The collapse of the bond insurers, ACA, Ambac and MBIA - 18-Jan-08 - Generational Dynamics

One of the tricks that financial engineers used to get AAA ratings for mortgage-backed securities that would otherwise be low-rated was to "insure" them with bond insurance agencies. Thus, a low-rated security was "doubly protected" -- either the security would pay off or the insurance would pay off. If the insurance agency itself had an AAA rating, then any securities it insured would also have AAA ratings.

As I mentioned last week, it's a simmering problem is that these bond insurers are themselves vulnerable to the subprime mortgage problem. It's been an incredible setup from the beginning:

So everyone was fat and happy, as long as the housing bubble was growing. When it started leaking, everyone was in trouble, because the models set up by the investment firms, the bond insurers, and the ratings agencies assumed that the housing bubble would continue forever.

One of the bond insurers, ACA Capital Holdings, lost its AAA rating in December. On Thursday, Merrill Lynch said it would write off any securities with insurance by ACA because it's worthless.

The two largest bond insurers, MBIA Inc and Ambac Financial Group, have been put on notice by the ratings agencies that they may lose their AAA ratings as well.

But for some extremely strange, odd reason, the ratings agencies keep putting off the action. It always seems to be a few weeks away.

On CNBC on Thursday Jim Cramer went into one of his shouting rants, focusing on the ratings agencies.

Long time readers of this web site will recall that I've quoted several of Jim Cramer's rants.

In fact, I had completely forgotten one of his rants myself. It occurred last February, at the time when it was first becoming apparent that many people were defaulting on their mortgages and losing their homes. Here's what Cramer said:

"I wish the bears understood how important subprime lending is to my thesis about the market going higher. But then again, if they did, they would be forced to cover everything.

For as long as I have been at this game, it has taken a crisis for the Federal Reserve to move. The Fed is always reluctant to move because it needs the crisis as a cover so it doesn't look like it's soft on inflation. ...

When you have the housing industry building a fraction of the homes it was building and credit hard to come by, you are giving Benanke the crisis cover he needs.

Some of my friends who read RealMoney are freaking out about the negative columns that are being written about how dangerous this subprime crisis is. I'm taking those columns very seriously, which is why I am growing more bullish by the day. The fact that the Fed chairman bought into it today in front of the House of Representatives shows me that the Congressional drumbeat -- remember, prime is Republican, subprime is Democrat -- could be building and building fast. ...

If anything, they're saying there might be a fire. I say it's raging, which is why I believe the crisis is about to give us that May cut that I am counting on to take the Dow up 17% this year."

On August 1, I quoted Cramer's rant where he advised people to walk away from their homes if you can't keep up with the payments. He advised paying off your credit cards before paying off your mortgage, because you can live with your relatives, but you'll need credit cards to buy groceries.

It was on August 5 that Cramer became completely hysterical, blaming Ben Bernanke because people are losing their homes. In February, the housing crisis was good news because the Fed would have to lower interest rates, and the stock market bubble would continue increasing. By August, he was screaming that his plan wasn't working, because Bernanke refused to cooperate. Of course, the Fed has lowered the interest rate several times since then, but it no longer has any effect.

"We keep hearing that there are two kinds of mortgages -- the AAA rated -- those are OK -- and the subprime. [But] we keep seeing that these distinctions are meaningless.

First of all, [even the high-rated mortgages are] based on insurance -- I don't think any of these bond insurers can pay off - they don't have the money. ...

The great fiction continues. These are all novels. All the earnings you're seeing from companies that need capital are written by Somerset Maugham or Mark Twain or Hemingway, Faulkner. They're all ghost written. It's all fiction.

[Question: What's the end game]

[The end game will occur] when the monoline insurers [another name for bond insurers] all admit that they can't pay, and AAA [rating] all goes away, then we see what these [financial] institutions look like. The good news is this -- it's bifurcated -- we now have banks that don't need capital -- JP Morgan, Wells Fargo, USB -- and we have banks that don't know what they're doing.

[Question: Merrill Lynch wrote down those assets to 34 cents on the dollar, not as aggressive as what you saw from Morgan Stanley. Is that enough?]]

That's nowhere near enough. They 've written down the bad parts. They don't realize the good parts are bad too.

There's just too much fiction involved here. Anybody who's being backed up by Ambac or MBIA -- Look, we used to think that there would be insurers we would have that would not pay for our auto if our auto had a collision, or maybe they wouldn't pay for fire if our house burned down.

Well, HELLO. These people are all banking on this insurance as if it's Allstate, as if it's Met Life. These are not Allstate and Met Life.

[Question: How come Ambac still has an AAA rating? How come ratings agencies haven't moved on any of these guys yet?]

Because the truth is too painful.

[[Note: On January 16, Ambac announced that its own credit derivative portfolio had to be written down, for a loss of $5.4 billion, or an enormous $32.83 per share. This is where Cramer in essence charges Ambac with securities fraud, and the SEC with negligence.]]

How can you take a $32 a share charge, and not have the Justice Department in there tomorrow? Where the heck is the SEC? Where the heck is the FTC? What are they doing? ...

[Screaming] Where's the SEC? How can you take a $32 a share charge and not have any disclosure about it beforehand? How can we have these levels of fiction in financials after Sarbanes-Oxley? How do people get away with this? How do they live with themselves? ...

Anybody who says they're triple A rated backed up by insurance -- that's a drama -- that's one of those dramas that's getting canceled on the other bad networks.

There's only one triple-A -- the guys who come and change your tire when you break down on the highway - those guys are reliable. The ratings agencies are just works of fiction -- Moody's is fiction, S&P is fiction, and the people who read the fiction are the boards of directors of MBIA.

[Question: Who's going to call them out on the carpet besides you?]

No one. It's too dangerous. I shouldn't do it. It's just going to make my life miserable. But I don't care.

[Question: I've heard people whispering about it. They aren't talking about it on the air.]

Let me tell you why people whisper. Because they play golf at the same country clubs as each other, and don't want to hurt each other. I don't play golf with anyone, and maybe that's why I tell the truth. Or maybe cause I'm completely nuts. ...

[Question from Rick: Do you remember a couple of years ago when the Fed behind the screens was scrambling because the sales people were selling the derivatives using paperwork on the back of cocktail napkins? They said that some of these derivatives' paperwork in the back office was nine months behind. They let that go on. There were so many red flags.]

Greenspan loved that. That was financial engineering. He applauded it. So did our pal Ben Bernanke. They loved it. They just didn't understand it. I sold that product. I put some of that product together at Goldman Sachs. We would sit there and say, hey, what happens under this and that. I don't know. But boy, the commission's so huge, let's jam it. The commish on structured product [like CDOs] is gigantic. I could make a fortune ... The guy who actually understood this, better than anybody, was in the book Appointment in Samarra [a 1934 novel by John O'Hara]. That is a book about this era, because he's about not telling the truth because of the other people at the country club. ...

We used to regulate people, but we decided that was bad and we don't regulate people any more.

The commission on a structured product is so gigantic. First of all, the customer has no idea what it really is because it's embedded.

Second the customer's really stupid. That's what you always do. You used to joke, you'd get off the desk and say, "The customer's really stupid. The German bank - they are BOZOs. Throw them anything. The Australians? MOW-rons." And then you look at the state. "Florida? The Florida fund? They're so stupid, let's give them triple-B."

And that's what they'd do. They'd laugh, and they'd laugh at the customer, and they'd jam them with the commission, and that's what happens. ...

But remember, this is about commissions, it's about how much money you can make by jamming stupid customers. I've seen it all my life. There are stupid customers, and you jam them.

Cramer makes specific accusations of a number of players in the structured investment business of the last few years. He particularly accuses Ambac of securities fraud for failing to provide early warning of a $32 per share charge.

This is the kind of fraud that I've analyzed at length in the past. It occurred because the generations of people who survived the Great Depression are all gone, because Boomers are incapable of leading, and because Generation-Xers are enraged at and contemptuous of everything that came before them.

Basically, the X-ers committed fraud at will, and the Boomers simply let them do it.

Now we're seeing how these actions are backfiring against the X-ers who perpetrated them and the Boomers who ignored them.

On Thursday, stock shares in Ambac and MBIA lost about 50% of their value. These two companies may well be close to complete collapse.

The stock market as a whole fell 2-3%, and this is being repeated in Europe and Asia. The Dow Industrials are down 15% from their Oct 7 high, as you can see from the bottom of my Dow Jones historical page, to 85% of their high value.

Generational Dynamics Web Log for 18-Jan-08
The collapse of the bond insurers, ACA, Ambac and MBIA

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Generational Dynamics Web Log for 18-Jan-08 The collapse of the bond insurers, ACA, Ambac and MBIA

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Generational Dynamics Web Log for 18-Jan-08
The collapse of the bond insurers, ACA, Ambac and MBIA