Quote of the Day: Bill Gross on Monolines

Bill Gross, in the FT, asks some rather intriguing questions late last week:

"How could Ambac (ABK), through the magic of its triple-A rating, with equity capital of less than $5bn, insure the debt of the state of California, the world’s sixth-largest economy? How could an investor in California’s municipal bonds be comforted by a company that during a potential liquidity crisis might find the capital markets closed to it, versus the nation’s largest state with its obvious ongoing taxing authority?"

Bill Gross

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The alchemy identified by Gross: Wrapping high risk paper in a high risk derivative / insurance contract does not eliminate any of the risk, nor does it make high risk paper investment grade.

This is slowly being realized for what it actually is: Massive fraud on a widespread structural basis.

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Source:
Rescuing monolines is not a long-term solution
William Gross
Published: February 7 2008 18:14
http://www.ft.com/cms/s/0/bb7e80c8-d58c-11dc-8b56-0000779fd2ac.html

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  1. michael schumacher commented on Feb 11

    Pimco talking it’s book.

    He should just come out and say what he WANTS to say but can’t or won’t.

    Ciao
    MS

  2. Dave commented on Feb 11

    Whoa with the hyperbole. Nobody was insuring the debt of California, the world’s sixth largest economy. It was insuring the debt of the state government which has huge taxing powers and with a Dem legislature an eagerness to use it.

  3. Joe black commented on Feb 11

    There is a reason that Buffett calls derivatives WEAPONS OF MASS FINANCIAL DESTRUCTION. He has been talking about all of the risks in derivatives in his annual meetings and in his annual report since 2002.

  4. Joe black commented on Feb 11

    There is a reason that Buffett calls derivatives WEAPONS OF MASS FINANCIAL DESTRUCTION. He has been talking about all of the risks in derivatives in his annual meetings and in his annual report since 2002.

  5. Stuart commented on Feb 11

    If those comments by Gross don’t crystalize consensus that the performance of the rating agencies have been criminally negligent, nothing will. One of these days, people will start quantifying counter party risk too. That’s when the fun begins.

  6. KP commented on Feb 11

    I blame both the insurers and insurees.

    Somebody on buy side of this equation HAS to seriously contemplate whether the sell side has the means to deliver and it doesn’t matter if “everyone else is doing it”.

  7. RW commented on Feb 11

    Exactly so. Try screening a pool of otherwise comparable muni’s into insured and uninsured subgroups then compare yield and default rate(s) and notice where the significant differences lie.

    Interesting, eh?

    Nice little game the rating agencies and bond insurance co’s had going wasn’t it?

  8. Justin T commented on Feb 11

    Before I read any other post, why don’t you and guys like you call these men out on this? I realize that the powers that be have lots of power, but should not the media be the place to bring the shady practices to the fore? Or is that just when one side of the isle makes the mishap ( and nothing is ever seen or heard) – cira Water Gate? (Let’s face it this is “MONEY” not politics.) What does it take to get a sensible polemic truth beyond the pale? Perhaps some truths are better served, upfront?

  9. Neal commented on Feb 11

    Even if you could separate out the “bad” stuff from the municipal bonds, what makes anyone think that the capital reserves of the insurers are sufficient to withstand the defaults that will occur as the economy recedes?

    The collapse of municipal and state revenues WILL follow the decline in real-estate funding structures. This second wave is big enough to alone take out the insurers.

  10. michael schumacher commented on Feb 11

    Massive Fraud that is being treated as if it were a puppy with a “cuteness” problem.

    And if these problems were in the favor of the banks and brokers we know what the outcome would have been.

    SEC is asleep at the wheel and would rather target people who make a few quid off of the market instead of the ones who fleece it for many billions-that continues to get larger by the day.

    Ciao
    MS

  11. ECONOMISTA NON GRATA commented on Feb 11

    When the smoke clears on this fiasco, there will be HELL to pay.

    Florida’s Municipal Investment Trust was recently raped by Lehman Bros. as they moved toxic waste out of their pipeline. Guess who’s a consultant to Lehman. You guessed it Good ol’e Jeb Bush, former Governor of FL. Most of the toxic garbage moved during 3/Q07….????????? A Lehman spokes person claims that JB played no role in the sale of the garbage to the State of Florida…. JB was the former trustee of this same fund…..

    Gee, As Henry VIII would say…..

    “What do they take me for……? A SIMPLETON….?

    Econolicious

  12. Roger Thatchery commented on Feb 11

    Thank you, Big Picture, for once again stripping away the veneer of respectability from parties that do not deserve it.

    This is indeed fraud. The bond insurance scammers and their partners in the ratings cartel perpetrated a fraud. It’s not “something that just sorta happened”. It’s called white collar crime.

    The absurd delay in downgrading these zombie outfits is entirely political. The New York AG’s performance was a political delaying tactic. They have made a mockery of AAA because the players are “too big to fail” – the biggest lie ever sold.

    But now, finally, these sharks are feeling the heat from other sharks, the class-action lawyers. Which tells us that there really is no sheriff in town. All we regular folks can do is hire freelance gunfighters to settle the score.

  13. Stuart commented on Feb 11

    AIG admitted today that basically because they don’t know how much of a derivative loss to quantify, they’re not going to quantify any loss.

    I’ll try that with my taxes. I can’t accurately quantify how much tax I owe, so I won’t remit a penny. I wonder if I will get away with that.

  14. steelhead commented on Feb 11

    A pig dressed up is still a pig…

  15. steelhead commented on Feb 11

    A pig dressed up is still a pig…

  16. Johnny Vee commented on Feb 11

    Oh Bill! You sound like my Dad sometimes. Loosen up.

  17. ZackAttack commented on Feb 11

    I see this dance daily…

    Moody’s or S&P downgrade some bond or some thousands of bonds insured by the monolines.

    Tiptoeing around an actual downgrade of the monolines themselves.

    I know what I think, but does anyone have any concrete evidence that the rating agencies have been pressured or coerced not to downgrade the monolines until some kind of plan is in place?

  18. Jay commented on Feb 11

    “Thank you, Big Picture, for once again stripping away the veneer of respectability from parties that do not deserve it.”

    Would it help to remind us that the Emperor is wearing no veneer?

  19. kk commented on Feb 11

    There is a difference between technical and monetary default, and there is no clear path to who is accountable and will bear the financial burden in the event of a default (even on insured bonds).

  20. larry commented on Feb 11

    I do not think you can have a bailout of this mess until someone is charged with fraud. Having said that how do you go after LEH, as an example? Any rational person will conclude that LEH knew that the toxic sludge they sold to Florida was essentially worthless. But to prove that they knew is another story and basically impossible unless you can flip someone inside of LEH.

    The other issue is that the Justice Department is filled w/Bob Jones U. bible thumpers who would not know a bond from a bidet.

  21. Bob Brandt commented on Feb 11

    Are there some good reasons why I – a momandpop investor – should NOT be scared to death of the financial consequences of this mess? Please help me end the nightmares. TIA

  22. Bob Brandt commented on Feb 11

    Are there some good reasons why I – a momandpop investor – should NOT be scared to death of the financial consequences of this mess? Please help me end the nightmares. TIA

  23. David Merkel commented on Feb 11

    The shoe is on the wrong foot here. Ambac is rational to insure California, which is unlikely to default, and if it does default, would be very likely to come back to payin status. Most municipalities do. Ambac would only need to pay interest for a little while. In the meantime, California sells its bonds at a lower all-in yield than if they weren’t insured. Perhaps Bill Gross is upset because he wants uninsured higher yielding California bonds.

    Where Ambac has really messed up is on structured products — CDOs. The munis are fine.

  24. Winston Munn commented on Feb 11

    What a nice surprise – bring your alibis.

  25. RW commented on Feb 11

    “The munis are fine.”

    Of course they are but they always were and that was Gross’s point: Municipalities have never needed insurance, at least certainly not the kind the monolines sell, for exactly the reasons he cited; what municipalities pay to the monoline insurers is essentially a bribe to secure a higher rating from the rating agencies who also take their cut; the insurance premium charged by the monolines and the pay-offs to the rating agencies is less in total than what municipalities would have to pay in yield if their bonds had a lower rating.

    But there is no other qualitative difference in any bond performance metric I am aware of.

    The ratings agencies (used to) know this, the monoline insurers (used to) know this, and most of the municipalities and investors in municipal bonds know this but that’s the way the system works so the ‘bribe’ and ‘baksheesh’ are structural and technically legal.

    The move by monolines to insuring structured products was a bad mistake, yes, as was the move to same by ratings agencies but aside from becoming greedy I suspect they also forgot that their business model requires a stable and relatively placid host with the kind of revenue powers Gross describes; municipalities have that, mature corporations have that, structured products do not.

    There are a lot of ways to make serious mistakes with models but one of the more subtle and dangerous errors is to forget that models not only have an internal set of variables and rules but also operate within a certain domain wherein those rules have demonstrated sufficiency. The model of the monolines didn’t change, it’s domain did: Like the mobster who not only tries to extend his protection racket to high rollers rather than shopkeepers but does so in a neighborhood inhabited by a hostile gang and where he has no precinct bagman.

  26. jock commented on Feb 11

    NOW you tell us, BILL! Why didn’t you say so a year ago?

  27. Alex commented on Feb 12

    Come on… you guys are too cynical. The system works just fine.

    I have a way to fix everything. The major banks, who have feverishly tried to recapitalized themselves, will recapitalize the monolines, and the monolines will in turn insure the banks…giving them a AAA rating!

    If there are any other macro-finacial difficulties that need fixing, just let me know.

    Everybody is a winnah at my table baby!

  28. DavidB commented on Feb 12

    How could Ambac (ABK), through the magic of its triple-A rating, with equity capital of less than $5bn, insure the debt of the state of California, the world’s sixth-largest economy?

    OUT OF THE MONEY PUTS!!

    ROTFL!

  29. Eclectic commented on Feb 12

    Winston,

    MonoCline Railways are steep, huh?

    BTW, I have to give Mauldin credit for the word.

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