Posted on June 23rd, 2008 in Daily Stock Market / Economic News - The Real Story
Tonight, FT’s Aline van Duyn broke a story that the bond insurers are begging banks to tear up $125 billion in credit default swaps in order to save their lives. You never know, this could be a blackmail situation…”hey, you rip up these Credit Default Swaps or you will take big losses when we fail”.
Yes, I ride these guys hard and always assume the worst first. Why shouldn’t I? Since New Century failed in March of 2007 we have been lied to at least in 99% of the cases regarding potential serious problems with companies claiming ‘there is nothing to see here’ and by officials, analysts and famous investors when talking about the mortgage, housing or credit crisis in general.
My standard operating procedure it to assume they are lying and let them prove they are not. What generally happens is a story like this breaks and the company says ‘there is nothing to see here’. The other companies involved and some sort of official, regulator or large scale investor backs up their story. Then, they find someone on which to blame the story as being ‘misconstued’. Two months later it comes full circle where the worst case scenario was true all along. I believe that this story could be big.
“Bond insurers such as Ambac, MBIA and FGIC are talking to banks about wiping out $125bn of insurance on risky debt securities in what could be the only way to limit the financial damage surrounding the bond insurers.
Discussions about “commuting” these insurance contracts, which were sold by bond insurers to banks in the form of credit default swaps, have taken on a renewed sense of urgency amid a rash of ratings downgrades in the bond insurance, or monoline, sector last week.
If agreements are struck about the value of these CDS contacts – and the discussions could take months – it could be significant for the entire financial system, which is clogged up by the uncertainty around the value of derivatives and complex bonds linked to mortgage-backed securities.”
By even asking this, it is obvious that the insurers do not have the capital to cover these bets and probably never did. It may also be a sign that the “great derivatives unwind” is underway.
“If firms and their counterparties can get across the finishing line in their commutation negotiations, a shadow of uncertainty would be lifted from the monoline sector, with the prospect of better rating stability,” said Matthew Elderfield, chief executive of the Bermuda Monetary Authority, which regulates a number of bond insurers.
Bond insurers are in different stages of financial trouble, with smaller ones such as FGIC already rated in the junk category. Last week, Ambac and MBIA lost their last triple A credit ratings after Moody’s downgraded them to double A and single A respectively. Both ratings have a negative outlook.”
Hey, maybe they are jumping too quickly! I am sure if they waited long enough or if the situation worsens enough to cause trouble with another investment bank that the Fed will think of something such as a new borrowing facility for Credit Default Swaps. I am sure Bernanke and Paulsen will be the first to say how profitable they will be in 5 to 10 years. Scratch that…I forgot the Fed doesn’t have enough capacity left for a CDS bailout, of which this is probably only the tip of the iceberg.
“The talks centre on CDS contracts issued by bond insurers to guarantee payments on collateralised debt obligations, complex debt securities often backed by mortgages which have plunged in value amid a wave of foreclosures on mortgages issued in recent years.
The nominal value of these CDSs on CDOs is about $125bn, according to estimates by Standard & Poor’s, and banks with the most exposure, such as Citibank, Merrill Lynch and UBS, have already taken writedowns related to the hedges as the credit quality of the bond insurers has deteriorated in recent months.
To commute an insurance contract, the policyholder usually receives an upfront payment in exchange for agreeing to tear up the policy.
There is little certainty about whether or not these CDSs will ever have to be paid out. In theory, bond insurers could be on the hook for billions of dollars, but it is possible that if market conditions stabilise and improve, their actual pay-outs might be low.”
This reminds me of when I make my typical $50 bets with friends on a sporting events and half way into it I am getting killed. I always ask, “how about I pay you $5 now and we call it even” before the game is over knowing my odds of losing $50 are near a sure thing. Hey, you never get anything in life unless you ask for it, right?
This desperate act comes as reports are surfacing that the public mutual fund universe has not been truthful about their structured mortgage debt marks. Sources say that most mutual fund managers have their MBS holdings mis-priced, which puts the public at significant risk. The job that structured mortgage debt did on hedge funds and banks has been bad, but a mark-to-market across the public mutual fund universe could be worse because it larger and directly effects Ma and Pa America. -Best Mr Mortgage
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