said last week.

The Federal Reserve may need to organize a bailout, Nangle at Barings said. “More generalized monoline meltdown would be a situation that would require intervention by the New York Fed,” said Nangle. The regulator should “get all the banks into a room, have them open their books, and then lean on them to inject capital.”

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  1. Anonymous

    Actually, Jim Cramer made the ‘have the fed bail out the monolines’ argument this past friday on Mad Money.

  2. Yves Smith

    Well, technically I didn’t see Cramer’s latest rant, and his proposal is different than what others appear to be suggesting. The Fed has no jurisdicaitonal authority, nada, to “bail out” insurers. It doesn’t regulate them.

    What some are advocating, instead, is an LTCM-style operation, getting affected parties together and have them work something out. The problem here is that I don’t see how that can succeed. First, there are way way too many parties at risk in monoline meltdown to get them all in a room (it was only 24 banks and brokerage firms, if memory serves me right, for LTCM). Second, the amount each firm had to stump up wasn’t that horrific (again, memory, but I think the largest amount any firm had to contribute was $400 million). The banks and investment banks (save Goldman) are all badly impaired and the amount required to shore up the monlines over time is likely to be considerably greater than the amount required to wind down LTCM.

  3. Lune

    Pardon a novice question, but what exactly would be the consequences of letting these insurers fail? Just because they fail doesn’t mean all the bonds they insured automatically default. In my view of things, if the insurance company goes broke, that means that the AAA rated bond you bought might actually be BBB or something like that. In other words, it means bonds get downgraded and people take writedowns based on those downgrades just like with any other ratings downgrade. That doesn’t imply the sky is falling (although I do understand that a lot of bonds will be downgraded if these companies fail).

    Secondly, if there were to be a bailout (and I vote adamantly against such a thing), then it should be in the form of the feds re-insuring all municipal bonds that were previously insured by these companies. In other words, the feds bail out local and state governments to allow those debt markets to continue to function. But for the billions of CDOs and commercial debt, etc, I say live by the sword, die by the sword.

    I’m sick of these private investors holding munis ransom, saying that if the Fed doesn’t bail out everyone, then local govts will die. There’s no reason why the muni market can’t be bailed out while letting the private markets fend for themselves.

  4. doc holiday

    I think what happened, as with Florida, is that some financial “fiduciaries” also known as pension managers, or fund managers were looking for hot and exciting credit enhancements and they were talked into entering the world of synthetic crap, versus staying with old school bonds, which had certain premium impacts that reduced return, like bond insurance. Thus as that new world adventure was explored and looked to be possible, more kids jumped on the bandwagon, and that included rating agencies, bond insurers and the securities dealers, the underwriters, the pension funds, The DOL (see Pension Reform Act), etc….

    Then, as the house of cards fell apart (because no one had been looking at fundamental reality or looking for evidence of collateral reality) people began to look for more and more evidence and found that everything under the financial sun had been packaged into risky derivative packages by underwriters that had been granted exemptions to daytrade pension money markets and fuse that fund with that entity with this and that and these people did a very excellent job of turning this economic engineering mess into a global liquidity trap/pandemic that will screw almost everyone.

    Ahhh, I feel better, and Im sorry if I didnt make sense, but dont tell me that whats going on makes sense either!

  5. George


    an expository article with a
    timeline of the unfolding mess would
    be most welcome by this average
    citizen…just what the heck is going
    on ? I heard that the spark that set
    the fire could have been extinquished
    if the white house enforced the
    homeowner’s equity protection act. Is
    that right ?


    I posted this a moment ago under your John Coffee thread — but now that you’ve addressed bond insurers directly, seems best to site it here.)

    I drafted CDOs and other structured finance instruments, along with bond insurance policies, credit card bond master trust docs and primary asset-backed securities for a major wall street law firm most of this decade.

    In August I posted a note here (and an article on my website: suggesting that the nascent disaster in structured finance might perhaps only be cured by price controls on the wounded bond classes. Perhaps for two years or so.

    Friends laughed; some politely up their sleeves.

    The time has now come, with the bond insurers on the brink. If something is not done almost immediately, we will have to stop tallying s-f bond writedowns with billions.

    As the monolines blew up last week, Jumpin’ Jersey Jim Cramer began shouting that the gov’t should simply buy the insurers and guarantee 50 cents on the dollar for the wounded bonds.

    Price controls might be better and simpler. Writedowns would come under control quickly. The world could catch its breath. Monetary and fiscal policy could begin to heal the underlying economic problems. And the bonds could continue to spew out a good deal of the interest they were intended to produce. Issuers could wind up early (almost all s-f deals are expected to wind up much sooner than their stated term in any case).

    Trades would still be hard to come by, since the Price Controlled price would have the stink of artifice about it. But I assure you that 95% of the trillions in complex derivatives out there were never designed or expected (by their buyer & sellers) to be traded in the secondary market. They were “bonds” in name only. Everyone on the inside thinks of and calls them “trades” or “deals”.

    Red faces on the masters of the universe at Davos this week, eh what? Maybe they’ll persuade Ben to lighten up for chrissakes.

  7. ronin

    The bond markets, despite the fear-mongering of Mr. Roche, are not in need of a bailout. The worst that could happen is that municipal borrowers would have to pay a somewhat higher interest rate going forward. Existing bonds may drop in price, but nothing like subprime mortgages and other garbage.

    I’m assuming Mr. Roche is not supremely ignorant, but is simply spreading fear to enhance the possibility of a bailout for the insurers- to help the banks and holders of CDOs.

    Either way, the toilets will still flush.

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