Deutsche Bank’s CEO Josef Ackermann issued a stark warning today: bond insurer downgrades would have catastrophic consequences, on par with the subprime crisis.
Note tha this view is in contrast with teh comparatively sanguine readings that have been coming from some US analysts and the US media, which now appears to regard teh increasing possibility of bond insurer downgrades are No Big Deal. The stock market is staging a wee rally despite a downbeat reading on the odds of success for the bailout talks led by New York insurance superintendent Eric Dinallo.
Ackermann’s warning is consistent with a rumor we heard earlier this week from a well-placed source, who said that Trichet, the ECB’s chief, had made a strong plea for the Treasury to bail out the bond guarantors. And by that we don’t mean mean merely “get involved in Dinallo’s talks”; we mean stump up cash. (Note this same source predicted Trichet’s about face on interest rate cuts, and said they would be triggered by worries about the banking system, so his quote at the end of the Bloomberg story may be obligatory posturing).
The reason is that European banks were big buyers of later vintage CDOs (2006-2007) and RMBS, which will not only take a hit when any credit enhancement provided by the bond guarantors is removed but independent of any price impact, downgrades will also reduce their statutory capital. Why? Banks (which bought primarily AAA tranches) can treat AAA paper as a risk free asset; the reserve requirements are minimal. A downgrade to AA increases the reserve requirements markedly, and CDOs are generally downgraded more than a mere grade or two when they fall (I wish I could be more crisp here, but Basel II makes matters more complicated). Thus a loss of the bond guarantor AAA has a quick and nasty impact on bank capital adequacy.
Deutsche Bank AG Chief Executive Officer Josef Ackermann said rating downgrades for bond insurers pose risks that could match the U.S. subprime market collapse.
“It could be a tsunami-like event comparable to subprime,” Ackermann said in a Bloomberg Television interview in Frankfurt today. Deutsche Bank, Germany’s biggest bank, is “well positioned” on its risk from bond insurers, he said…..
Banks and securities firms have already reported credit losses and writedowns of $146 billion. Downgrades of the bond insurers may force financial firms to write down a further $70 billion, Oppenheimer & Co. analyst Meredith Whitney said last month….
“It is bad practice to rely on the judgment of those whose misjudgments have caused the current crisis,” Ackman wrote in the letter dated Feb. 5.
European Central Bank President Jean-Claude Trichet rejected Ackermann’s characterization of the potential fallout from bond insurer downgrades.
“I certainly would not mention anything like waves of tsunami or any other mention of that sort,” Trichet said at a press conference in Frankfurt. “The fact that this correction continues along various markets is not something which should surprise us, its an ongoing process.”