Blog Spotlight: naked capitalism

Its been quite a while since our last edition of Blog Spotlight: Tonite, I am pleased to present Yves Smith’s naked capitalism.

Yves is a refugee from a big Wall Street iBank, and has put serious time into a well known consulting firm. I have been particularly impressed with Yves coverage of the monoline insurers (Ambac (ABK), MBIA, FGIC). As you will see, her thoughtful post below reflects both his sharp wit, worldly banking experience and insight into this sector.

This is part of our ongoing short list of excellent but somewhat overlooked
blogs that deserves a greater audience. I hope you find it as illuminating as I have . . .


Monoline Death Watch: Is There Really a Plan Here?

Posted by Yves Smith at 8:55 AM, Feb 19, 2008

Ever since Eliot Spitzer threatened the troubled monoline insurers
that he’d break them up, everyone has acted as if that’s a viable

But this talk of a split reminds me of movies about Hollywood, where someone buttonholes a producer with his pet idea:

it’s like Flashdance, except you reverse it: the girl is a Hispanic
ballerina who started stripping to pay her student loans…."

Like the film proposal, the break up notion is still at the high
concept stage, little more than, "let’s separate the muni operations
from the rest."

And while admittedly Ambac has had only the long weekend to work on its plan, the update as of Monday evening via the Wall Street Journal suggested that the group is flailing around.

Consider: they’ve already backpedaled.  Now Ambac wants to raise $2 billion first, then divide later:

Ambac Financial Group Inc. is discussing a plan to raise at least $2 billion in much-needed capital to help the world’s second-biggest bond insurer retain its top-notch credit rating, according to people familiar with the matter.

The extra cash, to be raised by selling shares to existing investors at a discount, would likely be a prelude to a trickier and lengthier move: splitting itself into two businesses.

Remember, Ambac was trying, like all the other bond guarantors, to raise money before Spitzer delivered his ultimatum. That went nowhere. But we are now back to Plan A, except with the break up idea added.  But does that make investing any more attractive?

The answer is no. Before, you had a situation that was either going to end badly, if you believed Bill Ackman and the shorts, or was misunderstood and therefore perhaps a buy, if you believed the insurers.  (Aside: my sense is no one has lifted the kimono enough for anyone to get a reading as to the exposures, which does not encourage investors). In other words, you had a high degree of uncertainty (how bad will the mortgage business get?  How much capital might be needed over time to keep an AAA rating?), but it could be analyzed.

Now, Ambac is seeking to raise money. It hopes to split up, but gee, we aren’t certain we can do that, and even if we can, we aren’t exactly sure yet how this will work.

Is any one with any sense going to invest in a proposition like that?  You have absolutely no idea what you are getting into.  This whole discussion of a breakup plan has increased uncertainty enormously and raised the specter of litigation risk. Those are not exactly comforting to investors.

Why this volte face? Remember, the earlier plan, as of Friday, appeared to be "split ’em up, we can raise capital for the good muni business, the hell with the rest."   Assuming you could segregate the muni operations, this plan might work. If MBIA could raise over a billion (albeit with a Warburg Pincus backstop), Ambac and its buddies might be able to stump up enough to pay the steep reinsurance rates that Buffett is demanding.

It appears they have discovered that they lack a legal basis for preferring the muni policyholders over the others, and even if they try not to prefer one group over another, it is going to be well nigh impossible to come up with a formula that won’t be contested. The Journal, along with others, sounded the litigation drumbeat:

Splitting the business between its municipal-bond and its riskier structured-finance operations…..would be financially and legally messy. It would pit policyholders and shareholders against both each other and regulators….

"It may sound politically convenient to separate out the muni business, but it’s going to invite a raft of lawsuits," says Sean Egan, managing director at research firm Egan-Jones Ratings Co.

In addition, you have the minor detail that a break up may Destroy the World of Finance as We Know It. From Bloomberg:

Credit ratings on more than $580 billion of asset-backed securities may be cut, sparking writedowns by banks, under New York regulator Eric Dinallo’s plan to break up bond insurers….

“This is one of the worst possible outcomes for the market,” Gregory Peters, head of credit strategy at Morgan Stanley in New York, said in a telephone interview. Lower ratings would force banks that own the mortgage-backed debt to write down the value of the securities by as much as $35 billion, he estimated.

And that $35 billion is far from the biggest damage estimate we’ve read.

As we said, this split up idea never made any sense. If you talk to any dealer, say in estates, they will tell you that you sell items individually only if you think they will attract bidders (remember, the "good bank, bad bank" construct works because there are bidders for each portfolio).

If you have some items you think no one will buy separately, you put it in a lot with a few nice but not spectacular items. There is something weird about human nature, but generally a lot with more stuff in it will attract higher offers, even if the bidders  really only want one or two items.

No one seems to expect that the "bad insurer" operations will attract investors. The comments from the regulators suggest the "bad" operation would be put in runoff mode.  But that violates the rule of auctions above. The regulators would be more likely to get a good (or any) offer for the insurers in whole rather than in parts (as MBIA’s example confirms).

Now unless Dinallo and some brilliant lawyers comes up with a way to cut the Gordian knot (ie, they find a legal theory that permits them to discriminate among policyholders), we see a complete mess here. The split up idea has made matters, as bad as they were, even worse:

1. Ambac may have backed off the idea, at least until it has a legal basis for the breakup and a plan for how to accomplish it, thinking (as the Journal intimates) that the rating agencies won’t hold off their downgrades that long. But no investor with an operating brain cell will invest until the break up plan is fleshed out.

2. At least for FGIC, the way the breakup idea was announced angered the rescue group (such that it was, it hadn’t gotten very far). Ambac appeared to have had the most serious investor discussions, but the switch over last week to trying to shore up the muni business is of no interest to the banks who had been solicited before (remember, they wanted to rescue Ambac to save the "bad" part that is now being written off). Thus the most likely investors have been shooed away.

3. If Spitzer or Dinallo tries to force a break up on any of the insurers, they may encounter fierce opposition. The regulator has the authority to step if there is an impairment of the insurer’s ability to meet its obligations to policyholders. But what authority does he have to step in to avert a downgrade? I’d wager he has none.

Microsoft has long used FUD, Fear, Uncertainty, and Doubt, to paralyze its competitors. This bunch has managed to introduce a ton of FUD into something they want to move forward.  Good luck.

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What's been said:

Discussions found on the web:
  1. Pool Shark commented on Feb 19


    Pension Benefit Guaranty Corporation is looking for higher-risk investments…

    Ambac is looking for investors who will turn a blind eye to risk and uncertainty…

    Sounds to me like a match made in heaven; what could possibly go wrong?

  2. Florida commented on Feb 19

    naked capitalism is definitely a blog I have on my essential reading list. Great site!

  3. UrbanDigs commented on Feb 19

    agreed. Yves does a great job on naked capitalism and is a daily must read!

  4. livefreeordieslow commented on Feb 19

    While we’re at it, how about a list of regular iTunes podcasts as well?

    Any recommendations from the peanut gallery on some good financial/educational ones?

    I’ll start:
    – Financial Sense Newshour (Doom, fiat complaints & Nat Res)

    – Businessweek Cover Stories (interviews of the authors)

    – Stratfor Geopolitical Daily (world in 5:00)

    BR – thanks as always for such a great site and great resource!

  5. Florida commented on Feb 19

    Bloomberg has podcasts available on their website, I believe.

  6. Advsy commented on Feb 19

    Gordian knot is right. There is no way to split that stuff up? The way minds work sometimes!

    My guess is that the monolines have been going along with this in the hopes that they can find a way to foist the toxic waste parts onto the taxpayers tab.

    I also question just how good the muni side of the business really is?? I understand that it is not nearly as toxic as the three letter crap they have insured but just because Muni failure rates have been very very low, does not mean that in this world of financial engineering that this will hold true over the next couple of years.

  7. Johnny Vee commented on Feb 19

    I heard the split theory on BP–I think Barry said his sharp sister mentioned it a while ago. Well, I’ve got an idea too. I’d like to split my business into two parts. One will have all the safe assets and the other will have all the risky assets. Think that the creditors on the risky side will go for it. Sure. This idea was a turd to start with. If you thought this was a good one you should re-evaluate other ideas you thought were good and give them a sniff.

  8. Stuart commented on Feb 19

    My top 7 must visits.

    The BigPicture (The one and only BR)
    Calculated risk (CR, Tanta)
    Financial Sense (Jim Puplava)
    JSMineset (Jim Sinclair)
    Naked Capitalism (Yves Smith)
    Global Economic Analysis (Mike Shedlock)
    Wallstreet Examiner (Lee Adler, Russ Winter)

    These 7, first class in my books.

  9. oroboros commented on Feb 19

    Big Picture (overall focus)

    Naked Capitalism (an alternate take on things, more institutionally focused) (for my daily dosage of apocalyptic visions and occasional brilliant insights)

    Calculated Risk (mostly real estate related, but some good macro analysis as well)

    Mish’s Global Economic Trend Analysis (another alternate take on things)

    Money and Markets (secondary, but interesting)

    Financial Sense (though the site is a beast to go through – gems and coal here)

    RGE and Roubini (when I’ve got the time to think that hard)

    Still haven’t found a good Currency or Eurocentric (A Fistful of Euros is the closest, but it isn’t strictly financially focused) site/blog yet.

  10. VoiceFromTheWilderness commented on Feb 20

    The really funny thing about the ‘split em in two option’ is that Warren Buffet had offered to take ‘the good’ part, which would have gotten the muni market back on it’s feet w/o incurring massive litigation, and he was turned down. Then a week later the monolines announce they want to do the same thing except to themselves.

    Could they be more transparent? ‘gee that idea of Buffets sure is smart — great way to make big bank insuring nice stable bonds like muni, maybe we can engineer it so we get that sweet deal’. Sure right. Having screwed themselves out of exactly that business, they want to let others hold the bag as they get back into that nice safe business.

    Hey, that’s what free market capitalism is all about.

  11. MrWoohoo commented on Feb 20

    “But no investor with an operating brain cell will invest until the break up plan is fleshed out.”

    They should be able to find plenty of investors that match the “no operating brain cells” criteria. Of course, they might be all tapped out from the dotcom crash, but I’m sure they could be convinced to take out 2nd mortgages on their homes to raise cash.

  12. Carlomagno commented on Feb 20

    Yves is a woman!? That’s a man’s name where I come from.

    Anyway, agree that Naked Capitalism is a great blog.

  13. Helen Thomas commented on Feb 20

    Carlo – us Brits at FT Alphaville are confused too – short for Yvette or Yvonne maybe? Either way, Yves writes a great blog.

  14. Max commented on Feb 20

    nakedcapitalism is a great blog, the depth of information and analysis there is unmatched. I always wondered who Yves was, considering the the bleeding edge information presented, so the fact that he is a former ibanker explains it.

    My most visited blogs:
    1. Global Economic Analysis
    2. TBP
    3. The Housing Bubble Blog
    4. nakedcapitalism
    5. Overcoming Bias
    6. Consumerist

  15. Independent Accountant commented on Feb 20

    Naked Capitalism is one of my favorite finance and economics blogs. I don’t agree with Yves Smith all the time, but I do about 90% of the time. He does a fine job distilling out that which is important from that which is trivial.

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