News hits us this late Friday that the word on Wall Street is all about the coming bank bailout of Ambac. The market was down big after yesterday’s loss and had dropped further until the news hit in the last 30 minutes of trading.
U.S. stocks rallied in the final 30 minutes of trading, helping the market post its second straight weekly gain, as speculation bond insurer Ambac Financial Group Inc. may be rescued overcame concern bank earnings will falter.
American International Group Inc. and JPMorgan Chase & Co. led the Dow Jones Industrial Average’s 243-point turnaround. Ambac, which guarantees more than $500 billion in debt, climbed the most in three weeks after CNBC reported that the bailout to salvage its AAA credit rating may be announced next week.
“This will cheer us up, if it in fact turns out to be true,” said Bill Stone, who helps oversee $77 billion as chief investment strategist at PNC Wealth Management in Philadelphia. “People are buying into the story.”
Remember, the global financial system is at its heart, a confidence game. People buy and sell stocks for what they believe these stocks are worth, the same with derivatives, CDOs, SIVs, and so on and so forth.
The Monoline Nuke happens when the rating agencies downgrade the monoline insurers. The only way the level of leverage that currently exists CAN exist is through supreme confidence. The monolines have seen their value tumble in the last two months. This is affecting their ratings from the ratings agencies.
The bottom line is that for companies like Ambac to exist, they must maintain the highest credit rating possible: AAA. They must have pristine ratings in order to ensure $2.4 trillion in bonds when the companies themselves are worth maybe a few billion at most, and have lost hundreds of millions in stock value since the subprime mess. In other words, these companies are insuring bonds that are roughly one thousand times the value of their company. You cannot do that without a triple A rating. You must have the highest possible credit rating to exist.
So, if the ratings agencies lower their ratings as has been rumored for quite some time now… (h/t and Big Shitpile(tm) Atrios)
As troubled bond insurers like MBIA and Ambac fight to maintain their triple-A ratings, officials at these firms are pondering how their businesses might look if they do indeed get downgraded, CNBC has learned.
The decision by the big ratings agencies, Moody’s, Standard & Poor’s and Fitch is imminent, and at least one of the raters could make an announcement sometime today.
Bond insurers guarantee bonds held by investors from default, agreeing to pay interest and principle if the issuer doesn’t do so. But maybe more important to investors is that insurers also lend their triple-A rating, the highest rating in the bond market, to the bonds as part of their insurance package.
People inside the New York State insurance department, which has taken the lead in trying to prop up the insurers, say both MBIA and Ambac have enough assets to cover losses stemming from their insurance of depressed collaterialized debt obligations, or CDOs, held by large banks like Citigroup.
The bigger question is whether these firms can compete with ratings less than triple-A, particularly now that the bond insurance business will be focusing on covering bonds of municipal governments. Many large investors of municipal debt can only hold securities with triple-A ratings.
…then the whole thing falls through. The bailout by the banks of Ambac is, quite frankly, the desperate move of the global financial system.
If this bailout doesn’t work…and we’ve learned something I think about throwing good money after bad here…then it’s over. The bond market collapses like subprime did. $300 billion in losses from subprime become trillions in losses from junked muni bonds.
So therefore, the bailout should be a done deal, yes?
No.
Of course, MBIA and Ambac could still convince the rating agencies to maintain their triple-A’s, something that New York State insurance commissioner Eric Dinallo has been working on for the past month.
As reported on CNBC, Dinallo is working on separate plans with consortiums of bank that may infuse capital and provide lines of credit to sure-up the bond rating businesses at FGIC and Ambac and prevent downgrades. MBIA recently raised several billion dollars in new capital from Warburg Pincus.
But analysts are increasingly skeptical that even with the infusion of cash downgrades can be avoided because of the massive losses the insurers might take on their coverage of CDOs and other bonds that are packed with depressed subprime loans. As evidence, they point to recent management changes at MBIA and other moves; just yesterday, MBIA announced that wants to split its municipal bond business to shield it from the losses on its business of insuring CDOs. The move is being seen as a way to placate regulators and bond raters as a decision nears.
The monolines are manuvering to leave all the bad debt behind from subprime, while keeping the good credit rating and assets. The problem is this…somebody has to assume that debt.
And that’s the problem. Nobody seems to know just how bad that debt is going to be, especially since the banks aren’t sure how much more they are going to have to write off as bad debt due to the continuing housing depression.
And the housing depression is getting worse.
Prodded in part by some of the nation’s biggest banks, the Bush administration and Congress are considering costly new proposals for the government to rescue hundreds of thousands of homeowners whose mortgages are higher than the value of their houses.
Not since the Depression has a larger share of Americans owed more on their homes than they are worth. With the collapse of the housing boom, nearly 8.8 million homeowners, or 10.3 percent of the total, are underwater. That is more than double the percentage just a year ago, according to a new estimate of the damage by Moody’s Economy.com.
Now, how bad do you think it’s going to be say, six months from now? Twelve? Do you think we’re going to see a multi trillion dollar bailout program?
Administration officials say they still oppose any taxpayer bailout for either people who borrowed more than they could afford or banks that made foolish loans during the height of the speculative bubble in housing.
But with the current efforts to arrest the housing collapse so far bearing little fruit, Washington is being forced to explore new ideas, among them the idea of a federal mortgage guarantee for troubled borrowers.
And policy makers are listening to proposals from industry and community groups to use government funds to purchase and refinance billions of dollars in mortgages now in danger of default.
Many owners are only gradually becoming aware that their homes would sell for less than the debt against them — a phenomenon, said Richard T. Curtin, director of the Reuters/University of Michigan Surveys of Consumers, that is “beginning to weigh on people, making them uncertain and nervous about the future.”
Negative equity triggers penalty rates on adjustable rate mortgages. When that negative equity reaches, say, a total of 110% or 115% of the mortgage…in other words, you owe $115,000 on a house that’s now worth $100,000…that’s when the bad things start happening.
The collapse in home prices is hurting people with prime mortgages now. Right now 8.8 million homes are in various stages of negative equity. And as housing prices continue to plummet, the closer they get to that trigger rate.
When that happens, their mortgages go through the roof. They need to sell the home and they can’t sell it. So…they’ll walk away from it and mail the keys in…jingle mail.
What happens when millions of people decide to do that at the same time, trapped by negative equity that continues to worsen thanks to inflation, depressed home values, and higher rates?
Boom. The problem with this financial crisis is that all of them are now tied together. If one system falls, it’s not limited to just one system. It’s like the human body…if your kidney fails, you have a second. You can survive.
If your kidney, heart, lungs, and liver all go at the same time, you die. It’s too much and the system, in this case you, break down. Systemic failure.
That’s what we’re facing here. The bailout of Ambac is a shot of medicine in a desperate attempt to save a dying organ, the body being the global financial system. But too many of these organs are failing at once: real estate, the dollar policy, bank reserves, derivatives, credit markets, stocks. They’re all in deep, deep trouble and individually on the edge. The more individual organ failures are prolonged, the worse its going to get with the shock crashes all of them at once.
And then the system dies.
The banks have no choice but to make this bailout work, if they don’t, The Monoline Nuke goes off for sure.
Watch next week carefully. It’s like defusing a bomb by putting the time in liquid nitrogen to slow it down…but it’s still ticking.
And when it stops….
Boom.