Monoline Duoline Rescue Plan: 5th Time the Charm?

US Equity markets were ending last week on a down note, when rumors of an Ambac (ABK) rescue plan started circulating (via Charlie Gasparino of CNBC)

A few issues that may be getting overlooked in the initial reaction to this:

1) This is the fifth such rumor in 2008, and I’m not sure why that is. Is it wishful thinking, or have the other deals have fallen apart? If they did, was it for good reason, too?

We had the initial rumor over a month ago (Next on the Worry List: Shaky Insurers of Bonds); that was a $15 Billion dollar bailout. Then came the Wilbur Ross – Ambac rescue plan. It went nowhere fast. Another bank consortium plan came and went. Lastly, the Buffett offer, which was widely misrepresented as Berkshire (BRK’A) injecting money into the monolines duolines, when in reality all Buffett offered to do was merely  sell reinsurance to the duolines.

2) The current rescue operation is for but $3B. This small sum is intriguing — not just relative to the prior rumors. First, the duolines have potential exposure anywhere from $30 to $75 billion dollars. On top of that, the bank’s counterparty and hedging exposure has been estimated at $150B to $200B. Can $3B really solve this problem?

3) From the FT Friday:  Banks to aid Ambac with up to $3bn

The banks looking at supporting Ambac include Citigroup (C), Wachovia (WB), Barclays, Royal Bank of Scotland, Société Générale, BNP Paribas, UBS and Dresdner. They have the most exposure to guarantees supplied by Ambac on structured bonds and derivatives, the value of which could fall sharply, resulting in billions of dollars of writedowns if the insurer’s credit ratings drop far below the triple-A level. (emphasis added)

Hence, the banks who are Part of the rumored consortium are (of course!) the ones who have the most to lose if any of the Duolines fail. This is not so much a bailout as a possible attempt to kick the can down the road. They have the most exposure to guarantees supplied by Ambac on structured bonds and derivatives, the value of which could fall sharply, resulting in billions of dollars of writedowns if the insurer’s credit ratings drop far below the triple-A level.

What’s truly bizarre is that a dozen banks spending three large may actually be a relatively good deal for them, if it avoids a quarter trillion in writedowns.

4) Coincidence or good timing?  Look who’s expected to report writedowns this week:  Fannie Mae (FNM), Freddie Mac (FMC), Lehman (LEH), Morgan and Goldman Sachs (GS), and Royal Bank of Scotland.

The bottom line: Until this deal gets done and the details are better known, its simply another in a loing string of rumors.  Worse yet is what it means: Banks have so much derivative exposure they are willing to throw away $3 billion to prevent the counter-parties from getting a ratings agency downgrade.

UPDATE: January 25, 2008 2:50pm

S&P has
reaffirmed MBIA’s AAA rating. Markets are rallying on the news. To achieve this feat, MBI was forced to sell surplus notes at par that yielded 14% during that capital raise –t hat is way above junk bond levels. In the markets, its trading between 97-100. Note that US Govt is AAA, GE is AAA , Exxon Mobil, Johnson & Johnson, Berkshire Hathaway and Northwestern Mutual are also AAA.

Peter Boockvar of Miller Tabak points out:

"What S&P is saying is that a bond
yielding 14% in the marketplace is also AAA. It’s now a game among the rating
agencies, regulators and banks with whether the bond insurers are rated AAA or
not when they clearly are not and their securities don’t trade as they are. This
is being done in an attempt to prevent the banks from going through another
round of writedowns."

What of Ambac? Any hope of its AAA
ratings reaffirmations are likely contingent upon a deal going thru — and if it
falls apart so, do any hope of AAA ratings for Ambac.

What this really points out is how worthless
and corrupt the S&P and Moody’s ratings actually are.

Forget that the foxes are watching the henhouse, it
appears that the regulators, banks, insurers, and SEC, Federal Reserve — pretty
much anyone else you can think of — are all in cahoots with each other. Its
American Socialism at its finest . . .

>

Source:
Banks to aid Ambac with up to $3bn
Aline van Duyn and Ben White in New York
Fri Feb 22 19:25:37 EST 200
http://www.ft.com/cms/s/91568ea8-e1b2-11dc-a302-0000779fd2ac.html

Alternate link
http://us.ft.com/ftgateway/superpage.ft?news_id=fto022220081945499701

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What's been said:

Discussions found on the web:
  1. Eric Davis commented on Feb 25

    Interesting questions?

    Why isn’t Morgan Stanley involved?

    Why isn’t there much clarity about if it’s a Capital infusion to save the AAA, or if it’s a Good Bank/Bad Bank… that will end up in litigation for the next 10 years?

    Why would the banks support a Bad Bank solution on the CDO portion?

    Newly Reported: Waiting for the Ratings agencies to Act, for the deal to happen?

    They are going to wait to rescue them till the Boat Sinks? (this sounds like a downgrade rescue plan.)

    It was some interesting market timing.

    Interesting stuff.

  2. dhukka commented on Feb 25

    As I understand it, the banks were not going to stump up cash but rather backstop a rights issue by AMBAC. If it were as easy as stumping up $3 billion to prevent ratings downgrades, why wasn’t this done months ago? Something doesn’t quite add up.

  3. Chief Tomahawk commented on Feb 25

    Goldman Sachs couldn’t possibly have a writedown… they’re the best there is! They gave us Treasury Secretary Paulsen, who tried to give us the SIV plan, something even Larry Kudlow shook his head at.

  4. Stuart commented on Feb 25

    The Art Of Financial Prestidigitation

    Author: Jim Sinclair

    The busted banks are putting up money (that can only come from the Fed) in order to save the busted guarantee company. The idea is to maintain the aura of a guarantee so that the busted banks do not become more busted by letting the busted guarantee company fail. Damn, they are good spinners. This is quite a transparent economic bandage. Consider the companies guaranteeing $1 trillion of debt in this financial condition. When splitting the companies was run up the flag pole the market said boo. This act of a new foundation of loose peddles holding up the Empire State Building is financial prestidigitation.

  5. mhm commented on Feb 25

    It is becoming clear that the bubble won’t burst. It is instead leaking fast, threatening a collapse.

    What we saw Friday 3:30PM was a violent injection of hot air to keep the balloon from crashing. Rumors is all that is left in the rescue kit?

  6. UrbanDigs commented on Feb 25

    100% correct. The banks are paying $3B for more time with AAA rating for duolines.

  7. Chester White commented on Feb 25

    The reaction of the market to things like this is utterly inane.

    Wilshire says total stock market cap is around $15 trillion.

    A rumor of a $3 billion dollar bailout and the total market cap goes up almost 2%, or $300 billion?

    100-to-1?

    Please.

  8. mhm commented on Feb 25

    “[list of banks to the rescue]. They have the most exposure to guarantees supplied by Ambac”

    And what guarantee a guarantor provides if it depends on its own subscribers? Can I write myself a $1,000,000 check and use that as a collateral for borrowing? _uck, how did I miss that all this years? [runs to the bank]

  9. Stuart commented on Feb 25

    “And what guarantee a guarantor provides if it depends on its own subscribers?”

    Well that certainly seems to be THE central point here that most supporters of this M-LEC copycat are missing. Self-fund my own collateral, self-fund my own insurance. Astonishing lengths Pigmen will travel to keep the game going instead of just taking their medicine and absorbing the write offs…. Perhaps they realize the losses are larger than acknowledged? Perhaps they realize full absorption of write-offs are simply not practical given their scale, especially factoring in counter party defaults? Perhaps realization is privately accepted that the collateral base, the foundation supporting a mountain of debt has much much further to erode worsening matters materially? Perhaps this is the last dance before a full scale request of a public bailout – already hearing well placed scuttlebutt about that coming soon to a taxpayer near you. http://www.nytimes.com/2008/02/23/business/23housing.html?_r=2&ref=business&pagewanted=all&oref=slogin

  10. Don commented on Feb 25

    When the insured has to bail out the insurer, the insured has no real insurance. Of anything.

    That the fiction of a better rating–not a more solvent counterparty–is all the banks seek, the fraud comes full circle.

    After this $3b gets their putative insurer a better rating, (nevermind the utter worthlessness of its validity) what happens when the banks try to make some of those $200b of claims outstanding? Will the rating pay them?

    No matter what happens from here, the banks are actually self-insured, which is to say not at all, unless you count the central banks, and with them around, what point are the duolines anyway?

  11. Winston Munn commented on Feb 25

    Wouldn’t it be cheaper to bribe the rating agencies directly?

  12. pjfny commented on Feb 25

    How can a AAA rating be attached to a company issuing stock below its current value diluting current shareholder……and issuing debt at 8-9-10–
    14?pct……the mkt will not buy the bonds at 25-30bp above treasuries (AAA rated)

    Who will be doing business with this company (buy insurance ) going forward, with the risks involved.

    How do you solve a potentially multi hundred bil problem with 3bil, when nobody knows how it will end in terms of foreclosures and impact
    on insured CDO.

  13. Pat G. commented on Feb 25

    $3B is the proverbial “drop in the bucket”. As I remember correctly “this plan” is supposed to be announced either today or tomorrow. Now I hear next week. When were the rating agencies supposed to make their assesment of the monolines/duolines by? This rumor will keep the markets afloat until the FED’s next cut.

  14. E commented on Feb 25

    With all these rumors abounding, playing the SKF/UYG swing trade is like playing roulette, without the free drinks.

  15. RobT commented on Feb 25

    They are reiterated as AAA so why do pundits still talk about them. They are the rating agencies, they should know the risk better then us.

    Why not AAAA?

  16. mhm commented on Feb 25

    “Why not AAAA?”

    They’ll be rated AAAAH when prices fall off the cliff.

  17. JAN commented on Feb 25

    Wouldn’t it be cheaper to bribe the rating agencies directly?
    Posted by: Winston Munn

    Stocks surged after S&P said that it is maintaining its top credit ratings on the nation’s two largest bond insurers. WSJ 3:03pm

    It was cheaper to bribe the rating agencies directly.

  18. Winston Munn commented on Feb 25

    Wouldn’t it be cheaper to bribe the rating agencies directly?
    Posted by: Winston Munn

    Stocks surged after S&P said that it is maintaining its top credit ratings on the nation’s two largest bond insurers. WSJ 3:03pm

    It was cheaper to bribe the rating agencies directly.

    See, there was an easy solution, all along.

  19. NoFate commented on Feb 25

    I think they are trying to keep this propped up long enough to talk congress into a taxpayer funded bailout. The only other end games are either eventual collapse or Japan style deflation.

    Irony of the day: With the Federal Reserve propping up the stock market they are helping to keep 10 year treasury rates high …and thus hurting the mortgage market. If the market were to crash then investors would rush to T-bills driving down the rates.

    Of course the other effect is when they lower rates the USD drops further raising inflation expectations …and offsetting every rate cut so far.

    The most rational thing for Bernanke to do would be do make a statement that would tank the stock market (and lower bond rates) …but he has to save Wall Street before he is willing to save Main Street.

    Welcome to the U.S.S.A comrades!

  20. Pat G. commented on Feb 25

    “When were the rating agencies supposed to make their assesment of the monolines/duolines by?”

    My question was answered later in the day by the rating agencies who say that all is well with the duolines. Really? Then why all the commotion to begin with?

  21. oroboros commented on Feb 25

    Delay, delay, delay …

    Prop up the old horse as long as possible until it all come crashing down.

    Lesson: The whole system is corrupt – there are no honest players.

    This will not end well.

  22. donna commented on Feb 25

    It only has to “work” until November.

    After that it can all be the Dems fault….

  23. zackattack commented on Feb 25

    I just… gotta share this. Of all the “WTF?” moments today, this has to the the WTF-iest:

    http://www.reuters.com/article/bondsNews/idUSN1264261420071212

    So, let me get this straight….

    Pfizer, which I see on Yahoo! Finance has $22b in cash, *lost* its AAA rating and had its outlook cut to negative.

    While MBI… oh, never mind.

  24. Karl K commented on Feb 25

    When I saw that MBIA and AMBAC had their AAA rating affirmed I had to laugh.

    No, not laugh because it’s ludicrous that the agencies did that. No, laugh because all of the fire-and-brimstone bears on here — and that means you too Barry — thought, even for a nanosecond that somehow this WASN’T going to be done, or SHOULDN’T be done.

    All of you…you are all SOOOOOOOO naive.

    Get real here…did you think a half dozen guys siting around a table were going to lower ratings on the monolines (exsqueeze me, DUOlines) and thereby set in motion a cascading credit market failure?

    Wow, all you guys (yep, that means you too Barry) are in dreamland.

    Look, I’ve said this before and I will say it again: it’s important to understand the REAL economic losses here.

    Not the fake, fictional, green-eye shade accounting stuff that is a function of a rating label slapped on piece of paper/or some electronic bits by a bunch of guys with off the rack suits who couldn’t get jobs with Goldman but instead wound up with S&P.

    Really, did ANYBODY on this blog ever take an accounting course? Do you KNOW that quite a few account concepts are fiction?

    So, too with these ratings. They are accounting fiction. But some fictions are good.

    Look, I have said this before, and I will say it again. All of you must keep in mid the length of the time over which actual economic monoline losses will happen. Don’t think naively about ratings. They mean nothing, except folks can keep stuff on their books as ANOTHER fictional valuation.

    No, think cash here — put yearly claims payments on one side and premium income/portfolio income less expenses on the other side and compare the outcome. Really, keep this in mind: All the mark to market adjustments killing the banks are irrelevant to a bond insurer. The risk the monolines face is whether investors lose principal and interest on the underlying investments and trigger their guarantees. Even if the guarantee is called, the monolines pay out claims on principal only at the original redemption date so the NPV exposure is a fraction of the notional sums insured.

    That means you need to look at these monolines as ongoing concern basis and in a runoff scenario.

    Another way to think about it is this: monline exposure can be compared to a written out-of-the-money put option to protect investors against extreme market events.

    But, to reiterate, so far we have had mark to market losses in a portfolio that is supposed to be kept until maturity.

    To date all the brouhaha has been about covenant triggers, valuations, and fictional accounting entries — green eyeshade stuff. Of course, the level of capital required to maintain an AAA is far larger than that required to merely assure that claims are paid for the next year or two. But again, that’s a labeling issue, not an REAL economic issue.

    The real economic losses will occur when claims are paid.

    Let the economic implications work themselves out slowly. You watch, they will.

  25. Jessica commented on Feb 26

    Please correct me if I am wrong, but

    If the underlying securities that the monoduolines are guaranteeing are basically fine and there is just an irrational, temporary devaluing, then this may stop that irrational devaluing.
    BUT
    if the underlying securities are not OK, then this is an agreement to basically just continue the suspension of real bookkeeping. That may postpones the day of reckoning but solves nothing. AND it reinforces the counter-party trust issue.

    To me, it seems the market is still pricing in 100% certainty that the Fed and allies can change the rules and make the problem go away.
    When the bubble of that faith pops, then things will get very interesting.

  26. mhm commented on Feb 26

    Karl K, you can’t conclude with:

    “Let the economic implications work themselves out slowly. You watch, they will.”

    When you point that:

    “did you think a half dozen guys siting around a table were going to lower ratings on the monolines (exsqueeze me, DUOlines) and thereby set in motion a cascading credit market failure?”

    So, a “half dozen guys” prevent a market failure by extending the AAA for while. That does not equate to the market working itself slowly.

    Also you should re-read the duolines post and understand the reasoning there.

  27. Mike commented on Feb 26

    How is this socialism?

    When the businesses collude with the government to obtain taxpayer subsidies and regulatory forebearance in order to string out their con game and defraud shareholders and investors, that is not socialism and certainly not communism – that’s mafia capitalism.

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