Bond Insurers

Is Bond Insurance Magical?

A few months ago, we beat up a couple of Portfolio writers on the subject of municipal bond insurance until it got so easy we started to feel bad for them. Their contention was that bond insurance was a scam perpetrated by a conspiracy of investment bankers, ratings agencies and insurance companies. We argued that bond insurance persisted because of genuine market demand for lower risk investments.
At the heart of the Portfolio position, however, was a genuinely important insight: municipal bond default rates were so low that insuring the bonds seems irrational. Do you really need to purchase insurance for a class of bonds that have a 0.5% historical default rate?
An article by one of favorite New York Times writers, John Tierney, points out that irrationally insuring against small risks is not confined to muni bonds. “We buy insurance not just for peace of mind or to protect ourselves financially, but because we share the ancient Greeks’ instinct for appeasing the gods,” he writes.

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  • 05 Mar 2008 at 3:11 PM
  • Ambac

Ambac Offering: Is That It?

Ambac Financial Group, the so-called monoline bond insurer which has operating under the shadow of a credit-rating downgrade that would likely wipe-out its business, announced plans to sell $1.5 billion of common stock and equity units to bolster its capital. The market promptly threw up all over the trading floor.
It’s a safe bet that Ambac has the offering fully subscribed at this point. If they didn’t have commitments from buyers they wouldn’t have given us the $1.5 billion figure. But the announcement fell short of the hopes and rumors that had become ubiquitous on Wall Street in the last two weeks. Reports had lead many to believe that Ambac would be receiving an immediate capital infusions from a consortium of banks. Instead we got a prospectus for a public offering. The market was looking for between $2 billion and $3 billion. It got one and half billion. It looks like the private equity money walked away from the deal, leaving Ambac short of market expectations.
The ratings agencies seem to be split. Moody’s Investor Services said it believes that if the offerings are successful they would be able to affirm the company’s top-notch AAA rating. Fitch immediately announced that Amac would unlikely to recover its AAA rating with this move—they’re keep Ambac at AA and on negative credit watch. Standard & Poor’s, which affirmed Ambac’s ratings last week, hasn’t said anything.
Shares of Ambac promptly dropped as much as 20 percent but have started to recover a bit.
The prospectus for the equity units is here. And the common stock prospectus is here.

Barry Ritholtz wonders if there might not be some kind of market manipulation behind the rumors that saw Ambac’s shares run-up earlier today.

WSJ Marketbeat announced “Ambac Bailout Imminent! Maybe! Possibly!”
Then we learn that the deal was dead, and that Ambac needs to raise $1.5 billion dollars. Thus, all of those rumors and CNBC appear to have been patently false.
But here’s the question that keeps coming up: Who are the people leaking this information? And, is this legal? Now, we have learned that all of these attempts at manipulating the market were based on rumors that proved to be false.

On Munis, Ratings And Contrarianism

We get called contrarian often enough that we’re nearly resigned to the label. From our perspective, of course, we’re not contrarians at all. We’re so deficient when it comes to having a decent respect for the opinions of mankind that we aren’t even aware of the prevalence or rarity of the positions we take. If we seem contrarian, we suspect it’s just because so many others are wrong so often.
The debate over municipal bond ratings is a good example of this. Over at Portfolio—published out of an august tower located in Times Square—they are convinced that Moody’s, Fitch and the like assign ratings that are too low to municipal bonds. This supposedly forces our towns, cities and states to pay higher interest rates or purchase bond insurance to achieve higher ratings. Jesse Eisinger, who holds the esteemed title of Senior Writer at Portfolio, estimates that this costs municipalities around $5 billion a year.

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Is Muni Bond Insurance A Racket?
The Portfolio Gang Responds!

Although it looks like MBIA is now out of the woods, rival bond insurer Ambac’s fate is still murky. Reports indicate that the ratings agencies are now considering the rescue plan worked out by banks and state insurance regulators. The plan may be revealed as early as this week, and will probably involve splitting Ambac in two to segregate the municipal bond insurance business from the less healthy business of insuring riskier credit products.
Last week Holman Jenkins pointed out that segregation is unfair to customers who bought insurance on CDOs because it would “retroactively award municipal clients privileged status at the expense of other clients with equal claim on the insurers.” Bill Ackman, who has been shorting the bond insurers for years, raised a similar point. Indeed, Jenkins expects that the policy holders left with guarantees from the suddenly even more precarious side of the business will launch lawsuits to prevent the break-up.
There’s also a much stranger objection to the segregation plan, one stemming from an objection to the very existence of municipal bond insurance. We first heard about it in Portfolio, of all places. In the latest issue Jesse Eisinger argues that municipal bond insurance is a scam, and it’s victims are municipal governments. This will no doubt come as a surprise to state regulators and treasuries who have been on knife’s edge fearing that the collapse of the bond insurers would make raising money costlier or, in some cases, perhaps impossible. If the governments are the victims here, why exactly are they working to keep the victimization going?

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The bond insurers have all rocketed today on the expectation that a bailout from the banks will be announced any time now. But this has hardly tempered the words of their critics. Everyone from Bill Ackman to Warren Buffett has criticized bond insurers for guaranteeing complex derivatives whose underlying risk they seem not to have understood. Even the core business of the insurers—guaranteeing municipal bonds—has come under fire.
In this month’s Portfolio, writer Jesse Eisinger argues that bond insurance is a racket, basically a tax-payer rip-off carried out by the collusion of bond insurers, Wall Street firms and credit rating agencies. It s a pretty extraordinary claim, for which Eisinger offers no real evidence other than the allegations of a Attorney General who hopes to be the next Eliot Spitzer and a claim that the ratings agencies consistently assign municipal bonds ratings that are too low.

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Bond Insurer Split: Worst Possible Outcome For Wall Street

When he first approached Wall Street to explore plans to rescue bond insurers, New York state’s top insurance regulator Eric Dinallo warned top bankers that they had helped create the mess and that they were facing serious losses if something weren’t done. After weeks of negotiations with an assortment of senior Wall Street bankers failed to produce a consensus on a bailout, it now seems as if Dinallo might push ahead with a plan that could trigger another round of record breaking losses for Wall Street firms.
Dinallo has proposed splitting the companies municipal insurance businesses from the businesses guaranteeing collateralized debt instruments that have suffered under the subprime meltdown. Credit ratings on more than $580 billion of asset-backed securities may be cut, according to Bloomberg. There are estimates that that could trigger write-downs of up to $35 billion. Citigroup and Merrill Lynch are often cited as having the largest exposure to the risk of an insurer downgrade.
“This is one of the worst possible outcomes for the market,” Gregory Peters, head of credit strategy at Morgan Stanley in New York, tells Bloomberg. And by “the market” he means Wall Street.
FGIC has already asked regulators for permission. MBIA has ousted its chief and replaced him with former chief executive Joseph Brown. He’s indicated that he will also seek to split the muni business from the CDO business.
Bond Insurer Split Threatens $580 Billion of Notes [Bloomberg]

Valentines Day Short Seller Massacre Plot Uncovered

poster Roger Corman The St. Valentines Day Massacre.jpgHow bad must things be up in Armonk?
It’s usually a sure sign of deep trouble when a company blames short-sellers or runs crying to lawmakers for protection. MBIA has announced plans to do both. It’s asking lawmakers to investigate or curtail “the unscrupulous and dangerous market manipulation activities of short sellers,” according to a written copy of testimony it plans to give to the U.S. House Committee on Financial Services that Reuters obtained.
What really has MBIA’s knickers in a twist is that scheduled appearance of Bill Ackman before the committee.
“MBIA notes that Mr. William Ackman is appearing on the hearing on February 14th as an ‘industry expert.’ Mr. Ackman is in fact not involved in the industry in any capacity except as that of a short-seller, and, accordingly, MBIA questions the characterization of Mr. Ackman’s expertise,” the testimony says.
Scandalous. Everyone knows that short sellers cannot be experts. Only corporate management count as experts. Just ask Enron. That damned Jim Chanos guy got up in their face, and he wasn’t even in the energy trading business. They really showed him.
MBIA to urge curtailing short sellers [Reuters]

Warren Buffett To The Resuce!

Warren Buffett Plan To Bail Out Muni Insurance.jpgHe’s Warren Buffett, and he’s here to help.
This morning Buffett revealed on CNBC’s Squawk Box that he’s extended an offer to tottering bond insurers to provide re-insurance of on up to $800 billion in municipal bonds. The offer does not, of course, cover the more complicated derivative instruments that have been the source of so much profit and trouble for the bond insurers.
Speaking on the phone with CNBC’s Ancient Billionaire Correspondent Becky Quick, the Oracle of Omaha, said Berkshire Hathaway a week ago made the reinsurance offer to bond insurers Ambac, MBIA and FGIC. One firm has already rejected his offer to insure the safest part of their business. We’re guessing that’s MBIA, which is newly flush with Warburg Pincus cash. The other two haven’t returned his calls are still considering the offer. The offer is ticking: he gave them 30 days to respond.
Buffett’s plan would likely insure ensure that the covered municipal bonds would not be affected by a downgrade in the ratings of MBIA, Ambac or FGIC. According to Buffett, the trouble with the bond insurers is producing strange price discrepancies, with some uninsured bonds trading above insured bonds. “Essentially, they’ve already lost their triple A. They’re trading as if they had lost it,” Buffett said. “In the market the triple A has gone away a long time ago.”
Shares of these insurance companies will initially spike on the news, although by satisfying some of the concerns of government insurance regulators it could wind up contributing to the demise of a industry-wide bailout plan. In short, this “bailout” could spell the end of the insurers if the CDO situation gets bad enough. Buffett noted that the CDO exposure for these companies would not be covered, adding that “we can’t figure it out” when asked about the extent of that exposure. He described the “natural course” of the CDO insurance as “disastrous.”
Perhaps still smarting from DealBreaker’s “Will Warren Buffett Go To Hell?” feature, the Oracle stressed that he would “not be presenting this deal to Saint Peter” when he shows at the pearly gates. “We’re doing this to make money,” Buffett said. “I did not dream this up in one of my pro-bono moments.”
We thought we should let you know about this development since the odds are your attention was riveted on Fox Business. While Becks was talking to Buffett, FBN’s “Money for Breakfast” co-anchor Peter Barnes wasinterviewing an M&M in a Split-Screen from Candyland. Candyland! Who wants a gumdrop!