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What Good Is Bond Insurance Anyway?

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The word this morning that MBIA would have to cut its dividend in order to preserve it’s credit rating has us asking how valuable bond insurance is when its coming from firms whose own financial position may be shaky.
More after the jump.

It seems relatively obvious that there’s not much use in buying insurance for borrowers with great credit—triple A rated titans of corporate America or the State of California—from an insurer whose own finances are shaky. If our economy gets bad enough that California defaults on its debt, does anyone think MBIA will really be in a position to pay off the insurance? That’s the major California and other municipalities have started issuing bonds without insurance, and many have begun to question the logic of insuring triple A rated debt at all.
But as it’s become all too clear that few firms have a firm grasp on their exposure to CDOs, it may be time to start questioning whether insurance from firms such as AMBAC or MBIA are worth the cost even for lower rated bonds. In addition to the news that it would cut it’s dividend and that it had reserved $614 million for losses in December (squarely between its earlier estimate of losses between $500 million to $800 million), MBIA revealed that it was making a $3.3 billion mark-to-market adjustment in it’s CDO portfolio, meaning that it estimates that it’s CDO portfolio’s value fell by that much in the past quarter.
This size of this loss would be shocking if we weren’t already so inured to billion dollar credit portfolio write-downs. As late as October, MBIA took only a $342 million write-down on its credit portfolio. If losses can expand that rapidly in a single quarter, what assurance do we have that they won’t grow even further? We seem to be in an age of rolling write-downs, after all.
To return to our original point: what’s bond insurance from MBIA worth if MBIA’s own financial position keeps deteriorating in this way?