Apologies for the high concentration of monoline items tonight, but that’s where the meatiest material is right now.
I received a surprising e-mail from an investor on a rumor he heard from a well-placed source. He was a bit incredulous as to what he was told, and I am skeptical too. Nevertheless, I thought it would be worth posting in case anyone else had heard something along these lines.
I had a conversation today with someone who is friendly with someone with access to the monolines, and he suggested that the path out of the current situation for the monolines was, assuming they did a split into a muni book and structured book, that the capital requirements for the muni only book would be lowered dramatically by the rating agencies and that this would free up a $10B+ amount of capital to support the structured book. This was, I believe, informed speculation on his part.
My reaction to it was that I had trouble believing that the rating agencies would cut the capital requirements for the muni business that much, despite the good loss record, given that they were revamping their models to indicate that substantially more capital was needed in the business as a whole. But I’m beginning to wonder whether this might actually be “the plan.” I thought Dinallo’s reaction to Ackman’s proposal was a little curious, since I think his plan or a variant of it is the most viable path to get some capital into the business while retaining the muni business as a continuing franchise and delivering as much economic value as possible to the SF policy holders, and it is a trade the SF policy holders might actually do if they didn’t have to put up much or any capital themselves. When Dinallo said it wouldn’t work because it doesn’t provide a AAA rating for the SF side of the house, I thought, what is he smoking – how much capital is going to be needed to really do that – there is no way they can raise that much. But perhaps this change in the muni reserve requirement is the path to maintaining the AAA fiction that the politicians are trying to orchestrate – the rating agencies “discover” that the muni biz has few defaults, suddenly realize it can be AAA with substantially less capital and release that capital for the benefit of the SF policy holders.
It seems to me that this flies in the face of a lot of history of what has been viewed as the appropriate capital levels for the muni business and against the rating agencies’ newfound religion that these entities were undercapitalized.
This frankly makes no sense. If the capital (technically, reserves, that’s the name for the cushion at the insurance subsidiary level) is insufficient for the combined entities, merely splitting them cannot suddenly make things better. In fact, the boundary condition is that the reserves needed to properly capitalize the combined book of risks is less than or equal to the reserves needed to insure them separately.
But recall what we said early on in this mess:
The mistake is believing, as we perhaps have too much, that the rating agency saber rattling means they have the will to downgrade. They don’t. The very last thing they want to do is be accused of causing The End of the Financial World as We Know It.
The rating agencies would welcome any excuse not to downgrade the bond guarantors. But this ruse seems too much of a reversal for them to pull off without destroying what little credibility they have left. It would make crystal clear that any claim of independence and objectivity is a complete sham.